Tax facts to consider on divorce or separation

It may sound harsh but if you’re going to leave your marriage then it’s best to split on 6 April for optimum tax savings and to give you more time to sort out the financial arrangements. Naomi Smith, Senior Tax Manager at Grant Thornton, offers some tax-saving facts for those planning a separation.

Divorce is a difficult time for any family or couple. But one question that should be easy to answer is: What are the tax implications? And yet many people pay far too much tax following a marriage breakup because they are unaware of the implications early enough. The last thing that a family needs is to pay large sums of money to the Exchequer as a result of a relationship breakdown.

So couples affected by this sort of situation might want to invest a few minutes thinking about tax. Trust me, it’s a good investment.

The most important thing you need to know about tax on divorce is this:

When a couple are married and living together, if they want to transfer assets between each other they can do so without a charge to capital gains tax (CGT).

But what many people don’t realise is…

…that this tax benefit of marriage disappears at the end of the tax year following permanent separation, not on divorce. So, say a couple separate, just to have a break on 1 January, but they then decide that the relationship is over six months later. By that time they have already lost the ability to transfer assets between one another tax-free.

What can you do about this?

Seriously, from a tax point of view one would ideally separate on 6 April, which would give the couple a whole year to plan the transfer of assets between each other.

Although that is not going to be practical for most couples, it is worth thinking about. The reality for most people is that by the time they start to think about tax planning on divorce, the CGT exemption will be gone.

There are still some shares and property that can be transferred without a tax charge, and some other tax exemptions:

  1. Businesses can be given away without a capital gains tax charge for example:
    • Sole trader businesses
    • Interests in partnerships that are trading
    • Certain shares in unquoted trading companies

For this to work, the business must not be a property rental/investment business. Also, if you want to take advantage of this you must write to HM Revenue & Customs (HMRC) with a formal election signed by both ex-spouses. There are some pretty detailed requirements that must be met to qualify, so if you’re thinking of using this idea, please speak to a tax adviser.

  1. The family home will qualify as being capital gains tax-free on transfer if it has been the couple’s main residence throughout the entire period of ownership. This is because of principal private residence relief which is a capital gains tax relief available on the sale of houses which have been occupied as someone’s main home.
  1. Principal private residence (PPR) relief may also be extended in some circumstances if the family home has not always been the main residence. There are plenty of ways to extend the relief, for example, the last 36 months of ownership are always tax-free if the house has been the couple’s main residence at some stage.

    There is also a special extension to PPR relief on divorce, which works by extending the relief, which in turn reduces/removes the tax bill on transferring the family home on divorce. PPR relief can be claimed if all of the following conditions are met:
    • One spouse or civil partner stops living in the family home because they have separated
    • The partner that moved out has not formally elected with HMRC for another house to be their main home
    • The partner that moved out later gives their interest in the family home to their ex
    • The other partner keeps living in the family home as their main house
    • The transfer is made as part of the divorce settlement
  1. Inheritance tax. For inheritance tax (IHT) purposes, transfers between spouses are exempt transfers right up until the final annulment of the marriage or civil partnership. Transfers made on divorce, or for the maintenance of the family, are exempt from inheritance tax, too.

I’ve mentioned some of the more common scenarios above. But anyone who is planning to separate or to divorce would be well-advised to speak to a tax adviser, because the Exchequer should not be a beneficiary on divorce.