Lindsey Wicks, ICAEW TAX Faculty Technical Editor, examines whether changes to the no gain/no loss provisions on separation and divorce will prevent unexpected capital gains tax charges from arising.
In its report Capital Gains Tax – second report: Simplifying practical, technical and administrative issues, the Office of Tax Simplification (OTS) focused on the capital gains tax (CGT) rules surrounding divorce and separation in Chapter 4. It concluded that the government should extend the current no gain/no loss window that closes at the end of the tax year of separation to the later of:
- the end of the tax year at least two years after the separation event; or
- any reasonable time set for the transfer of assets in accordance with a financial agreement approved by a court or equivalent processes in Scotland.
As an aside, the OTS also mentioned (at paragraph 4.29 of its report) that an extended time horizon could also apply in relation to eligibility for private residence relief (PRR). This would ensure the relief continued to apply to both parties until the later of these two criteria has been met.
On 30 November 2021, the government agreed that the no gain/no loss window on separation and divorce should be extended, and stated that it will consult on the detail over the course of the next year. What could this mean for divorcing couples?
An unexpected tax cost from the biggest asset
Most unrepresented taxpayers incorrectly assume that their home, which in most cases will be their biggest asset, will always be exempt from CGT. They will be unaware that moving out of the home when separating could lead to the loss of PRR.
Recent changes to the CGT rules have increased the risk of a charge arising as PRR for the final period of ownership, reduced from 36 months to 18 months for disposals on or after 6 April 2014, and then to nine months for disposals on or after 6 April 2020.
Where a CGT charge does arise, the tax must now be paid within 60 days of the transfer – a particular challenge where this is a dry tax charge (ie, a liability arising from a transfer where no money changes hands).
Extended relief?
There are other circumstances in which PRR can be preserved after leaving the family home following a separation. Section 225B, Taxation of Chargeable Gains Act 1992 (TCGA 1992) enacted a former extra-statutory concession and provides that where the home is transferred to the spouse or civil partner, it can continue to be treated as the transferor’s main residence (and qualify for PRR), but only if:
- the transfer is made pursuant to a court order or an agreement between the couple in connection with their permanent separation or divorce;
- the home has continued to be the only or main residence of the transferee spouse or civil partner; and
- the transferor has not elected for any other home to be treated as their main residence for that period.
However, this is not helpful where:
- the transferor has acquired another property and it would be more beneficial for that property to attract PRR; or
- the matrimonial home is disposed of to a third party.
Delaying the inevitable
It is not uncommon for the departing spouse or civil partner to transfer their share of the matrimonial home to the other on the proviso that the spouse or civil partner remaining in the home must pay the transferee spouse a share of the proceeds when the home is eventually sold (often triggered by the first of: the youngest child reaching the age of 18, death, or remarriage).
How this arrangement is achieved legally can lead to very different tax outcomes.
HMRC accepts that a Mesher Order creates a settlement with the non-resident party being the trustee (see HMRC’s Capital Gains Manual at CG65365). This has the benefit that PRR is available to the trustee of the settlement created by the order for the trust period, during which the property is occupied as the only or main residence of the spouse entitled to occupy under the terms of the order. A deemed market value disposal arises at the end of the stipulated period.
Where there is a Mesher Order, the departing/transferee spouse or civil partner needs to consider their CGT position on three occasions.
On the creation of the settlement. The availability of PRR will depend on the length of time since they left the marital home and whether the conditions of s225B, TCGA 1992 are met.
At the end of the settlement period. PRR should be available under s225, TCGA 1992 (private residence occupied under terms of settlement).
On the disposal of the property to a third party. While PRR will not be available, the amount of any gain arising may be negligible if there is a relatively short time period between the end of the settlement period and the disposal.
If the arrangement is a deferred charge order, the tax treatment will be very different. Under a deferred charge order, complete ownership of the matrimonial home is vested in the party remaining there, but the property is charged with payment of a sum of money to the departing party. If the deferred charge order is for a variable amount (eg, 50% of the sale proceeds), the departing party acquires a distinct asset – a chose in action.
Not only will this asset not attract PRR, the calculation of the gain when the charge is realised is also complex. The acquisition value is the open market resale value (at the time the charge is created) of the right to receive in the future the amount secured by the charge.
When is the disposal and what is the consideration?
The amount of consideration to be brought into the computation of the gain on the transfer of an interest in the former matrimonial or civil partnership home between separated spouses or civil partners depends on when the transfer takes place.
In the tax year of separation, the consideration for the disposal is an amount that gives rise to no gain or loss on the disposal (s58, TCGA 1992).
Following the end of the tax year of separation, spouses and civil partners remain connected persons until the decree absolute, which ends their marriage, or the final dissolution order, which ends their civil partnership. Transactions between connected persons are always treated as transactions otherwise than by way of a bargain made at arm’s length and require that any actual consideration must be replaced by the market value of that asset at the date of transfer.
Where a transfer happens after a couple have divorced or a civil partnership is dissolved, HMRC may accept that the transaction is at arm’s length. However, it may challenge the valuation where the sale price differs substantially from the expected market value (see HMRC’s Capital Gains Manual at CG65346). Also, where that transfer is in pursuance of a court order, this is not considered to be a bargain between the parties (as the court decides the value), so the market value rule applies.
Extended no gain/no loss period
This article has just scratched the surface of the CGT issues potentially faced by divorcing couples and does not contrast those rules to the different treatment for other taxes.
The values involved do not need to be large for a tax charge to create a big financial impact – particularly if there is limited cash available.
Will a longer no gain/no loss period help? In many cases, the answer will be yes. However, challenges will remain if it does not extend to the asset created by a deferred charge order, for example.
Author bio
Lindsey Wicks, Technical Editor, Tax Faculty