Divorce can be taxing

Getting divorced can be very expensive. Quite aside from the legal fees that it involves, people who divorce must find a way to divide their assets and income between them in order to meet their and their children’s needs. It costs more to live separately than it does together. Resolving the financial aspect of a divorce usually involves having to spread one household’s finances between two new households. It is therefore regrettable that the Chancellor of the Exchequer has now made this even harder.

In Monday’s budget, Philip Hammond announced amongst other things that capital gains tax will be incurred at a much earlier stage than before in relation to the sale or transfer of people’s homes. Normally, when you sell or transfer your house to someone else, you do not incur capital gains tax because you are selling or transferring your home; you can rely on the principal private residence relief (PPR). However, once you have not lived at the property for a period of time, it no longer counts as your home and you may be liable for capital gains tax if you sell it or transfer it to anyone else, even if you are selling it or transferring it to your spouse as a result of the divorce.

Over the years, the Chancellor has repeatedly cut back the period of grace that home owners have before they might become liable for capital gains tax. Not so very long ago, this grace period lasted for 36 months. A few years ago, Chancellor George Osborne decided to reduce this period to 18 months. This started causing significant problems in divorce cases. Many people would separate and not do anything about the house until they divorced a few years later. It is not unusual for a spouse to instruct me that as the couple separated two years ago, they have now decided that they wish to go ahead with a two years’ separation divorce, and that it was now time to sort out what happens about the house. I would often have to advise the client in those cases that because he or she had not lived at the house for over 18 months, a capital gains tax bill might be incurred by the client as a result of selling it or transferring it to his or her spouse, and therefore they should seek the advice of a tax accountant to find out precisely how much tax they might have to pay. This often came as a very nasty surprise.

Philip Hammond has now made matters even worse. From April 2020 the period of grace will fall to 9 months. This is going to make it even harder to avoid a nasty tax bill as a result of getting divorced. Many couples take a lot longer than that to get divorced and to resolve financial matters. It is not unusual for someone who wants a divorce to be separated for at least a few months before he or she decides that it is time to seek legal advice, which reduces the window for avoiding capital gains tax even further.

Even if a couple are agreed about all financial issues right at the very outset of their separation, it is going to be difficult to obtain a financial consent order from the court reflecting any agreement within nine months of their separation. The Family Court is extremely slow in dealing with divorce proceedings. It may become faster once digital justice is possible and the court starts to process matters using online applications (currently only possible for the start of the process) rather than paper applications, but even so it will still be difficult to reach an agreement and then obtain a financial consent order from the court within nine months.

This is because the court cannot make a financial consent order until the Decree Nisi has been pronounced in the divorce; it can take many months to obtain the Decree Nisi. Furthermore, if the couple are not agreed about financial issues at an early stage and have to engage in negotiations, mediation, arbitration or litigation through the court, it may very well take significantly longer than nine months to get everything sorted out.

The capital gains tax burden arguably falls on both parties; although no capital gains tax will be incurred by the spouse who has remained living in the house, it is perfectly arguable by the other spouse that his or her capital gains tax bill must be factored into any negotiations or court decision and that he or she should not be expected to shoulder the burden on his or her own.

Implementing agreements at an early stage may result in there being no tax bill. However, it is risky to implement the terms of any financial agreement without first obtaining a financial consent order from the court, because of the possibility that an agreement can be implemented, and then one party decides to renege and to seek more. Until there is a financial order in place, no financial agreement can be enforced (including a financial clean break).

The safest way to deal with matters is to negotiate an agreement, then reach an agreement, then to obtain a financial consent order from the court, and only then to implement the terms of the order. The need to avoid a nasty tax bill may cause couples to decide to implement the terms of an agreement without the benefit of an order, and then to obtain the order from the court at the earliest possible date thereafter. They will have to run the risk that the other side stops cooperating in obtaining a financial consent order once he or she gets some money from the agreement.

It would be nice if the Chancellor would recognise that it is unfair to divorcing couples to impose a tax burden on them in this way. I see little chance of this, especially in the current environment where HM Treasury is particularly keen to maximise the income that it generates from taxes.

This change to the capital gains tax rules serves to highlight the need for people who separate to seek legal advice at an early stage, to identify the best and possibly quickest way to resolve any financial dispute and to implement agreements without delay.

31 October 2018

 

Comments are closed.