By Michelle Stevens

In the last edition of Coutts Woman, we talked about the tax benefits of being married or in a civil partnership. However, as over 150,000 people a year become painfully aware, marriages can come to an end, leaving people facing a very different financial reality. Divorce like marriage has tax consequences, which together with emotional and practical issues become very relevant if a marriage or civil partnership breaks down.

Most divorces will result in a financial settlement between the couple dividing the assets. But what many may not be aware of is that where this involves the transfer or disposal of capital assets held by the couple, there may be capital gains tax implications that need to be considered.

In the case of a financial settlement between the couple involving the transfer of all or part of a capital asset, there will usually be a 'disposal' meaning that they will be treated as having sold or gifted the asset at market value for capital gains tax purposes. The actual capital gains tax position depends on the asset being transferred and the timing of this.

As highlighted last month, any transfer of assets between spouses or civil partners who are living together are treated as being made on a no gain/no loss basis for capital gains tax purposes. This allows assets to be transferred between the couple without an immediate charge to tax. However, this benefit ends from the beginning of the tax year (i.e. 6 April) following the date of the couple's permanent separation. This means that a couple do need to be aware of their timings if separating towards the end of a tax year, as they would need to organise their affairs quickly for transfers to take place on a no gain/no loss basis.

Where assets are transferred between the couple after the end of the tax year in which they are separated but before they are divorced (i.e. receive the decree absolute), the spouse/civil partner transferring the asset will be treated as disposing of it at market value ¹ . This is because the couple are regarded as connected persons ² until the decree absolute is issued. This may therefore result in a capital gains tax liability.

For many couples, the largest asset they own that will need to be dealt with under any financial settlement, is generally their matrimonial home. Where this has been the couple's main residence throughout ownership, any gain arising on transfer/disposal will be exempt from capital gains tax. However, it is likely that there will be a period after separation and before transfer/disposal where the property is not the main residence of one member of the couple, and this is where divorcing couples really need to be aware of the implications.

Where a property has been the couple's main residence at some point during ownership, any gain arising in the last 36 months of ownership is covered by the 'principal private residence exemption' for capital gains tax purposes. Therefore providing any disposal takes place within three years following the departure of either spouse/civil partner, and that the property was their main residence throughout the period of ownership up to the separation, the full exemption should be available meaning no capital gains tax should arise on the property. If however the property has not been the couple's main residence throughout the whole period of ownership, advice should be sought to determine the relief available.

Where the departing spouse's/civil partner's half interest in the property (assuming joint ownership initially) is transferred, or the property is sold to a third party more than three years after the individual moves out, a period of ownership will not be covered by the principal private residence exemption ³ . Therefore a chargeable gain and tax liability could arise in this regard.

However in certain circumstances there may be some relief in the event of the above, as a result of a concession. If this concession applies, the property will continue to be treated as the principal private residence of the departing spouse/civil partner until transfer takes place. In order for the concession to apply the property must have been the couple's only or main residence throughout ownership and it must be transferred to the remaining spouse/civil partner as part of any financial settlement. Additionally, the departing spouse cannot have made a principal private residence election in respect of any other property.

The two main issues in respect of this concession are that it only applies where the departing spouse's half share is transferred to the other. It is not available where the property is sold to a third party. Careful consideration is therefore required in this regard to determine whether any tax planning is required before disposal if the property is being sold to a third party. In addition, if the departing spouse has acquired another property in the meantime, they will not be able to elect for this to be treated as their principal private residence for capital gains tax purposes and this will of course have tax implications that will need to be considered as well.

For the purposes of inheritance tax (IHT), it is the date of the decree absolute that is important as the couple is regarded as married until this point. Any transfers of value which take place before the decree absolute will therefore not have any IHT implications, as they will be covered by the spouse exemption. After the date of the decree absolute, if a transfer takes place perhaps under a court order, it is still unlikely that there will be any IHT implications. This is due to the fact that there are exemptions from IHT where a transfer of value is not intended to provide gratuitous benefit to the receiving party or where the transfer takes place for the purpose of family maintenance. However Wills should always be reviewed to ensure that they reflect current circumstances and wishes.

As you will see from the above, there are various tax implications of separation and divorce that many people may not be aware of or feel ready to consider at such a difficult time. However it is recommended that advice is sought as soon as possible to minimise any liabilities.

¹ Market Value: Where any transactions take place between connected parties at a price other than open market value, the proceeds and acquisition price must be adjusted to the open market value for tax purposes.

² Connected Persons: In broad terms, a person is connected with his/her spouse/civil partner, his/her own and his/her spouse's/civil partner's close relatives and their spouses/civil partners, and with business partners and their spouses/civil partners and relatives. Relatives include brothers and sisters, ancestors and lineal descendants.

³ Capital gains in respect of the property are assumed to accrue evenly over time. Therefore time apportionment is used in calculating gains covered by the Principal Private Residence Exemption. For example assume a couple have owned a property for 10 years during which a capital gain of £100,000 has arisen. In addition assume that the PPR exemption applies for 9 out of the 10 years of ownership. The exemption available would therefore be 9/10 *£100,000 = £90,000. The capital gain subject to tax, before any additional reliefs and the annual exemption would be £10,000.