The Impact of CGT
16th April 2009 by: David Lillywhite
Is there ever a right time to get divorced? Commentators often point to the emotional benefit of separating in early January after the rush of the festive season has subsided and this is demonstrated by the rise in new enquiries around this time from couples taking advice and beginning proceedings in the new year.
But few couples give any thought to the most tax-efficient way of separating, particularly in relation to Capital Gains Tax. With a little foresight now, a significant financial burden can be avoided later on.
Capital Gains Tax (CGT) is essentially a tax levied on the increase in value of a “chargeable asset” such as shares, business property, second homes and items worth over £6,000 where there has been a sale, gift or transfer. Spouses can transfer assets between themselves with no liability for CGT but it is a different situation for a divorcing couple. Instead, they become liable for CGT on the date that they formally stop living together in circumstances that are likely to be permanent. From that point onwards, the couple are treated as separate individuals, each with their own annual exemption (£9,600 for the 2008/9 tax year). They are also no longer able to transfer to the other any qualifying chargeable assets without incurring any CGT liability.
Chargeable assets
However, one important caveat is that upon separation (usually taken to mean when one party formally leaves the home although this can include a separation under the terms of a court order or separation deed), both parties will still be treated as living together for the remainder of the tax year in which they separate. Therefore, the decisive element in obtaining any exemption from CGT will be the date on which the couple formally separate.
The UK’s tax system runs its financial year from 6 April to 5 April. As a result, the couple that separate on 7 April 2009 will have nearly a year to assess their respective positions and agree a financial settlement whilst retaining the key advantage of not attracting CGT on the transfer of any assets. The couple that formally separate on 1 April 2010 will have just five days to instruct solicitors, consider their options and implement the transfer of any assets. This is simply not a realistic proposition.
The former matrimonial home
A common order in any financial settlement is the transfer of the former matrimonial home into the sole name of the husband or wife. Often, the former matrimonial home is the main asset and in most instances, a separating couple will be able to take advantage of the exemption for CGT on the transfer of the former matrimonial home provided that the transfer takes place in the tax year during which the parties are still living together as outlined above.
It is important to note that a spouse will be held to have been resident in the former matrimonial home during the last three years of his ownership whether they are actually living there or not. This means that most transfers between separating spouses will be caught by the exemption provided that the transfer takes place within three years of the spouse leaving the property.
If, prior to any transfer, three years have elapsed since the spouse left the former matrimonial home, then provided they have not elected another property to be their principal primary residence, and their spouse has continued to live in the former matrimonial home, they will still be deemed to have been in occupation for the purpose of the CGT exemption. This extra statutory concession is known as ‘Statement of Practice D4’.
Even where the departing spouse has elected a new principal primary residence, their liability for CGT is not calculated from when the former matrimonial home was purchased or during the three years following his departure. Instead, the CGT liability will be calculated on any gain in value of the property from the end of the three year period.
Working in tandem with your solicitor, specialist advice should be sought from an independent tax advisor or accountant for a full appraisal of any potential liability. With such advice, an informed decision can then be made about moving ahead with the pre-emptive transfer of any chargeable assets.
But few couples give any thought to the most tax-efficient way of separating, particularly in relation to Capital Gains Tax. With a little foresight now, a significant financial burden can be avoided later on.
Capital Gains Tax (CGT) is essentially a tax levied on the increase in value of a “chargeable asset” such as shares, business property, second homes and items worth over £6,000 where there has been a sale, gift or transfer. Spouses can transfer assets between themselves with no liability for CGT but it is a different situation for a divorcing couple. Instead, they become liable for CGT on the date that they formally stop living together in circumstances that are likely to be permanent. From that point onwards, the couple are treated as separate individuals, each with their own annual exemption (£9,600 for the 2008/9 tax year). They are also no longer able to transfer to the other any qualifying chargeable assets without incurring any CGT liability.
Chargeable assets
However, one important caveat is that upon separation (usually taken to mean when one party formally leaves the home although this can include a separation under the terms of a court order or separation deed), both parties will still be treated as living together for the remainder of the tax year in which they separate. Therefore, the decisive element in obtaining any exemption from CGT will be the date on which the couple formally separate.
The UK’s tax system runs its financial year from 6 April to 5 April. As a result, the couple that separate on 7 April 2009 will have nearly a year to assess their respective positions and agree a financial settlement whilst retaining the key advantage of not attracting CGT on the transfer of any assets. The couple that formally separate on 1 April 2010 will have just five days to instruct solicitors, consider their options and implement the transfer of any assets. This is simply not a realistic proposition.
The former matrimonial home
A common order in any financial settlement is the transfer of the former matrimonial home into the sole name of the husband or wife. Often, the former matrimonial home is the main asset and in most instances, a separating couple will be able to take advantage of the exemption for CGT on the transfer of the former matrimonial home provided that the transfer takes place in the tax year during which the parties are still living together as outlined above.
It is important to note that a spouse will be held to have been resident in the former matrimonial home during the last three years of his ownership whether they are actually living there or not. This means that most transfers between separating spouses will be caught by the exemption provided that the transfer takes place within three years of the spouse leaving the property.
If, prior to any transfer, three years have elapsed since the spouse left the former matrimonial home, then provided they have not elected another property to be their principal primary residence, and their spouse has continued to live in the former matrimonial home, they will still be deemed to have been in occupation for the purpose of the CGT exemption. This extra statutory concession is known as ‘Statement of Practice D4’.
Even where the departing spouse has elected a new principal primary residence, their liability for CGT is not calculated from when the former matrimonial home was purchased or during the three years following his departure. Instead, the CGT liability will be calculated on any gain in value of the property from the end of the three year period.
Working in tandem with your solicitor, specialist advice should be sought from an independent tax advisor or accountant for a full appraisal of any potential liability. With such advice, an informed decision can then be made about moving ahead with the pre-emptive transfer of any chargeable assets.
Add new comment