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TaxationWeb by Jennifer Adams

When a couple divorce tax problems may arise if not thought through carefully - the timing of transfers of assets could have large tax implications, as Jennifer Adams explainsIt is sad when a married couple separate - hopes and dreams that started maybe 10 or even 20 years ago are now dust. If the couple decide to place the separation on a formal footing with the intention of divorce then apart from the emotional upset there may be pressing concerns on the financial side to face. It is best for all concerned that these issues are dealt with as quickly, cleanly and fairly as possible before difficulties ensue particularly if children are involved. Although it will possibly be a solicitor who deals with the detail of any financial settlement, if there is an accountant he should be made aware of the situation as his files may well contain relevant information.

The main problem with respect to Income Tax is with the Working Families Tax Credit the level of which is dependent upon the amount of weekly earnings and capital held. The Inland Revenue calculate how much credit you will be entitled to based on the completion of a comprehensive form and tell you or your employer the amount. However, it is with regard to the Capital Assets of a marriage that a couple may find themselves dealing with tax problems; what they decide and the timing of the transfers could have large tax implications.

There are no firm rules as to how assets are divided on separation and how much money should be paid one to the other; this is for the Court to decide and it has wide discretion to make whatever financial orders it thinks fit. For example, there is no presumption that if any asset is in joint names that each will be entitled to half. There is a list that the court must consider before making an order and they include earning capacity, respective ages, present and future needs, the interests of any children and the contribution each has made to the marriage.

THE MATRIMONIAL HOME

Usually the most substantial asset owned by a couple is their house. A sale of that property and a division of the sale proceeds may be necessary to meet the couples' respective requirements. The ideal situation would be for both to have sufficient funds to buy each of them a new home however, the ideal is not always possible. The Courts are generally anxious to ensure that if the majority of the proceeds of the family home are used to re-house the parent who will be looking after the children on a day to day basis, or if they remain in the original home, then the other parent should receive some capital. It is a difficult situation to resolve and much depends upon the financial resources available and whether either of the partners is able to borrow. Sometimes the home is in the sole name of one spouse and if this is a concern then an appropriate entry can be made at the Land Registry to protect the interests of both.

For CGT purposes, the family home ceases to be the main residence of the spouse who leaves it. Subject to the "Principal Private Residence" exemption, CGT may be due on their share of the difference between the proceeds of sale and the original purchase price (or 31 March 1982 Value) less any indexation and/or tapering relief, restricted to the period of non residence. Of course, if this is the only gain for that year and it amounts to less than the Annual Exemption then there will be no tax due. The PPR exemption exempts gains made when people sell their main home and the relief is normally available up to 3 years after leaving even if a new residence has been acquired (this is to cover situations where it takes a long time to sell the first house).

There is an exemption (D6) covering absences of more than 3 years following separation but only where the property is eventually transferred to the remaining spouse under a formal financial settlement AND an election has not been made by the former spouse for another house to be deemed the PPR. Of course, if the house is sold after the 3 years having not been transferred to the remaining spouse then CGT will be due but only in the proportion that the excess period bears to the total period of ownership or 31 March 1982.

If the house is transferred but not sold immediately the remaining spouse will take over the base cost uplifted by indexation (if relevant) of the spouse who left but if the remaining spouse continues to occupy the house as their PPR then any gain on its ultimate disposal will obviously be exempt. The most tax-efficient answer is to ensure that transfer of ownership takes place at the latest by the time that the new house is purchased by the leaving spouse.

OTHER TAX IMPLICATIONS

There will be no IHT on the transfer of a share of the house as up to the date of the decree absolute any transfer between spouses is exempt. After that date the Inland Revenue normally accept that the financial settlement agreed upon is sufficient consideration meaning that there is no drop in value of the transferor's estate so no IHT charge.

There will also be no Stamp Duty payable on the transfer as it is specifically exempt. You may, however, find that the Mortgage Provider levies an administration charge for the transfer of names and wants a revaluation undertaken of the property - at the householders' cost, of course!

All assets owned by both parties from cars to life assurance policies, bank and building society accounts have to be considered in reaching a financial settlement. Unless Children are involved the courts usually aim for a "clean break" where it is ordered that neither spouse will claim maintenance or capital in the future but sometimes this is only be possible if substantial assets are transferred or a lump sum paid large enough to meet needs. It may be necessary for some assets to be sold and some assets are easier to sell than others. For example, it may be difficult to enforce the sale of overseas assets and if this is the situation then other assets of the same value may be transferred.

Provided the division of assets is made before the end of the financial year in which separation took place then any gains will be covered by the "spouse relief". The effect of this relief is for the recipient spouse to take over the original costs of the disposing spouse together with full indexation and taper relief computed by reference to the couple's combined period of ownership, resulting in no Capital Gain on transfer. This exemption is all very well if you separated in say, May of the tax year but does not give you much time to arrange transfers if you separated in say, February. If assets are divided after that date then there will be a potential CGT charge as the assets will be deemed to have been transferred at their open market value.

If the transfer of assets is made prior to divorce they are deemed exempt transfers for IHT purposes irrespective of whether the giving spouse survives 7 years. If the transfer is left until after the divorce, then the Revenue are likely to treat the transfers as being made at full value so again there will be no IHT implications. The transfers will also be exempt from Stamp Duty.

If there is a business or shares held in a private company the courts are reluctant to make an order that will destroy the viability and running of that business. If a wife has been shown as a partner for tax purposes only or has contributed little to the build up of the business then she may receive less than the wife who can prove that she assisted in the build up of a joint business with her husband. Some form of valuation will generally be necessary if a fair settlement is to be reached and this again will cost.

CGT RELIEF

All shareholdings in unquoted trading companies and shares and securities in a listed trading company where the individual is an employee or where the individual is able to exercise at least 5% of the voting rights in the company are now deemed to be "business assets" for CGT purposes so if the end of the year deadline for husband and wife transfers is missed you can still qualify for "gift relief" and not be chargeable.

Be aware that if gift relief is claimed under these circumstances and then the asset subsequently sold, taper relief is only available on the donee’s holding period as taper relief restarts from zero on the date that the donee acquires the asset. However, with the percentages of relief now available after 6 April 2002 the donee only has to hold on to a business asset for more than 2 years for maximum taper relief to apply and then sell.

Each divorce is as different as each marriage so even though you can go to the local County Court to complete the free form and the Internet is producing the possibility of divorce from your front room with a click of the mouse, professional advice should always be a priority.