In addition to the emotional upheaval, there is a natural fear that the other spouse, lawyers or the taxman, will further erode the resources. Some therefore embark upon taking practical steps towards effecting separation. Before resorting to self-help and an early distribution of marital assets, some independent advice and consideration of a collaborative approach with the soon-to-be ex-spouse might help maximise the tax planning opportunities and minimise risks.
Early factfinding and sharing of data between spouses is essential as unilateral steps rarely assist anybody other than HMRC. Also, delay may reduce options available. Often one spouse will have more of the information than the other. Identifying where spouses are resident and domiciled may not be as straightforward a task as it sounds as different criteria are used by family courts to enable parties to litigate in England to those relied upon for fiscal purposes.
Factfind
Financial factfinding is usually by way of a standard 27-page document (Form E), which is more comprehensive in scope than a UK tax return. Supporting documents for each figure is necessary. Values of assets and income streams are as at the time of valuation and not date of separation. Gross and net figures after disposal costs are needed even if in the short term assets are to be retained or transferred between spouses. Computations for any anticipated income or capital taxes are also needed.
This might involve gathering the impact of overseas tax regimes and treaties on the parties’ assets and income streams too. The factfinding exercise is front-loaded both in terms of cost and time but is an investment for the future of both spouses. It does need to be carried out at a pace that enables the widest range of options available to be considered and be proportionate to the level of wealth in the family.
Once both parties are clear as to the extent of the assets and income streams available and the way in which they are taxed, it should be possible to advise upon possible options for a fair division (the English legal criteria upon divorce) and embark upon any fiscal planning integral to those options.
The payment of spousal and child maintenance largely falls outside the English tax regime. It is usually paid out of taxed income and is not tax deductable for the payer. It is not generally taxed in the hands of the recipient. There may still be some who receive child benefit or child tax credits and planning should include ensuring that these are retained. Income streams will be sorely tested.
If divorce involves the restructuring or demerging of any business assets, then the impact of liquidating shareholdings and the availability of reliefs should be explored. Monies distributed by way of dividend or the use of directors’ loans can be investigated too. Ideas involving cooperation between spouses may be possible but cannot be imposed, and options involving third parties are inevitably more complex.
Capital taxes may have a greater impact on the family’s future. When exploring options about the timing and transfer of assets to meet housing or capital commitments, there may be a number of imaginative ideas where practical, legal and carefully timed steps might reduce the incidence of capital gains tax or exclude stamp duty land tax. SDLT can be avoided if any transfer upon divorce is pursuant to a court order or separation agreement. Such steps might enable each spouse a greater housing budget for the future.
In England, separating early in the tax year commencing 6 April provides the widest window for effective tax planning for CGT in particular. A separating couple is treated as being married only for the remainder of the tax year in which separation takes place, so any asset that is transferred between them that year is CGT free.
The base cost of the receiving spouse is the original cost to the other spouse rather than the value of the asset at the time of transfer or any amount paid for the asset. From the end of the tax year of separation, even if decree absolute has not been obtained, parties are treated as unmarried for CGT purposes.
Separating shortly before 6 April therefore provides only a narrow window of opportunity to transfer assets between the parties.
Transferring second homes between the parties is likely to trigger real CGT liabilities but transferring the former matrimonial home has its own rules. Principal private residence relief should apply to avoid any CGT liability. Where one party owns the property and moves out leaving the non-owning party in occupation, perhaps with the children, care has to be taken to comply with special rules to ensure that a CGT charge does not arise on a transfer of the property to the party in occupation.
This is most relevant if the transfer takes place at the end of an extended period of separation. If both parties have left the former matrimonial home, or if both have elected another property to be their main residence, the rules do not apply and a tax charge could arise. Similarly, if the property is sold to a third party after a long separation, rather than transferred to the occupying party, a tax charge could arise.
Until the end of the tax year of separation, the parties to the marriage can only have one principal private residence between them, but thereafter they may have a principal private residence each.
Fortunately, the assignment of life assurance policies no longer attracts CGT as a chargeable event as long as they are pursuant to a court order. Pensions can be shared upon divorce and are particularly appropriate and effective when there is to be a clean break. If pensions are particularly large there may be lifetime allowance implications.
Measure
The parties and their advisers will also need to measure the net effect of any options explored on each spouse both now and in the future before a court will consider it and approve it. The starting point for capital division is equality unless needs cannot be met.
Depending on the age of the parties, thought should also be given not just to the immediate readjustment of assets and income streams, but also to the inheritance tax implications. Usually transfers between spouses during their lifetimes and on death are exempt from IHT, unless the receiving spouse is non-domiciled. Spousal exemption continues beyond separation until divorce (decree absolute) and transfers of capital for the maintenance of spouse or ex-spouse and children will normally be exempt. All other capital transfers are usually potentially exempt transfers.
Divorce should trigger a comprehensive review of a family’s finances with the incidence of tax and steps to minimise this being an integral part of future financial planning.
Sarah Anticoni is a partner in the family team at City law firm Charles Russell
Key points
- On top of the emotional upheaval, there is a natural fear that the other spouse, lawyers or the taxman, will further erode resources.
- Early factfinding and sharing of data between spouses is essential.
- Thought should also be given not just to the immediate readjustment of assets and income streams but also to the inheritance tax implications.
