Tax relief on the transfer of business assets on divorce

Divorcing couples who have a business have previously benefited from HMRC guidance which stated that when a couple are divorcing and business assets are transferred between them, that Hold-over relief could be available to defer the taxable gain on transfer.

Both parties would need to agree to the Hold-over relief claim and the liability would transfer to the person receiving the assets. They would then agree to pay any necessary taxes when they sell the assets in the future.

Hold-over relief, also known as Gift relief, is only available on the transfer of business assets and part of the reason it is exists is to help ensure that people who gift business assets are not suffering a tax charge when they have no cash to settle the liability.

As an example, Julie and Tom are divorcing having separated a couple of years ago. They own a company which has a value of £2 million and each own 50% of the shares. Tom stopped working for the company when they separated and therefore, he is not eligible for Business Asset Disposal Relief, previously Entrepreneur’s relief, and essentially this means he would not qualify for the 10% tax rate on the sale of his shares.

As part of the Order, Tom must transfer his whole shareholding to Julie. As they are outside the tax year of separation, Tom is deemed to sell his shares to Julie for £1m (half of £2m). Tom will have a Capital Gains Tax (CGT) liability of £200,000; CGT at 20% of £1m, and the tax would be due by 31 January following the end of the tax year of the gain.

HMRC Old Guidance

Under the old HMRC guidance Tom and Julie would have been able to make a Hold-over relief claim on the transfer. This claim would remove the immediate CGT liability from Tom. Julie would receive the shares with a latent CGT liability which would become chargeable on future sale of the shares. Essentially the claim moves the liability from Tom (transferor) to Julie (transferee), and this can be helpful for individuals who do not have the cash to meet the immediate tax liability on transfer.

HMRC New Guidance

The HMRC updated guidance at CG66886 references the case Haines V Hill [2007] EWCA Civ 1284 which effectively states that where assets are transferred on divorce, the transferee is deemed to have paid the transferor the market value of the assets being transferred; the case states money’s worth has been given.

Therefore not only will the transferor suffer immediate CGT without any cash arising from it, but the transferee will inherit the asset at its market value essentially realising a benefit equal to the CGT paid by the transferor.

Following on from our example, Tom is deemed to receive £1m for the transfer of his shares. As there is consideration (all be it deemed) for the gift, the amount of the gain eligible for Hold-over relief is reduced to nil, resulting in the whole gain being taxable on Tom. Julie will inherit the shares from Tom with their current market value of their base cost.

Why has this change occurred?

There has been little communication from HMRC regarding this change but essentially, the argument seems to be that on the transfer of shares, the transferee would be surrendering rights they would otherwise have been able to exercise to obtain alternative financial provision across the divorce settlement and the value of those rights represent consideration for CGT purposes, effectively removing or restricting any gift relief claim.

What does this mean?

It is important to note that HMRC guidance is not law and there has been no change in the tax law, however we cannot ignore this recent update HMRC have made.

It remains possible that genuine gifts between divorcing spouses and civil partners could still benefit from gift relief but the instances of this being the case are likely to be few and far between.

For divorcing couples with business assets, this is now likely to be an area they will want to address and plan for and until we see cases put forward to HMRC in challenge of this, we would look to be advising our clients that a Tax Clearance is obtained from HMRC on any cases where a gift relief claim was to be made.