Mark McLaughlin points out that transfers of business assets as part of court orders in divorce proceedings can have unwelcome capital gains tax consequences.
The end of a marriage (or civil partnership) is often difficult and stressful. Unfortunately, the tax rules could make a bad situation worse.
Gifts of assets
Where one unconnected individual gifts a capital asset to another individual, the gift is generally treated for capital gains tax (CGT) purposes as having been made at market value. Similar treatment applies to transfers between ‘connected persons’ in general.
However, if spouses are living together in the tax year and one of them disposes of an asset to the other, they are normally treated as if the asset transfer was for consideration resulting in no gain or loss.
Separation and divorce
Care is needed when inter-spouse transfers of assets are made in the tax year following separation. For CGT purposes, the ‘no gain, no loss’ treatment is not available. However, the individual is still ‘connected’ with their spouse, so disposals and acquisitions of assets between the spouses are treated as having been made at market value.
When the couple divorces, their connection ends for CGT purposes. Hence the market value rule no longer applies automatically.
Holdover relief
If there is a gift of a business asset (or a transfer at undervalue), CGT ‘holdover’ relief will potentially be available. If the transfer is not a pure gift but a transfer at undervalue (i.e. if some consideration is given, which is less than market value), unrestricted holdover relief may still be available if the proceeds are less than the base cost of the business asset (TCGA 1992, s 165(7)).
However, gift relief is not available if market value consideration is given for the business asset.
Unfortunately, there is no statutory definition of ‘consideration’ for CGT purposes. In practice, ‘consideration’ can include not only cash but non-cash assets.
Moving goalposts
Until fairly recently, HM Revenue and Customs (HMRC) guidance (in its Capital Gains manual, at CG67192) stated that where a court makes an order in divorce proceedings (e.g. under the Matrimonial Causes Act 1973), in HMRC’s view the transferee spouse did not give actual consideration (i.e. in the form of surrendered rights) for the transfer. As there was no consideration, HMRC accepted there would be no restriction in holdover relief if the assets transferred were business assets.
However, HMRC’s view subsequently changed. HMRC’s current view (at CG66886) is broadly that the value of the statutory right surrendered represents actual consideration for the assets received. This may restrict (or preclude) holdover relief on transfers of business assets.
HMRC’s change of view on the availability of holdover relief follows the decision in Haines v Hill [2007] EWCA Civ 1284, where the transfer of an interest in a property in a divorce settlement was held to be a transaction made for consideration in money or money’s worth for bankruptcy law purposes.
Practical tip
Some commentators have questioned HMRC’s guidance at CG66886 and the effect of Haines v Hill (a non-tax case) in the context of holdover relief under TCGA 1992, s 165. Accordingly, taxpayers and advisers must decide whether to accept HMRC’s guidance and its interpretation of Haines v Hill when considering claims for holdover relief on the transfer of business assets upon divorce.
