Breathing space from Capital Gains Tax for separating couples

The Office of Tax Simplification’s (OTS) demise was one of the few lasting legacies of Kwasi Kwarteng’s time as Chancellor. But in spite of its closure, some of the OTS’s recommendations to improve the Capital Gains Tax system still came into effect from April 6 this year. As outlined in the Spring Finance Bill 2023, this includes provisions to allow separating couples more time to agree how assets are to be split before CGT starts to bite.

For simplicity, I refer in this article to married couples, couples or spouses, and to divorce. However, the rules apply to civil partners as much as to married couples, and to dissolutions of civil partnerships in the same way as divorces, as well as to annulments of either.

Why the change?

The simplest form of tax-planning for couples involves maximising the use of allowances and lower tax rates by transferring assets between them. That basic measure works because assets can be transferred between spouses at ‘no gain, no loss’, meaning no CGT charge arises.

However, the couple have to be living together in the tax year of transfer for the ‘no gain, no loss’ transfer to be effective. HMRC Manual CG22202 tells us HMRC will accept that this treatment applies where the couple have lived together at any point in the year.

Previously, where a couple permanently separated part-way through a tax year, they only had until the end of that tax year to transfer assets between them without creating a CGT liability. After that point, any transfer of assets between them would be deemed to take place at market value for CGT purposes, often creating a tax charge even where no cash consideration changed hands.

What’s new for CGT?

The OTS observed that only allowing couples the remainder of the tax year of separation to transfer assets between them caused several problems, particularly where separation happened close to April 5.

Permanent separation and the division of joint assets is inevitably a stressful time, and willingness or ability to address the resulting financial split can vary significantly. Equally, pinning down exactly when permanent separation occurred can be subjective and contentious enough without the added pressures of the CGT ramifications when dividing assets.

The Spring Finance Bill 2023 adopts the OTS recommendations in this area in full. Subject to Royal Assent, where separated couples transfer assets between them on or after April 6 2023, the transfer will take place at ‘no gain, no loss’ for CGT purposes until the earlier of:

1. the end of the third tax year following the tax year of separation; or
2. the date of their divorce/separation order.

Transfers which are made outside those time limits, but during or after divorce, can also be made on a no gain no loss basis where the transfer is made under a Court Order or similar agreement.

What about Private Residence Relief (PRR)?

The Spring Finance Bill 2023 offers further good news for separating couples who jointly own and occupy a marital home.

Suppose that on separation one spouse moved out of the marital home. As they are no longer occupying the property as their only or main residence, under the previous rules, any sale more than nine months after they left could have resulted in a CGT charge.

The only way for the marital home to continue qualifying for PRR for the departing s[pise beyond those nine months was if their share was transferred to the remaining partner, and that partner had continued to occupy it as their main residence and the leaving spouse had not elected for another property to be their main residence in the intervening time since their departure from the property.

Spring Finance Bill 2023 provides greater flexibility in that:

1. A disposal by the departing spouse of their share in the marital home to the other spouse who continues to occupy it no longer needs to take place within nine months of them moving out. Thanks to the extension of the ‘no gain, no loss’ window explained above, the transfer can now take place up to three years after the end of the tax year of separation
2. If the former marital home is sold to a third party following separation, the departing spouse can claim PRR in respect of any period after they left the property as long as the other spouse has remained in occupation and the departing spouse has not elected for another property to be their main residence
3. In some cases, the departing spouse may make an initial transfer of their share of the former marital home to the other spouse (who remains in occupation), but retain an entitlement to a share of any profit on the eventual sale of the property. In this situation, the departing spouse’s share of the sale profits can now be eligible for the same tax treatment that would have applied on the initial transfer of their share in the marital home to the spouse who continued to live there. For instance, if full PRR would have been available to exempt the gain on the initial transfer, the later receipt of a share of the profit on disposal will also be exempt.

The greater flexibility provided by the measures introduced in The Spring Finance Bill 2023 are to be welcomed. Separation and divorce is a complex, stressful and often expensive experience. The above measures not only ease the tax burden, but provide more time for couples to agree how assets are to be divided.