Assessing marital wellbeing: should tax be a priority?

Whilst 2020 data from the Office for National Statistics from the Office for National Statistics suggests a 4.5 per cent decrease in divorces granted in England and Wales in 2020 compared with 2019, the divorce rate in the United Kingdom is still very high, currently estimated at 42 per cent. The 2020 figures could also mask the reality that many couples have split up during the pandemic but have not yet divorced, potentially storing up costly tax consequences. 

Relationship experts warn that pandemic-induced break-ups are yet to be quantified, but the Citizen’s Advice Bureau reported a 122 per cent rise in divorce enquiries at one legal firm between July and October 2020 compared with the same period in 2019. 

Having to self-isolate due to Covid-19 was a strain on relationships and may have been cause for a trial separation for many couples. Experts warn that whilst some couples have put divorce on hold during the pandemic, the cracks are starting to show and a new wave of divorce cases may be on the horizon. 

Often, married couples and civil partners are not aware that they may have to pay capital gains tax (CGT) on assets transferred to their ex-partner after their relationship has legally ended. HMRC guidance makes it clear that the date of permanent separation is a key date for determining when the facility to transfer assets at a no gain/no loss between spouses and civil partners ceases for CGT purposes.

When assessing marital wellbeing, tax is generally not on the priorities list, but should it be?

For inheritance tax (IHT) purposes, transfers between spouses are exempt from IHT until the date the decree absolute is issued. Similarly, transfers between civil partners are exempt until the date of dissolution of the civil partnership. Any transfers to the spouse or civil partner after that date are likely to be potentially exempt transfers for IHT purposes, with a potential tax exposure if the donor dies within seven years of the date of the transfer.

Whilst it is not typically payable on an individual’s main residence, CGT may apply to the transfer/sale of second properties, including holiday homes and buy to let properties. Where one spouse or civil partner leaves the matrimonial home, they may continue to be eligible for main residence relief, the tax relief available on an individual’s main or only residence, even if they no longer live in the property. There are specific conditions that need to be satisfied for this to apply. A transfer in the ownership of pension savings, however, is not subject to CGT.

Currently, married couples and civil partners only have until the end of the tax year in which they permanently separate to transfer assets between themselves if they want to benefit from the no gain/no loss rule and avoid being hit with a CGT bill on transfers of assets that would otherwise be chargeable on gains arising based on their market values.

Circumstances such as the pandemic may have forced former spouses to continue sharing a roof despite being permanently separated, and HMRC will often look closely at the facts to establish the date of permanent separation for tax purposes in such cases.

Given the challenges the CGT rules present in cases where the date of permanent separation falls towards the end of a tax year, the Office of Tax Simplification recommended to the Treasury that the no gain/no loss rule should be extended to two years from the date of permanent separation. The Treasury has gone further in its draft Finance Bill 2022-23, providing that former spouses and civil partners will have up to three full tax years in which to transfer assets without incurring a CGT charge. This period will be extended to an unlimited time if the assets are transferred as part of a formal divorce agreement.

Finance Bill 2022-23 also proposes further rules to ensure that those who continue to hold a financial interest in their former marital home are not penalised on its eventual sale and may be able to claim main residence relief. The new legislation is expected to come into effect for disposals that occur on or after 6 April 2023.

Many will consider these changes in the rules to be long overdue as the existing legislation was arguably unfair on some separating married couples and civil partners. For example, a married couple that permanently separated on 6 April could have a year to sort out their affairs whereas one breaking up on 4 April would have just one day. There was no real logic to this approach and thankfully this has now been addressed.