Wealth and Marriage: Getting Divorced in England and Wales—Why Timing is Everything

Getting divorced in England and Wales requires two decrees that are pronounced by the court. The first is decree nisi. The second is decree absolute, which formally divorces the couple. A minimum of six weeks and one day must pass between the decree nisi and the decree absolute. However, usually there is a significantly longer period in between the two decrees, while negotiations or court proceedings concerning finances take place.

You would be forgiven for thinking that a marriage or civil partnership is not over until decree absolute is pronounced, but for tax purposes, the benefits of being married or in a civil partnership may end sooner than you think. For high net worth individuals (HNWIs) and ultra high net worth individuals (UHNWIs) paying a high rate of tax, it is important to understand the additional costs associated with disposing of an asset at the wrong time.

Income Tax

Spouses or civil partners are treated as living together unless they are separated under a court order, by deed of separation, or where the separation is likely to be permanent.

Individuals are treated as no longer married for income tax purposes from the date of permanent separation.

As spouses and civil partners are taxed separately for income tax purposes, a divorce may have very little impact on the income tax position of the individuals involved. The transfer of assets under a divorce settlement does not attract an income tax charge. In addition, maintenance payments are not subject to tax in the hands of the recipient or relievable as a deduction for the payer.

Notwithstanding the above, individuals should take care to see whether they have acquired any income-generating assets which may be subject to tax.

Capital Gains Tax

Broadly, there are three key stages in divorce proceedings which may impact the capital gains tax (CGT) position:

• before the point of separation;
• after separation but before decree absolute; and
• after decree absolute.

These will be discussed in more detail below.

Before the Point of Separation

Under normal CGT rules, transfers of capital assets between spouses or civil partners take place at “no gain no loss.” This means that the transaction will not attract a CGT charge provided that the couple are living together at some point during the tax year.

Earlier this month, the Office of Tax Simplification recommended some major changes to the CGT regime, including increasing tax rates to raise some much-needed revenue. In light of this, HNWIs and UHNWIs should take tax advice before making any decisions to separate or leave the family home.

After Separation but Before Decree Absolute

Following the tax year of permanent separation but before decree absolute, spouses and civil partners are treated as connected persons for tax purposes, meaning that transfers will take place at the market value at the date of transfer.

In addition, where a loss arises on a transfer during this period, those losses can only be used against chargeable gains in respect of the same spouse. These rules apply up until the date of decree absolute.

This means that the timing of any separation becomes even more important. A couple who separate at the end of the tax year may find themselves in an unfavourable position from a tax perspective.

After Decree Absolute

After decree absolute, spouses or civil partners are no longer connected for tax purposes. This means that transactions will be calculated based on the actual consideration received (provided that the transaction is on an arm’s-length basis).

Losses can also be used more widely for other disposals, not just those with a spouse or civil partner.

U.K. Property

Often, one of the most significant classes of capital assets in the U.K. is property.

Most people assume that there is no CGT to pay on the disposal of the marital home (mainly due to the no gain no loss rule outlined above). However, not understanding the impact of the date of separation could result in an unexpected tax bill. For example, if a party leaves the marital home and the sale or transfer of their interest takes place at a gain more than nine months after the date of the departure, the leaving party may pay CGT on the increase in their share of the property.

Principal Private Residence (PPR) relief is available on the disposal of the main residence and exempts some or all of the gain which may arise on sale or transfer of the asset. Where a couple owns a number of properties, it is possible to elect one of the properties to be treated as their main residence. Such elections can be made within two years of acquiring or disposing of a property. In the absence of an election, the couple’s main residence will be determined based on their specific circumstances.

When the main residence is to be sold, one must consider the position of both the spouse or civil partner who remains in the property at the date of sale and the spouse or civil partner who has left.

As long as the sale (exchange of contracts) takes place within nine months of any separation, the disposal of the main residence is likely to be CGT exempt for both parties (subject to their respective periods of occupation). Before April 5, 2020, the relief was available on a sale 18 months after separation.

Whilst it may appear that the shorter time limit has a greater impact on the departing spouse or civil partner, it is in the interest of both parties to try to reduce the amount of tax to pay—as this will have an impact on available funds in the context of the divorce settlement overall.

If an individual has lived in a property as their main residence at any point, the last 18 months of ownership are treated as a period of residence regardless of whether that individual lived in the property during that time or not.

Where the home is not sold but rather the departing spouse or civil partner’s interest in the property is transferred to the occupying spouse or civil partner, it is possible in some circumstances for the departing spouse to claim that the home should be treated as continuing to be their main residence from the date they left it until the date it is transferred to the remaining spouse. Where this claim is made successfully, there will be no charge to CGT on the transfer to the occupying spouse (provided that the departing spouse or civil partner has not elected for another property to be treated as their main residence).

Stamp Duty Land Tax

Stamp Duty Land Tax (SDLT) may be payable on transactions involving land, including the purchase of a residential property.

However, transactions in connection with divorce or dissolution of civil partnerships and made pursuant to a court order for divorce, dissolution or separation are generally exempt from SDLT. This would include transfers of the family home between spouses or civil partners.

SDLT will be payable on acquisition of any new residential property, for example if the non-occupying spouse or civil partner decides to buy a new property in which to live.

Purchase of an additional property will normally give rise to an SDLT surcharge of 3%; this is added to the standard SDLT charge based on the value of the property. However, it is possible to claim back this charge if, within two years, property assets are sold such that the additional property becomes the only property that an individual owns.

However, where the court has made a property adjustment order (an order changing the ownership of property held by a separating couple) any ownership of the property in this way does not attract the 3% surcharge, provided that it is not the main residence of the person seeking to argue that the surcharge is not applicable to the acquisition of a new property.

Currently in the U.K. there is an SDLT holiday until March 30, 2021. This means that no SDLT is payable on a property worth up to 500,000 pounds ($663,000) (unless you are acquiring an additional property, in which case the 3% SDLT charge applies). For assets worth over 500,000 pounds there are still significant SDLT savings to be achieved. Due to the popularity of the scheme, there are reports that it may be extended, although this is not known at the time of writing this article.

Inheritance Tax

Transfers between spouses or civil partners are exempt from Inheritance Tax (IHT) and this remains the case throughout a period of separation and until decree absolute is pronounced. This is a strong reason to get married for many HNWIs and UHNWIs, as addressed in our first article in this series. It may also be a reason for older or unwell couples to consider staying married, rather than getting divorced (although they may choose to live separately). Consideration should be given to what benefits there may be, from a tax perspective, to staying married even if the marriage has broken down, and advice should be sought if this may apply to you. However, the domicile of the spouses or civil partners must also be considered as this will impact the exempt amount.

HMRC accepts that transfers of property which take place after decree absolute, but are made under the terms of a court order in relation to the divorce proceedings, are exempt from IHT, as long as there is no intention of conferring any gratuitous benefit on the recipient. Maintenance payments to a former spouse or civil partner are also exempt from IHT.

Any other transfers between former spouses after decree absolute are treated as Potentially Exempt Transfers and, under current legislation, are exempt from IHT if the donor survives for seven years following the date of gift.

Other Considerations

Overseas Assets

If the separating spouses or civil partners own foreign assets, it is important to understand the impact of foreign currency movements on the capital gains position on disposal.

Further, it is important to be mindful of the local tax position upon the transfer of foreign property and seek local advice as needed.

Making a Will

While marriage makes a will invalid, divorce does not. Divorce does, however, mean that your former spouse or civil partner will no longer act as an executor, nor inherit from your will. This is because from the date of decree absolute, the will takes effect as if the former spouse or civil partner had died. In practical terms, this means that assets that an individual stood to inherit from their former spouse or civil partner would fall back into residue for the benefit of the residuary beneficiaries.

If the will stipulated that a spouse or civil partner should be left everything, after decree absolute, the rules of intestacy would apply to the distribution of the estate.

Where a former spouse or civil partner was a trustee of a trust (for example for the benefit of any children) prior to decree absolute, the trust may fail.

Because a will does not become invalid at divorce, there is no need to wait for decree absolute to make a new will. It is advisable to prepare a new will at any time after separation but before divorce, so that these types of issues do not occur.

Conclusion

The tax implications arising on divorce can be diverse and will largely depend on when and where assets are transferred. Seeking family law and tax advice as soon as possible in the divorce process is encouraged, to ensure that assets are transferred as tax efficiently as possible and to avoid any unexpected tax liabilities.

There are significant backlogs within the family court at the present time, exacerbated by the pandemic. Take advice before making any assumptions as to how quickly the court may process an application or approve an order.

Planning Points

• Seek family law and tax advice before separation if possible, and otherwise as soon as you can.
• It is in the interests of both spouses or civil partners to minimise the tax payable in order to maximise the funds available to be distributed as part of the settlement.
• Review all capital assets and ascertain when a disposal is likely to take place.
• Consider the status of the main residence and whether any elections need to be made.
• Understand the tax implications of any orders made by the family courts.
• Revisit your will and take advice as to what amendments to it should be made.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Morag Ofili and Daisy Minns Shearer are Senior Associates with Harbottle & Lewis.

The authors may be contacted at: morag.ofili@harbottle.com; daisy.minnsshearer@harbottle.com