What are the Tax Implications of Divorce? Will I need to Pay Tax on my Divorce Settlement?

Janine Huston, Senior Associate

There were significant changes in the Autumn Budget to the rates of capital gains tax and stamp duty land tax, and the circumstances in which these are paid. Although the budget did not make any specific changes to tax payable on separation or divorce, a divorce settlement will almost inevitably involve a transfer of property or other assets between the separating couple.

The potential tax consequences of these transfers, and amount of tax payable, will be an important consideration when negotiating the terms of a financial settlement.

In 2023, significant changes were made to the capital gains tax rules for separating couples. These changes were welcomed by family law practitioners as the previous rules had been particularly restrictive.

Prior to 2023, it was necessary for assets to be transferred between a separating couple within the tax year of their separation, to qualify for ‘no gain, no loss’ treatment for capital gains tax purposes. In a ‘no gain, no loss’ transfer the value of the asset for tax purposes is its original base cost, not its current market value. Capital gains tax would therefore not be payable at the time of the transfer.

But it was often difficult for separating couples to agree terms of settlement before the end of the tax year of their separation. This became almost impossible if they separated shortly before the end of the tax year.

Since 6^th April 2023, transfers between a separating couple can take place on a ‘no gain, no loss’ basis in the following much wider circumstances:

• Transfers which take place before the end of the third tax year following the tax year of separation, or before the divorce is finalised (if this happens earlier).
• Any transfer which takes place in accordance with an agreement or Court Order. This creates an indefinite period in which the transfers can take place, as long as the transfer forms part of the couple’s financial settlement agreement or Court Order.

However, it will be important to consider the eventual capital gains tax liability which will arise on disposal of the asset in the future. If the spouse receiving the asset had the benefit of a ‘no gain, no loss’ transfer on divorce, when they sell the asset in the future a capital gains tax liability will arise on any increase in value from the original base cost. The capital gains tax liability attached to the asset is not reduced or avoided. The liability remains, it will only be delayed. This tax liability, at the new higher rates, will be an important consideration when negotiating the terms of the financial settlement.

Since 6^th April 2023, the circumstances in which Private Residence Relief can be claimed are also more generous for separating couples. Following a separation, it may be agreed that one spouse will move out of the family home and the other spouse will remain living there for an agreed period. Following this period, the property will be sold and the proceeds of sale divided between the separated couple. The spouse who moved out would be able to claim Private Residence Relief when the property is eventually sold, if they have not purchased a new home. If they have purchased a new home, careful consideration should be given when electing one of the properties as their private residence.

Transfers of property between separating couples will also be exempt from stamp duty land tax if the transfers take place in accordance with a financial agreement or Court Order. However, if one spouse purchases a new home while remaining as a joint owner of the family home, they will need to be aware of the stamp duty land tax liability which will arise, at the new increased rate.

Payments received as part of a divorce settlement are also not subject to income tax. Income tax is not due on spousal maintenance or child maintenance payments received. If income producing assets are transferred between a separating couple as part of their settlement, the spouse receiving these assets will need to pay income tax on the income received from the date of the transfer. Finally, if a couple claimed Marriage Allowance, to reduce their income tax liability during their marriage, this claim must be cancelled in the event of a separation of divorce.

The tax implications arising from a separation can be complex and advice should be sought at an early stage to avoid any unexpected or unnecessary tax consequences.

For more advice on separation, divorce or legal assistance for families please contact the Family Law department on 0161 832 3434 or email info@kuits.com.