Consult your calendar before you split
By Graeme Fraser
Published: Financial Times Saturday November 18 / Sunday November 19 2006
When relationships break down, sorting out your financial affairs is unlikely to be your number one priority.
But with divorced partners facing sizeable capital gains tax bills unless they split their assets quickly, many love-lost couples are coming under pressure to reach financial settlements in lightning speed.
Under current law, all transactions between married couples or civil partners are classed as a “no gain/no loss” by the Revenue. This means assets can be transferred between them without being subject to any tax. So, with careful planning, married couples can substantially slash their tax bill by reducing the size of chargeable gains that are liable to capital gains tax.
But when couples get divorced this all changes. Under HM Revenue rules, the “no gain/no loss” tax perk is lost on April 6 (the beginning of the next tax year) in the year that permanent separation takes place.
So, if you separate on April 5, you literally have just a few hours to make use of the “no gain/no loss” benefit. Failure to do so could mean assets that have risen in value may suddenly be subject to capital gains tax (CGT). Conversely, if you separate on April 7, the “year of separation”, and hence exemption from CGT, extends for a further year.
This lottery effect has prompted solicitors to lobby the government for change. Earlier attempts to reform the tax rules failed as the government was not convinced sufficient people, other than the very wealthy, were affected by the existing rules to justify a change. But this time, the government appears to be listening and is believed to be receptive to reform.
A survey conducted by the Law Society, in conjunction with Resolution, the family lawyers’ association, found family law practitioners strongly in favour of change. Seventy per cent of respondents to the survey favoured a longer cut-off date for deferring liability to CGT. The majority thought that the most appropriate cut-off date was six months after the financial settlement was finalised or the decree absolute of divorce.
Reforming the current rules would mean that rather than compelling couples into dividing their assets too quickly after separation, more time would be given to enable them to reflect, reconcile their differences and minimise bitterness.
Seventy per cent of practitioners surveyed confirmed that decisions on the transfer of assets were taken earlier than might otherwise have been the case, and 82 per cent confirmed that this was to the detriment of one of the parties.
Fortunately, if the family home is transferred as part of the settlement, so long as it is retained as the principal private residence (by either one of the divorced couple) or sold within three years, it will normally be exempt from CGT.
But recent trends indicate that the loss of tax benefits on the breakdown of a relationship can still create a “double whammy” for many couples who are already forced to make economies when dividing their assets, since a heavy tax burden may arise as a result of this redistribution.
Since the landmark House of Lords decision in White v White in 2000, greater equality between spouses means that there are more substantial transfers of property. Additionally, with “buy-to-let” investment in property becoming more widespread, transfers inevitably create substantial CGT liabilities.
The survey appears to confirm that significant tax is frequently incurred by divorcing couples. The findings indicate that a significant proportion of the available assets are lost to tax, irrespective of the wealth. For instance, on average, where the amount of assets involved was £1.4m, the amount of tax deducted was £205,000 but where the amount of assets was £25,000, the amount of tax deducted was £8,000.
Although the response indicated that approximately 250 cases were affected by the CGT provisions in a year, this is unlikely to reflect the true total accurately.
Some law firms said that the difficulties had arisen in more than 20 of their cases in a year. This number looks set to increase after December 5 this year when the first of the registered civil partnerships will be able to be dissolved.
While the rules remain, early planning, swift action and good legal advice are essential to keeping the taxman at bay and ensuring assets are protected. Couples contemplating divorce or dissolution of civil partnerships should obtain advice now to protect their assets as much as possible from the taxman as this allows sufficient time to arrange and implement a financial settlement during the divorce.
Graeme Fraser is a Solicitor with Cumberland Ellis LLP
graemefraser@cumberlandellis.com
Copyright The Financial Times Limited 2006
