If you are a couple that is getting separated or divorced, apart from the emotional stress, there are also tax issues that can have significant implications. Whilst this is unlikely to be uppermost in your mind it is important that the tax consequences of the break-up are carefully considered.
Whilst Income Tax does not automatically cause an issue for separating couples as it is an individually assessed tax, there are other taxes that need to be considered. For example, when a couple are together there is no Capital Gains Tax (CGT) payable on assets gifted or sold to your spouse or civil partner. However, if a couple separate and do not live together for an entire tax year or get divorced then CGT may be payable on assets transferred between ex-partners.
While a separated couple can’t use the CGT exemption, they are still deemed to be connected for capital gains tax purposes. This means that if they transfer assets between each other while they are still technically married, they are deemed to do so at the market value regardless of what they pay one another or indeed if they pay anything at all. There are special rules which restrict the use of losses made on the transfer of assets made to a separated but not divorced spouse.
This means that the optimum time for a couple to separate would technically be at the start of the tax year so that they would have up to a year to plan how to split their assets most tax efficiently. Obviously, in the real world most couples will have far more on their minds than deciding to get separated on a certain day, but these issues should be kept in mind. After the divorce, the parties are no longer connected and they are also no longer connected to each other’s siblings, parents or children. The arm’s length rules will still apply – that is, would such a price be paid/accepted by an independent third party.
It is also important to make a financial agreement accepted by both parties. If no agreement can be reached, then applying to the court to make a ‘financial order’ will usually be required. The couple and their advisers should also give proper thought to what will happen to the family home, any family businesses as well as Inheritance Tax implications. The spousal exemption for inheritance tax applies until the decree absolute, but this is a good time to consider.
Helen Smith, Private Client Tax Manager