This newsletter aims to give an overview of issues relating to the main UK taxes which may arise from a divorce or the dissolution of a civil partnership.
One of the quirks of the tax system is that for some purposes separation is the significant event whereas for others the date of divorce or the dissolution of the partnership is important. Couples who are splitting up will need to consider the tax implications for both parties of any prospective arrangements before reaching any agreement. The Court may itself take tax implications into account in considering the financial arrangements which should be made between the parties.
The extraction of funds from a family company to fund a settlement on divorce or dissolution is an area in which income tax considerations will need to be weighed against the operational needs of the business and the interests of other shareholders. An increase in directors’ remuneration, by way of salary or bonus, will be subject to income tax and National Insurance Contributions (NICs) in the hands of the shareholder/director and the company will also be liable to Employer’s NICs. By contrast, increased dividend payments to a shareholder/director do not attract NICs although they will be subject to income tax after deducting the annual dividend allowance.
A tax-efficient way of extracting funds from a family business, if available, is the repayment by the company of any loans outstanding to the shareholder/director. If this is likely to cause difficulties for the business, the shareholder/director could consider replacing the funds extracted with borrowed funds, as in certain circumstances he or she will be able to obtain relief from income tax on the interest payable on the borrowings. In general, a shareholder/director aged 55 or over may also be able to release funds for a settlement by drawing down 25% of the value of his or her pension funds tax-free with additional draw-downs being subject to income tax.
Maintenance payments, whether paid or received, have no effect on the income tax position of anyone born after 5 April 1935.
Capital Gains Tax (CGT)
Spouses or civil partners may transfer assets between themselves without paying CGT in the year in which they separate. CGT may however be payable when an asset transferred between the parties is subsequently sold: at this point tax will be charged by reference to the difference between the net sales proceeds and the original cost. After the end of the tax year in which they separate, a transfer of assets between spouses or civil partners may result in a CGT liability for the transferor. By concession, however, a chargeable gain on the transfer of a business asset which arises as a result of a Court Order may be “held over” until the asset is eventually sold.
As far as property is concerned, an individual’s principal private residence (PPR) avoids a charge to CGT. If a couple own more than one property, they will have had to decide which was to be the PPR. Moreover, care needs to be taken in situations in which the spouse or civil partner who moves out of the couple’s former home retains an interest in the property.
Transfers of pension rights made under Court Orders under a “pension splitting” arrangement will not attract a liability to CGT. Certain other types of asset are also exempt from CGT.
Inheritance Tax (IHT)
Divorce or dissolution, rather than separation, is the key event for IHT purposes: the exemption applying to transfers between spouses or civil partners ends on divorce or dissolution. However, transfers between former spouses or civil partners may be outside the scope of IHT if they are conducted on an arms’ length basis without conferring gratuitous benefits. Non-exempt payments are normally taxable only if the person making the gift dies within seven years of the payment.
The change from one household to two and the need to realise assets to achieve a financial settlement will have tax consequences for one or both parties. Clearly, the wealthier the couple, the more likely it is that the potential tax consequences will need detailed consideration.
The information contained in our Newsletters is provided as general information only. It does not constitute professional advice and should not be relied on or treated as a substitute for specific advice relevant to particular circumstances. In addition, since the Newsletters were published in recent years, the information contained in them may not be applicable at the current time.