In November 2021 the government published its responses to the Office of Tax Simplification’s (OTS) reviews and recommendations in relation Inheritance Tax and Capital Gains tax. Particularly noteworthy for family lawyers amongst these responses is the recommendation regarding a change to the ‘no gain no loss’ window.
Current ‘No Gain, No Loss’ Rules
Although married couples and civil partners are separate individuals for tax purposes, if they live together they are able to take advantage of the ‘no gain no loss’ rule, which allows them to transfer assets between one another at a value which for CGT purposes, does not give rise to a gain or a loss. This does not avoid CGT entirely, as the recipient will essentially be acquiring the asset at the transferor’s base cost, meaning if they were to sell the asset in a few years’ time the CGT would then be payable at the point of sale.
What this rule does mean though is that the parties’ will not be liable to pay CGT on these transfers at the point of (or shortly after) a divorce, when finances are being divided and there may be limited cash available to meet any tax liabilities. The parties will be treated as a tax unit rather than individuals for the purpose of CGT. This rule continues to apply once the spouses separate permanently, as long as these transfers take place during the remainder of the tax year following their separation.
Difficulties with the Current Rules
In reality, when a couple separates they often do not seek legal advice for some time after they have separated, which may mean they are not able to reach an agreement regarding the division of assets (and make the relevant transfers) in the tax year of separation, meaning they cannot benefit from this rule. After something as life-altering as the breakdown of a marriage, especially where there are young children involved, the timing and tax implications of any eventual settlement may not be the spouses’ initial concern. Even for those individuals who happen to separate early in the tax year, a year is often not enough time to go through the process of disclosure, negotiations and/or court proceedings, and agreeing the terms of a consent order, especially if they have complex finances. Where a couple happens to separate towards the end of the tax year, it becomes significantly more difficult for them to take advantage of this rule.
Potential Reform
The recommendation of the OTS was therefore that the government should extend this window so that such transfers between spouses will not incur CGT as long as they are made by the later of either the end of the tax year at least two years after separation, or, any reasonable time set for the transfer of assets in accordance with a financial agreement approved by a court.
The government has accepted this recommendation and is now set to consult on the detail over the next year. Although the government has accepted that the window should be extended, there has been no confirmation that the OTS recommendations regarding how this should be extended will be implemented.
This will be a welcome change for separating couples, and will mean that those separating earlier in the tax year will no longer be arbitrarily favoured by having longer to arrange for the tax-free transfer of assets between them. It will allow spouses more time to take advice and agree upon the division of their assets, and will alleviate the pressure of having to make decisions regarding the transfer of assets in the short period before CGT becomes payable at the end of the current tax year.
In addition to the removal of looming threat of CGT as a motivating factor in reaching an agreement on finances post-separation, this will also mean marital assets won’t be depleted by immediate tax bills, so they can be made available to contribute to the parties’ respective needs.
Whilst couples considering separation will look forward to these changes, given there will need to be a government consultation it is likely to be some time before any new rules take effect. For practitioners, this will, for the time being, mean a requirement to continue to advise clients based on the current system and its often narrow time constraints.
Written by senior associate Michael Finnegan.