Don't forget the tax!
February 2019 | Martin Fuller
It may be boring, but tax is one of the two certainties in life, and is often overlooked in family matters. Indeed, we had a matter in court last week with some tricky tax points, and yet, the lawyer for the other side was unaware of the tax issues, and in fact argued that tax was irrelevant! So if a family lawyer representing a client has no knowledge of when tax is an issue to be considered, who else is under the same misapprehension?
Let’s state the rule of law: Tax is payable on all gains - unless an exemption or specified relief can be claimed. There are exemptions and reliefs that apply in family law and this fact can lead the unwitting to think tax does not apply in any cases, but if you receive a lump sum, then Capital Gains Tax will apply to any gain on an asset sold or transferred to the other spouse or civil partner to fund the lump sum. The treatment of tax arising on the disposal of these assets will depend on factors such as whether the assets are transferred in the year of separation or afterwards, whether they are transferred to the spouse/civil partner, or to a third party, and even the nature of the assets being sold.
Whether giving up or receiving interest in the matrimonial/family home as part of an overall settlement, the transfer would be deemed to be at the market value, and any gain for tax purposes would be exempt, provided certain criteria are met to qualify for Principle Private Residence exemption. This means that to qualify for the exemption the individual must transfer their interest in the family home within 18 months of leaving the property, which will decrease to 9 months from 6 April 2020. This can be extended in certain circumstances.
Sometimes one party may sell their interest in the family home to the other spouse/civil partner and instead of taking cash exercises a charge (loan) over the property. This allows the other spouse/civil partner to live in the property until a ‘triggering event’ enables the property to be sold and the charge repaid. Such triggering events would be the children leaving school, the death, remarriage / cohabitation of the occupying spouse/civil partner, or the property becoming vacated for a specified period. How the charge is expressed will determine how the gain will be treated for tax purposes and you should seek specific advice before entering into this arrangement so that you can express the terms of the charge in the most tax-efficient way taking into account your circumstances.
A Trust might be created, where the family home is held in trust by the former spouses/civil partners and occupied by one spouse/civil partner to the exclusion of the other. The trust comes to an end when one of the agreed triggering events occurs. In most cases the Capital Gains Tax payable on the disposal will fall under the Principle Private Residence exemption, but Inheritance Tax may prove to be a problem and specific advice should be sought.
If business interests are to be transferred, it may be possible to transfer them without immediate Capital Gains Tax arising if both parties can claim holdover relief so no tax arises at this point. Holdover relief must be made by the transferor and transferee within specified time limits. Also, if there is a disposal of part or the whole of the business or shares the business or shares may be eligible for entrepreneurs’ relief, reducing the tax rate from 20% to 10%. It may be possible to reduce the tax payable still further if one of the divorcing couple is a higher rate taxpayer and the other is a basic rate taxpayer. Again specific advice should be sought.
This blog is not legal advice and should not be treated as such, it merely highlights the tax considerations you should be thinking about and taking advice on if you are negotiating your own settlement to ensure your tax liabilities do not reduce your share of the settlement unexpectedly.
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