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Divorce law blog

Elephant traps on tax for family lawyers

22/05/2012   By:

A gallop through the main issues for family lawyers to watch out for and, where appropriate, ask for expert input!

Capital Gains Tax

Relationship breakdown will commonly involve the transfer of assets either between the parties (transfer of property, shares etc) or to third parties to raise funds to pay lump sum orders.

Major liabilities may arise and capital gains tax is usually payable at a flat rate of 18% or 28%. 

Date of separation

The date of permanent separation for spouses/civil partners is significant for both capital gains and income tax purposes.

Trap - it is a question of fact and it is not possible to specify one date for tax purposes and another in such documents as a divorce Petition, Form E or a deed of separation.

Separation can still be permanent for tax purposes when the couple remain at the same address but living separate lives. Conversely, residence at different addresses, or even in different jurisdictions, does not automatically mean the couple is separated for tax purposes.

Transfers between spouses/civil partners before the end of the tax year of permanent separation

Such transfers are subject to the “no gain, no loss” rule. This means it is often advantageous to expedite the transfer of assets from one party to the other before the end of that tax year.

Trap - will this have negative implications in the future for the recipient spouse/civil partner who will then be taking on the asset at its existing acquisition cost for CGT purposes?

Tax advantage - the “no gain, no loss” rule applies even where the recipient spouse/civil partner is non-UK resident and thus not subject to UK CGT. This means that the asset may not attract CGT at all if it is transferred before the end of the tax year of permanent separation to someone who is a non-UK resident.

Transfers between spouses/civil partners after the end of the tax year of permanent separation

Trap - The “no gain, no loss” rule will not apply.

Query – is hold-over relief available? This may reduce the immediate tax liability but…..trap, as with expediting asset transfers to take place within the tax year of separation (above), this may store up problems for the transferee by reducing the acquisition cost. This may mean a higher tax liability on disposal of the asset.

Watch the timing of any disposals to ensure CGT becomes payable at a time to maximise the availability of exemptions and loss relief. Also, ensure that you/your client know when it will become payable (which depends upon when the disposals take place).

There are complex rules determining the date of disposal where that disposal is made pursuant to a Court Order. The views of HMRC are set out in their helpful manual CG22423 (available at www.hmrc.gov.uk/manuals/cgmanual/CG22423.htm).

The former matrimonial home and capital gains tax

First, establish which of the properties involved attracts the main residence exemption. There can be only one main residence for both spouses/civil partners whilst living together (unless the three year rule applies – see below). The breakdown of the relationship may result in one party transferring his/her interest in the main family home to the other.

Trap – when dealing with larger properties incorporating land and additional buildings, check whether the entirety of the land and buildings will be eligible for the main residence exemption. Expert advice may be necessary so that a realistic CGT liability can be included in any asset schedule.

Trap – practitioners should be aware that the main residence exemption may not apply to one party’s “share” in the family home if it was purchased at or shortly after separation, a point when some families decide to downsize. Careful tax advice should be taken in this instance.

Trap – any restriction to the main residence exemption that applies to the transferor’s occupation (for example, if part of the property was used for business purposes) passes to the transferee if the transfer takes place whilst they are still living together and they are occupying it as their main residence. This may mean that when the transferee comes to sell the property in the future, the transferee will be liable to tax on the relevant proportion of any gain.  
Contrast this situation with the position if the transfer of the property takes place after permanent separation but within the same tax year. In this situation, the “no gain, no loss” rule will apply and the chargeable element of the gain falls away. Note the importance of timing! 

The three year rule

Upon relationship breakdown, one party commonly moves out of the family home. In this situation, the non-occupying spouse/civil partner has a period of 36 months within which to transfer his/her interest in that property before losing entitlement to the exemption.

Note – review client matters to ensure you are not sailing perilously close to the end of this period.

Hint – the non-occupying party can transfer his/her interest in the property to the occupying party within the 36-month window so that it can be sold to a third party at a later stage. 

Hint – if the benefit of exemption under the three year rule has expired, obtain advice as to whether there is the possibility of claiming the benefit of TCGA 1992, s.225B. 

Mesher orders and capital gains tax

The view of HMRC in such cases is that the property becomes settled property for CGT purposes (see CG65365 to be found at www.hmrc.gov.uk/manuals/cgmanual/CG65365.htm)

The capital gains tax consequences on creation of settlement

Usually, there will not be any CGT consequences as the person occupying the property will benefit from main residence relief and the person not occupying it will usually benefit from the three year rule.

The capital gains tax consequences once settlement established

The person occupying the property will normally do so as his/her main residence and so main residence relief will apply. Once settled, the interest of the former spouse/civil partner will be an interest in settled property and therefore exempt from CGT.

Mesher orders and Inheritance tax

The spouse exemption will apply to outright transfers until decree absolute, even after permanent separation.

Loss of Inheritance tax relief or exemption on change of ownership – if assets are to be transferred within the context of the relationship breakdown, determine (a) if those assets before transfer attract any reliefs/exemptions and (b) if those will be lost on transfer. Expert advice will be required to advise about potential exposure to inheritance tax where, for example, business or agricultural assets have been transferred as the transferee will have to satisfy the length of ownership and/or occupation requirements in his or her own right.

Trap – changes made by Finances Act 2006 to the inheritance tax treatment of settled property mean that the settled property will be “relevant property” exposed to the ten-yearly and exit charges. These charges are currently at a maximum of 6%, which may present difficulties as the nature of the arrangement means there will normally be no liquid funds to meet the charges.

Expert advice should be sought upon the drafting of the Consent Order and associated documents so as to safeguard the position of the parties as far as possible, as reducing the inheritance tax exposure may result in CGT exposure.

An alternative is for the non-occupying party to have a charge over the property perhaps for a fixed sum with interest so that CGT does not apply (such a charge does not constitute an interest in the property) on the basis the property is transferred to the occupying party subject to that charge. Seek specialist advice so as to minimise exposure to tax.

Transfer of shares and capital gains tax

If there is to be an outright transfer of shares from one spouse/civil partner to the other then, provided the transfer takes place before the end of the tax year of permanent separation, such a disposal will benefit from the “no gain, no loss” rule.

Note – the receiving party may have to pay CGT  on a later disposal of the shares.

Hint – if you act for the transferee obtain details from the transferor of the acquisition dates and purchase prices of the shares as your client will need this information to work out the CGT liability on a disposal of the shares later on.

Watch out – the financial arrangements on relationship breakdown may involve the extraction of funds from a company, for example, the disposal of shares by one party to meet a lump sum payment to the other. There are no special exemptions that apply when funds are extracted from a company for a spouse/civil partner in this way and the usual tax considerations must be thought through.

Income tax

…and periodical payments

Periodical payments (whether secured or not) are not taxable in the hands of the recipient.  Tax relief is, by and large, not available to the person paying periodical payments.

This tax treatment applies also to maintenance payments made by an order of an overseas court. However, they may attract tax relief overseas.

…and income derived from transferred assets

Watch out – if one party transfers capital to the other , any income derived thereafter from that capital will be subject to income tax in the hands of the recipient.

…and funds from income distributions from family trusts

Watch out – if one party is to be provided with income distributions from a family trust (in lieu of future periodical payments) then that income will be taxed in the hands of the recipient.

…and interest payments on lump sum orders

Interest payable under a lump sum order will be taxed in the hands of the recipient and there is no tax relief available for the paying party.

Query – if a delay is envisaged, consider continuing periodical payments (and at a higher rate) in lieu of interest on the lump sum to avoid this?

Jointly held property

If income producing assets are held in the joint names of spouses/civil partners, they are treated for income tax purposes as entitled to the income in equal shares.

This can be altered by making an election of unequal beneficial interests (in accordance with the genuine beneficial ownership) so that the income tax arising will be split between the parties in those unequal shares.

Trap - The presumption of equal entitlement ends on permanent separation.  If an asset that produces significant income is to be held in joint names post permanent separation and there is a marked disparity in beneficial ownership, thought must be given to the income tax consequences. 

Parties with non-UK domicile

Trap – if one or more of the parties is not ordinarily resident and/or not domiciled in the UK, that party is entitled to claim the remittance basis of taxation.   In those circumstances,  expert advice should be sought  to ensure that the financial arrangements or asset transfers following the relationship breakdown will be arranged to minimise the tax consequences of the remittance of funds to the UK, and that any tax consequences will be factored into the financial arrangements.

Life policies

Income tax

Trap – watch out for tax issues arising upon the assignment of or transfer of interests in life policies.  ITTOIA 2005, Pt 4 Ch 9 indicates there may be a charge to higher rate tax, although if the spouses remain living together, under ITTOIA 2005, s 486, any assignment will not be charged to income tax.  HMRC’s latest position regarding the assignment of or transfer of an interest in such a policy is that as long as it takes place under a Court Order, no income tax liability will arise.

The person receiving the interest in such a policy may have to meet an income tax liability in the future if/when a chargeable event arises.

Capital gains tax

By and large life policies are not within the scope of CGT (TCGA 1992, s 210), and so the transfer of a life policy upon divorce/civil partnership dissolution will not attract a CGT liability.


The income derived from a pension will be charged at the individual's marginal rate of income tax. A tax free lump sum can be drawn, usually but not always to a maximum of 25% of the fund value.

Since 6 April 2011, income may be provided by either capped drawdown or flexible drawdown. Capped drawdown replaced the previous rules for unsecured pensions (USP) and alternatively secured pensions (ASP). The maximum amount of income that can be drawn is 100% of a comparable annuity based on GAD tables. Flexible drawdown is such that, in addition to the possibility of taking a tax free lump sum, an individual with a secure lifetime pension of at least £20,000 pa gross ("the minimum income requirement") can withdraw the whole pension fund as a lump sum. State pension and annuities in payment will count towards the minimum income requirement but investment income does not. Lump sums taken under flexible drawdown will be taxable at the individual's marginal rate. This could be a particularly useful facility in the context of divorce where a pension sharing order is unavailable, perhaps on an application for the variation of an order for periodical payments arising from proceedings where the petition was issued before 1 December 2000.

From 6 April 2011, there is no longer any obligation on individuals with money purchase pension funds to purchase an annuity at age 75.

If an individual's pension funds from all sources are worth less than £18,000 with effect from 6 April 2012, the entire fund may be paid out as cash (a trivial commutation lump sum) subject to income tax at the individual's marginal rate over and above the 25% tax free lump sum. Additionally, commutation is also available for certain pension rights individually valued at less than £2,000.

From 6 April 2011, the maximum allowable pension contribution (known as the Annual Allowance) has been £50,000. Tax relief is available at the individual's marginal rate up to and including the 50% rate. Any unused allowance may be carried forward from the 3 previous tax years. If there are pension contributions in excess of the Annual Allowance, a tax charge is due. This can create a trap for members of defined benefit schemes. By reference to an HM Treasury example, a pay rise from £60,000 to £70,000 for a member of a defined benefit scheme with a 1/60 accrual rate who is in their 35th year of membership will give rise to a £23,712 charge to tax. This is a hidden liability which must be calculated and taken into account when presenting an individual's financial position on divorce.

With effect from 6 April 2012, the Lifetime Allowance for an individual's pension fund is reducing from £1.8m to £1.5m. The value of £1.8m may be protected if all contributions and benefit accrual stops to all schemes with effect from 5 April 2012 (fixed protection). Otherwise, fund value above £1.5m is taxed at 55%. Again, for those individuals with substantial pension funds who are engaged in divorce, this latent tax liability must be taken into account when assessing their financial position.

This is a highly complex and technical area: Trap failing to take appropriate expert advice.


Watch out – of course, there is no inter-spousal exemption on CGT under the “no gain, no loss” rule.

Watch out – Stamp Duty Land Tax may be payable upon a transfer between the parties as they are not spouses/civil partners. This is to be contrasted with the wide exemption from Stamp Duty Land Tax for spouses/civil partners.

Watch out – for the tax implications that arise upon the making of capital orders for housing under Schedule 1, for example, a settlement of property order with the “paying party” entitled to the reversion at a later stage such as the child reaching age 21 or finishing full-time education. In much the same way as with Mesher orders, advice must be sought upon the drafting of such orders to minimise the parties’ exposure to tax.

  • Nicola Rowlings 4 years 361 days ago
    The High Income Child Benefit Charge is aimed at those parents who have an income over £50,000 (or who have a partner who does) and who currently receive child benefit. The HMRC considers that “partner” means a husband, wife or civil partner (or the couple are living together as husband and wife or civil partners – so the charge affects cohabiting couples too) unless the couple are separated in a way that is expected to be permanent (for example, they have divorced). When the separation happened is also a very relevant factor. So, in the example you gave, if the husband and wife divorced or permanently separated some years ago, the wife could continue to receive the full child benefit and the husband (despite earning over the £50,000 threshold) would not be subject to the clawback i.e. having to repay some or all of the child benefit received. However, if the couple separated during the current tax year, the husband would face having some of the child benefit clawed back at his next self-assessment for the period they were still living together as a family. Remember though that the High Income Child Benefit Charge applies to cohabiting couples as well as to married couples. So if the wife in your example was to start living with a new partner who earned over £50,000, her new partner would be subject to the clawback and he would have to repay some or all of the child benefit the wife had received - despite them not being married and the children not being his biological children. Our blog on "Changes to child benefit rules" also provides further information which may assist. However, every individual’s circumstances are unique and we suggest that you contact a member of the team for advice on your personal circumstances.
  • Scott Davie 4 years 362 days ago
    Regarding the child benefit taxation changes, if the married couple are separated (husband earns > £60k). Can the ex-spouse retain the full child benefit without the husband having to repay benefit back.

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