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What are the tax implications of a no fault divorce?

‘No fault’ divorce went from a legal possibility to a reality in April 2022. Though there have been no connected changes to tax rules, this type of divorce still has financial implications for the divorcees.

Now that ‘no fault’ divorces allow estranged couples in England and Wales to end their marriage without having to assign blame, each person has more time to focus on finances and tax efficiency.

Here’s what you need to know about the tax implications of no fault divorces in England and Wales.

What is a no fault divorce?

Under the previous divorce laws in England and Wales, couples had to prove that their marriage had broken down. Unless a couple had been separated for at least 2 years before applying for divorce, the person filing was required to assign blame for the breakdown to their spouse’s behaviour.

Even if the couple were in mutual agreement over the separation, one would still have to make allegations about the other’s behaviour to validate the divorce application. This often leads to emotional finger-pointing, forcing children to witness mud-slinging arguments, and even spouses contesting the divorce purely out of vindictiveness – trapping people in unhappy relationships.

The Divorce, Dissolution and Separation Act (2020), in force since 6th April 2022, removes the need for apportioning blame for misconduct during the marriage. This makes communication easier and allows individuals to focus on the more practical decisions relating to the divorce proceedings.

The new laws allow people to apply for divorce in a more straightforward way:

  • One or both parties file a divorce application (petition) following a marriage breakdown
  • After 20 weeks, one or both can proceed to apply for a Conditional Order (Decree Nisi)
  • After 6 weeks, the court can make a Final Order (Decree Absolute) to end the marriage

With a minimum timeframe of 26 weeks (6 months) for proceedings, the law allows enough time for applicants to change their mind if they want to reconcile, or to sort out important administrative arrangements regarding children and shared property if they don’t.

A couple will still be treated as married for tax purposes until the Final Order is issued after 26 weeks. Depending on the time of year that proceedings start, and possible administration delays, this means that the transferring of assets from a divorce might be pushed into the next tax year.

Which taxes are affected by no fault divorces?

There are no new tax regulations for no fault divorces, so tax concerns are essentially the same as divorces under previous laws. Transferring assets through divorce settlements is not usually subject to Income Tax, and maintenance payments generally come from income that’s already been taxed.

However, if you receive income-producing assets from your former spouse, any income generated from such shares, bonds, or dividends is likely to have taxable interest from the date of its transfer.

When it comes to property, such as a shared family house, the departing spouse is considered a resident. If the home is transferred or sold as part of the divorce when the spouse leaves, Private Residence Relief (PRR) could apply. This means it’s likely that no Capital Gains Tax (CGT) or Stamp Duty Land Tax (SDLT) will be payable if the transfer occurs within the last 9 months of ownership.

As for Inheritance Tax (IHT), asset transfers from a divorce settlement may be liable, depending on when the transfers occurred. These are usually referred to as Potentially Exempt Transfers (PET), as they should be exempt from IHT, unless the person who transferred the asset dies within 7 years.

It’s also important to remember that finalised divorces don’t revoke existing Wills. So, if your divorce will affect your chosen beneficiaries and asset distribution, you should review and update your Will.

How does a no fault divorce affect Capital Gains Tax?

The biggest tax issue for most couples getting a divorce will be Capital Gains Tax. Transferring assets is almost unavoidable as part of a divorce, and it’s only possible to avoid paying CGT if the transfers happen before the end of the tax year of the separation.

Previously, spouses could avoid CGT under the ‘no gain, no loss’ principle, whereby one partner receives the asset at the original cost to the other partner. This means no CGT is applicable if the transfer happens during the same tax year when the couple was still living together.

Now, after separation, partners are considered ‘connected persons’ for CGT purposes, so any transfers will be at market value, regardless of proceeds paid – so the person making the transfer could be liable for CGT, even without receiving profits to pay the tax with.

This is why divorce settlements require such careful tax planning. Private Residence Relief (PRR) only applies to the main family home, so couples with multiple properties, high-value assets, or company shares could find themselves in trouble.

Of course, you can try to mitigate Capital Gains Tax
from divorce by agreeing to wait until the following tax year to transfer assets, but this still requires planning and co-operation. CGT allowances
and thresholds can also vary from year to year, so it’s crucial to stay on top of your tax bracket information and relevant liabilities.

Do you need tax advice for a no fault divorce?

Taxes aren’t always the priority when dealing with a divorce settlement, which can be extremely stressful even when there’s no fault assigned. That said, it can lessen the stress significantly to have expert tax guidance while you’re negotiating your divorce.

HMRC has updated their online help-sheet with information on the CGT implications of no fault divorce, which you can read through here. If you’re planning to apply for a no fault divorce, or are already in the process, and think you would benefit from tax consultancy services, feel free to contact GBAC, accountants in Barnsley, who also cover Leeds and Sheffield, on 01226 298 298 or at info@gbac.co.uk.