Married couples and those in civil partnerships have access to a number of tax advantages. This includes passing assets between themselves during their lifetimes without tax charge, inheriting assets from their spouse free of tax and the potential to reduce income tax through the transfer of their personal allowance. In the context of capital gains tax (CGT) the principal advantage is that spouses can make no gain / no loss transfers of assets between themselves, the transfer of which would otherwise be subject to CGT.
What are no gain / no loss transfers?
Individuals disposing of capital assets such as houses, shares and personal possessions worth £6000 or more will usually pay CGT when they dispose of these assets. This is the case even when they are gifting the assets rather than selling them. However, married couples and those in civil partnerships can pass assets between each other without incurring CGT. The effect of these transfers is that the spouse receiving the asset inherits their partner’s base cost and when they sell the asset the receiving spouse will be liable to CGT on the difference in value between when their partner acquired the asset and when the receiving spouse sells it. This operates effectively as a deferral of the CGT that would otherwise arise, and can be particularly helpful where one spouse is a higher rate taxpayer and the other is a basic rate one.
What is the issue?
Divorcing couples are rarely immediately concerned with the loss of these tax advantages as they navigate a separation. Unfortunately, the no gain / no loss rules have previously only applied in the tax year of separation. Crucially, the year of separation is not necessarily the year a divorce is finalised, as under the current legislation spouses are treated as "living together" unless separated under a court order, deed of separation or where the separation is likely to be permanent. These rules left couples separating on 31 March with only a few days in which to transfer the matrimonial home and other capital assets without incurring a CGT liability, while couples separating on 8 April had nearly a year to do so.
This was compounded by the application of principal private residence relief (PPR) on disposal of the matrimonial home. PPR is a relief from capital gains tax for individuals disposing of their main home, and under the previous legislation (in the context of a separation) would only be available to the party disposing of their share in the matrimonial home if certain conditions were met and they disposed of it to the other party to the marriage. This left those disposing of their homes to third parties or where orders for deferred sale were made (usually to prevent the family home being sold before children had reached the age of 18) with unexpected CGT liabilities.
Given the time taken to negotiate financial settlements through the courts and the difficulties experienced by couples in navigating these rules, the Office for Tax Simplification recommended reforms to the CGT legislation and, in particular, an extension of the time periods for no gain no loss transfers.
What is changing?
From 6 April 2023 the Finance (No.2) Act 2023 (which received Royal Assent on 11 July 2023) now includes the extension of the no gain / no loss window for separating couples so that disposals that occur on or before the day that a court order is made, or the last day of the third tax year after the couple stops living together, will still benefit from no gain / no loss treatment. Helpfully there is also no time limit for disposals under a formal separation agreement. Further changes to PPR now mean that disposals to third parties can attract principal private residence relief (provided the conditions are met) and there is a new provision for relief when a separation involves a deferred sale.
The new legislation presents a welcome change to what some considered arbitrary rules and provides those dealing with the stress of separation with reasonable time periods in which to arrange their financial affairs.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, August 2023