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The tax implications of divorce for business owners

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Many companies are successfully founded and run by couples who bring complementary skills, and can perhaps share deeper levels of trust than unrelated shareholders can achieve.

There are many examples of successful business ventures run by husband and wife teams, but as the headlines about Johnny Depp and his separation from Amber Heard demonstrate, marriage has the potential to turn sour.

Whether embarking on a new business venture, in a rocky relationship and pondering the future, or considering whether to award shares in your company to your husband or wife, couples are wise to understand the practical ramifications and likely tax implications of divorce on joint shareholdings.

Shares in privately-owned companies are frequently split between husband and wife, and this can be advantageous for tax purposes. Although one shareholder may have the largest strategic involvement in the company, their spouse may undertake a lot of operational responsibilities which entitles them to receive a salary. If they have a shareholding in the company, this also entitles them to receive dividends, and these can be a tax efficient form of income, even though the rate of tax payable on dividend income has recently increased. Sounds like a win/win situation.

However, if the couple separate with a view to divorcing, this can cause a number of problems. There are obvious issues to be addressed, such as the ongoing day-to-day running of the business, but beyond this there is the larger question of whether the couple actually wish to remain in business together. It may not be viable for the couple to continue working together or to remain as joint shareholders and an agreement may be reached that one party will cease to be a shareholder. In this case, the parties will need to agree the value of the shares to be transferred, which is likely to involve appointing an outside valuer; and of course, the spouse who is transferring their shares will also be losing the dividend income they receive from the company. For these reasons, shares are frequently used as a bargaining tool by a shareholder seeking the best possible divorce settlement.

Once negotiations have been settled however, the capital gains tax (CGT) implications of any share transfer will also need to be considered, and these will vary depending on when the shares are transferred. The general rule of thumb for tax purposes is that the quicker you can reach an agreement about the division of jointly-owned assets, the less complicated the tax situation although practically this can be very difficult to achieve where business assets such as shares are concerned.

The capital gains tax implications

The following example highlights the different scenarios couples can find themselves in and the tax implications:

Tim and Julie are joint shareholders in a company and have an 50/50 shareholding which was worth 10,000 each at the time of incorporation and is now worth 100,000 each.

Scenario one: They separate and Julie agrees to transfer her shares to Tim during the tax year in which they permanently separate, and before they divorce. Irrespective of the amount Tim pays for the shares, no CGT is payable because this is a transfer between husband and wife in the year of separation. Tim acquires the shares at Julies original base cost of 10,000 and will pay CGT on the excess sale proceeds he receives over this amount when he eventually sells the shares. Julie has no CGT liability.

Scenario two: They separate but do not agree on the distribution of assets until well into the next tax year. CGT will need to be considered on the share transfer because the shares are not transferred in the tax year of separation, when Tim and Julie can still be treated as married for CGT purposes, but are transferred in a later tax year, during which they are still legally married. In this situation, Tim and Julie are treated as “connected” for tax purposes and irrespective of the consideration actually paid by Tim for the shares, HMRC will substitute the market value of 100,000. Therefore, a capital gain of 90,000 will arise in Julies hands. If no further action is taken, CGT will be payable by Julie at her marginal rate of tax; if she is a higher rate taxpayer this will be at the rate of 20 per cent. Julie may be able to claim entrepreneurs relief if she has a minimum five per cent shareholding and voting rights, and is an officer or employee of the company, and in this case she will pay CGT at the rate of ten per cent.

Ability to claim holdover tax relief

Where an individual gives away business assets or sells them for less than theyre worth, they can claim gift hold-over relief. This means no CGT is payable when the assets are transferred, and the person they are given to pays CGT when they sell the shares. This is however a claim that must be made jointly between both parties. Therefore, if Tim and Julie jointly agree, and make a claim, Julie can claim holdover relief and avoid the CGT liability. In this case, Tim will pay CGT when he sells the shares, based on the excess sale proceeds he receives over 10,000. The result is therefore the same as in scenario one, but there are tax reporting requirements and the necessity to make a joint claim, in order to arrive at this position.

Read more about business in the family:

Scenario three: Tim and Julie do not agree the share transfer until after their divorce (decree nisi) is granted, or the transfer is made as part of an agreement reached under court order. Once the decree nisi is granted, Tim and Julie are no longer connected for tax purposes and the actual consideration paid by Tim for the shares will be the amount which determines the capital gain arising in Julies hands. If the shares are transferred for no consideration, or for less than they are worth, Tim and Julie may be able to make a joint holdover election.

Scenario four: The couple divorce but agree that both will remain as shareholders. This will give Julie an ongoing entitlement to dividends voted by the company. This scenario can be desirable in the case of an amicable divorce and working relationship and where ongoing income is required.

In summary, every situation is different, but where matters can be agreed between the parties quickly, the tax considerations and reporting burdens are likely to be minimised. Where they cannot be agreed quickly, it pays to be aware that there may well be tax implications, and these can often be overlooked.

Lesley Stalker is a tax partner at RJP.

If you’ve enjoyed this article, discover the five ways to stay sane in a family business.



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