Taxing times; navigating the complexities of family law finance

Albert Einstein once said, “The hardest thing in the world to understand is the income tax.” So, you certainly wouldn’t be alone if you find getting to grips with the tax regime something of a challenge. However, as family lawyers, we need to identify when tax issues may arise so that we can refer clients for specialist advice.

This article aims to highlight the basic principles of the tax issues you are most likely to encounter and to signpost you to where you can access more information.

Capital Gains Tax (CGT)

CGT is a tax on the profit when you sell (or dispose of) an increased asset. The gain is taxed, not the amount of money you receive. Disposing of an asset includes selling, transferring, gifting, swapping, or getting compensation. You generally have to pay CGT on the gain when you sell any of the following –

• most personal possessions worth £6,000 or more, apart from your car.
• property that’s not your main home (principal private residence).
• your main home if you’ve let it out, used it for business, or it’s very large (over 5000 square metres).
• any shares that are not in an ISA or PEP.
• business assets.

Depending on the asset, you can reduce any tax you pay by claiming a relief. You do not usually pay tax on gifts to your spouse, civil partner, or a charity or on gains you make from ISAs, PEPS, government gilts, premium bonds, or betting wins.

You only have to pay CGT on your overall gains above your tax-free allowance (called the Annual Exempt Amount). This is currently £6,000 and £3,000 for trusts, though it will change again in April 2024 to £3,000 for individuals and £1,500 for trusts. This will increase the CGT liability for taxpayers who make gains above the reduced threshold. You generally do not have to pay CGT when selling your family home as this will meet the criteria for Private Residence Relief, which are as follows:

• you are selling your only home.
• you have lived in the property as your main home for all the time you’ve owned it.
• you have not used a part of your home exclusively for business purposes.
• the grounds and all the buildings have a total size of less than 5,000 square metres.
• the property wasn’t purchased solely to make a gain.

New CGT Rules since 6 April 2023

The Spring Budget of 2023 made changes to the rules on CGT for divorcing couples. Under the old rules, the transfer of assets between spouses and partners living together was made on a no-gain/no-loss basis as long as they were made in the tax year of separation. CGT was not triggered on assets transferred to a spouse or civil partner, provided they lived together from 6 April to 5 April the following year. Any gains or losses from the transfer were then deferred until the asset was disposed of and later subject to CGT. This meant that if a couple separated in February, they only had a few weeks to transfer assets to the other spouse before the end of the tax year on 5^th April to benefit from the no gain/ no loss rule, which often led to a very stressful negotiation under huge time pressure.

The new rules mean that:

• when married couples separate, they will now benefit from the ‘no gain, no loss’ treatment for CGT on asset transfers for up to three years after the tax year of separation.
• if the couple gets divorced or obtains a judicial separation before the three-year period ends, the ‘no gain, no loss’ treatment will cease upon the finalisation of the divorce UNLESS the asset transfer is part of an official divorce or judicial separation agreement.
• when assets are transferred as part of an official divorce or judicial separation agreement, no specific time limit is imposed on the application ‘no gain, no loss’ treatment for asset transfers.
• a spouse or civil partner who retains an interest in the FMH will be given the option to claim private residence relief when it is sold to a third-party and;
• individuals who have transferred their interest in the FMH to their former spouse or civil partner and are entitled to receive a percentage of the proceeds when that home is eventually sold will be able to apply the same tax treatment to those proceeds when received that applied when they transferred their original interest in the home to their former spouse or civil partner.

The new rules mean that the physical date of divorce is largely ignored; the relevant date is either that of the consent order or the final order.

The changes to CGT have been welcomed by practitioners as reducing the risk of a sudden unexpected tax bill; however, it is still very important to ensure you obtain timely tax advice to establish net asset figures, as CGT will still be payable at a later date when the asset in question is sold by the person to whom it has been transferred. The tax liability is not extinguished; it is merely deferred until future disposal by the recipient. It’s important that the recipient spouse understands the NET value of the asset they receive. In addition, if the final order predates 6 April 2023, CGT, under the old rules, may be payable even if there is a delay to the actual physical transfer of the asset in question.

Income Tax

Income tax is payable on:

• earnings from employment and taxable employment benefits-in-kind
• profits you make if you are self-employed or in partnership
• some state benefits
• most pensions
• rental income
• income from a trust
• income from savings over your savings allowance
• bonus payments
• dividends (the tax rates payable on dividends differ to those payable on other forms of income)

Most people get a personal allowance of tax-free income and various other reliefs may apply.

There is no relief for payments of spousal maintenance except where either party was born before 6 April 1935 – so you’re unlikely to come across this all too often! Therefore, except for this limited concession for older taxpayers, maintenance is tax-free to the recipient, and the payer receives no tax relief on their payments.

Income tax

Income tax on employment earnings is deducted at source under the pay-as-you-earn (PAYE) system. Tax on earnings from a trade, profession or vocation is currently paid in advance in tranches on 31^st January during the tax year and 31^st July after the end of the tax year, based on the profits of the previous year.

Additional tax due on all sources of income is payable on 31^st January after the end of the tax year in which the income was earned.

Individuals and partners self-assess their tax liability by completing a self-assessment tax return. Over the next few years, annual income tax returns will be replaced by the digital tax system (Making Tax Digital or MTD) commencing (for income tax) for accounting periods starting on or after 6 April 2024 for businesses, on 6 April 2026 for the self-employed and landlords with an income above £50,000 and or on or after 6 April 2027 for the self-employed and landlords with an income or property income above £30,000, although it is possible to sign up for the income tax pilot instead of filing a self-assessment return.

MTD is already in place for sole traders and partnerships that are VAT registered (turnover threshold £85,000).

Stamp Duty Land Tax (SDLT)

SDLT is a tax payable by the buyer of any property over a certain value or for a property transfer where anything of monetary value is given. The amount payable will depend on various factors such as the value of the property, the SDLT threshold at the time, whether the property is residential or non-residential and whether the buyer is a first-time buyer. Currently, SDLT only applies to properties over £250,000.

A property transfer (which can be one property or more) between a couple during a divorce, annulment, judicial separation, or separation order will be SDLT-exempt. This applies when the transfer involves only the couple and falls under either a court order or an agreement made by the couple before or after an order of the court, provided it’s related to or in contemplation of the order. The agreement should be a formal written document signed by both parties.

The usual stamp duty rates will apply when selling the marital property to a third party after a divorce. If the property was a couple’s main residence, one of them may qualify for the main residence replacement exemption by purchasing a replacement property within 3 years, but this will only apply to one party, so be sure to factor the cost of SDLT into budgeting for replacement properties if your client cannot claim the exemption.

There is a higher rate of 3% on top of SDLT rates if buying a second residential property.

Therefore, you need to be alert to situations involving SDLT where the main home is being retained, usually to provide a home for children. If the party who moves out and needs a replacement home buys a new property before the property adjustment order is made, they may be faced with the additional 3%. No refund would be possible once the financial order is made – therefore, be sure to ensure your client obtains appropriate tax advice in this kind of situation and be aware of the timing of the order vs the property purchases to ensure your client does not fall into this trap.

Note that SDLT ceased to apply to any land transaction involving property in Wales from 1^st April 2018. Land Transaction Tax applies to such transactions.

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