With the next Budget Day fast approaching on 3 March, there has been a lot of speculation about a possible rise in rates of capital gains tax (CGT).
This speculation has been fuelled by the release by the Office of Tax Simplification of a report on 11 November 2020, in which it was suggested that CGT rates should be more closely aligned with income tax rates. While many commentators believe that a full alignment with income tax rates is unlikely, there is a general consensus that CGT rates may increase.
As we are still in the midst of the pandemic, some argue that the March Budget is not the appropriate time to raise rates of tax. However, it is clear that the government is going to need to raise funds to cover the huge costs of the Covid-19 pandemic, and given their “triple-lock” promise not to raise income tax, VAT or National Insurance, CGT does seem to be a likely target.
Any change could affect partners going through a divorce. While we cannot predict the CGT rates post-budget or any changes to the exemptions to CGT currently available, partners going through a breakdown of their marriage or civil partnership should give careful consideration to avoid an unexpected CGT bill. This bill may well be higher if the rates are increased in the anticipated March budget.
CGT – No gain, No loss
Generally, the transfer of assets between spouses or civil partners, if they are living together, does not create a taxable gain or loss. There is no suggestion currently that this exemption is under threat. This means that spouses or civil partners can transfer assets to each other without incurring CGT, at a value that gives rise to neither a gain nor loss. These rules continue if the couple is living together at some point during the tax year.
It is most tax efficient for partners to permanently separate on or soon after 6 April (the start of the new tax year) as that then gives them a full tax year before the divorce is finalised, within which to transfer assets with no CGT consequences.
CGT following the tax year of permanent separation but before the Decree Absolute
For tax years following the year of separation, up to the point at which Decree Absolute is pronounced, further transfers between partners are potentially subject to CGT, and the rates could be higher after March than they are now.
Gains arising on a transfer made following the tax year of separation are assessed on the transferor spouse and are based on the market value of the assets transferred. However, special rules apply where a loss arises on assets transferred to a recipient spouse following the year of separation but prior to the Decree Absolute. Such losses (known as ‘clogged losses’) may only be set off against chargeable gains arising from transfers to the recipient spouse whilst they remain connected to the transferor, i.e. before pronouncement of Decree Absolute.
Where it is not possible to complete transfers in the tax year of separation, negotiations of any financial settlement should always take into account any potential CGT liability of either or both spouses, in respect of transfers of assets between them. This may enable the CGT burden across the family to be minimised by balancing the assets to be transferred at a gain with assets to be transferred at a loss, so that the transferor is able to offset any clogged losses as far as possible and avoid wasting them.
Transfers which take place after Decree Absolute are calculated based on actual consideration received and are subject to CGT.
The matrimonial home
For many couples, the matrimonial home is likely to be the most valuable asset to be considered in a divorce. The matrimonial home is usually exempt from CGT upon divorce where the property has been the couple’s main residence throughout their period of ownership.
However, when one of the parties leaves the matrimonial home and buys or rents a new property then their main residence may change. Final Period Exemption Relief is available and currently provides exemption from CGT for nine months after he or she vacates the matrimonial home.
In some cases, it may be possible for this nine month period to be extended. However, this only applies where the matrimonial home is being disposed of to your spouse or civil partner, not to anyone else. In addition, three conditions must be met.
- the disposal is broadly under an agreement or court order made in connection with the dissolution or annulment of the marriage or civil partnership
- your spouse or civil partner continues to live in the property as their only or main residence
- that you have not given notice that another property will be treated as your principal private residence.
Trisha Siddique is senior associate in the family team and Helen Barnett is senior associate in the private client team at Wedlake Bell