Personal tax – when is income tax and capital gains tax payable?

One of the many painful aspects of divorce is the potential tax bill at the end of the process. As accountants, helping a divorcing couple understand and manage the tax implications could bring a bit of happiness to them in tough times, writes Yogesh Patel.

According to the ONS, 42% of all marriages in England and Wales end in divorce. Given the emotional rollercoaster for either spouse (or civil partner), you cannot blame them if they have not considered the potential tax bombs that could be triggered on divorce.
As accountants, it is worth having either a basic level of knowledge or consider providing expert advice to lawyers or separating couples on the financial implications of divorce.

Below are some key points to consider:

Timing is everything

Research shows that ‘divorce day’ is normally around January 7, where solicitors expect to see the biggest spike of married couples wanting to throw in the towel after the ‘quality time’ spent over the Christmas break.
So when a client brings up their marital breakdown when you were simply wishing them a happy New Year and chasing them for their tax return information, you may want to check in with them when they are looking to formalise the separation.

The main reason for this is that the no gain/no loss rule on transfer of assets between spouses ceases for capital gains tax purposes at the end of the tax year in which the couple separate. If the divorce is finalised (formally known as the Decree Absolute) after tax year of separation, then both spouses (or civil partners) will be treated as ‘connected parties’ and any transfer of assets will be treated as made at market value, resulting in a potential capital gains tax due.

To give this some context, we can look at Jeff Bezos, the founder and CEO of Amazon. Jeff and his now ex-wife, MacKenzie decided to separate in January 2019, (yes, January). Now if Jeff, who has an estimated net worth of $150bn, was subject to UK tax laws, he would pay CGT at 20% on gains from shares and 28% on gains from residential property. Assuming 50% of his shares were transferred to MacKenzie outside of the tax year of separation, and the gain arising on those shares was 90% of the value, then Jeff would be faced with a capital gains tax bill of around $13.5bn.

So however painful it may be, a married couple thinking of separating may want to consider waiting until just after 6 April. This would give them and their divorce lawyers nearly a year to deal with all the processes to formalise a divorce, and sort out all the financial arrangements without HMRC being a beneficiary in the asset split.
Of course, some divorce proceedings take years to reach a successful conclusion, so separating on or just after the 6th April will not help those, but at least it does open a window of opportunity for a divorcing couple and it may concentrate minds to get the proceedings resolved within 12 months.

Family home

In divorce cases, the family home is often the largest asset. Currently, if you move out of your main family home, the final 18 months of ownership will still benefit from the capital gain exemption even though you are not meeting the occupancy condition in that period. According to the draft Finance Bill 2019/20, this final period exemption will be reduced to nine months for disposals made on and after 6 April 2020.
To make matters worse after April 2020, any capital gains tax payable would be due within 30 days of transfer of the property. This could cause significant cash flow issues for the couple, who could already be in dire straits after payment of professional fees.

Good news is that there will be no Stamp Duty Land Tax (SDLT) if the couple agrees to split/transfer their family home (or other property) under the terms of a court order. However, worth being aware of a potential ‘tax trap’. If one of the parties buys another home before the marital home is sold, they would be subject to the ‘second home’ 3% SDLT surcharge (4% LBTT in Scotland).

Wills: Divorce doesn’t revoke a will

Another key consideration when advising clients in the process of divorce is to ensure they update their wills. Most people assume that divorce cancels out any will they have made: unfortunately this is not the case. This can have unintended consequences if appropriate actions are not taken.

An example is where an ex-spouse is named on the original will, which was made before divorce. However, the owner of the will divorces then re-marries but forgets to update the will. You can imagine the fallout from that situation! If we put our accountants’ hat on, not only is there a legal nightmare to unravel but there could also be inheritance tax to pay if the higher value assets are transferred to the ex-spouse.

Inheritance tax: Divorcing couples

It is well known that transfers between married couples (who are both UK domiciled) are exempt from inheritance tax (IHT). In addition to the transfers, the unused nil-rate band allowance (NRB) and any available residential nil rate band allowance (RNRB) is transferred automatically to the surviving spouse.

However, the IHT position gets complicated when the spouses are in the process of going through a divorce. Separated couples will be treated as ‘married’ for the purpose of IHT until the date of the Decree Absolute. This is different from Capital Gains Tax rules, whereby you are only qualified for exemptions for married couples while you are living together andup until the tax year of separation.

This may be a positive as the surviving spouse may be able to claim any unused available NRB or RNRB, but this may be against the wishes of the deceased spouse if there are others involved.

However, once the decree absolute has been granted, any unused NRB or RNRB will not be transferred to the ex-spouse. Consequently, it is only available to either party if they re-marry.

The above points are just some of the tax issues that may crop up when a couple are going through a divorce. It is worth being equipped with some knowledge about the tax treatment on divorce so that you can help the soon to be divorced couple navigate through divorce taxation.

By helping the couple reduce the potential tax take in the divorce you could actually bring a bit of happiness to them in what would be certainly tough times.

On a related matter…

Providing independent expert witness reports or acting as a mediator can provide a new revenue stream for accountants to help facilitate revenue growth and offset the potential loss of revenue through automation and tech.

This is particularly relevant because of key developments driven by The 2016 UK Briggs Report (see ACCA’s article alternative dispute resolution is a business stream worth tapping) and more recently the signing of the Singapore Convention which facilitates international trade disputes by mediation, which the UK is expected to sign in the future.

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