Transferring property between spouses – benefits and pitfalls

Transferring property between spouses – benefits and pitfalls

“[The introduction of independent taxation between spouses was] bound to mean that some couples would transfer assets between themselves so that their total tax will reduce; this was an inevitable and acceptable consequence of taxing husbands and wives separately“.

Taking this statement from the Chancellor of the Exchequer in the early 1990s as the starting point, it could be argued that ministers and inspectors have done their utmost over the intervening decades to curtail the bold sweep of that statement. This article takes a brief look at the key tax mechanisms in relation to transferring property between spouses and civil partners.

Income tax

Possibly the most common issue is the distribution of income and/or income-producing assets between spouses. Typically, it will be to ‘balance’ total taxable incomes between the couple, so that one spouse or civil partner is not paying tax at a higher marginal rate on more income unnecessarily. One spouse in business may arrange for the other to be paid a salary, consultancy fee or similar to utilise the second spouse’s personal allowance and lower tax bands. This is perfectly in order, so long as the paying spouse can demonstrate that the amount paid was commensurate with the work done, when considered on an arm’s length basis, so as to justify the standard ‘wholly and exclusively’ test (ITTOIA 2005, s 34; CTA 2009, s 54). There is guidance on relatives’ wages in HMRC’s Business Income manual at BIM37735; note that it could easily be inferred from the guidance that (say) a slightly too generous reward could make the whole payment disallowable. However, it is common for inspectors to allow a reasonable proportion of costs deemed to be excessive overall (which would follow the aforementioned legislation). 

Jointly-held assets

Where assets are held jointly between spouses, ITA 2007, s 836 states that the income therefrom must be split equally in most scenarios – the common exceptions being where:

  • The income derives from partnership activity, with implications for spouses jointly holding a portfolio of investment properties – is it mere joint ownership, or a bona fide partnership?
  • The income derives from furnished holiday lettings.
  • The joint beneficial ownership is unequal, and the couple makes a joint declaration to that effect to HMRC (ITTOIA 2005 s 837). This is commonly referred to as a ‘Form 17 declaration’.

This regime is less flexible than for joint ownership between non-spouses. Non-spouses may generally allocate profits from joint investments as they see fit. But spouses who jointly own property must either split the income equally, or exactly in accordance with their underlying beneficial interests. They may re-set the arrangement by changing their joint beneficial interest again – in which case it will revert back to 50:50, until a further Form 17 is submitted to reflect the new arrangement.

Settlements

Spouses and civil partners need to be particularly cautious that they do not fall foul of the settlements anti-avoidance provisions (ITTOIA 2005, s 619 et seq). These provisions state that income diverted by one spouse or civil partner to the other will be treated for tax purposes as remaining in the hands of the donor spouse. The regime, which is targeted primarily at spouses and minor children does, however, have a ‘spousal exemption’ (s 626) for outright gifts where, simply:

  • The recipient spouse gets all of the income to which he or she would be entitled, in relation to the interest transferred; and
  • The transfer is not wholly or substantially a gift of income

A useful case for family company shares split between spouses or civil partners is ‘Arctic Systems’ – Jones v Garnett [2007] UKHL 35. The courts ultimately agreed that ordinary shares represented substantively more than merely a right to income (e.g. voting rights, rights on a winding-up, etc.), so their outright gift from one spouse to another may have been a settlement, but it, in turn, benefitted from the ‘spousal exemption’ as the gift was more than mere income. However, such cases do not always go in favour of the taxpayer, and probably would not if the shares were non-voting preference shares, or similar.

Capital gains tax

The legislation (TCGA 1992, s 58) permits the donee spouse to ‘stand in the shoes’ of the donor, where they are living together as a couple. Strictly, the transfer is deemed to take place, for CGT purposes, for proceeds that give rise to neither a gain nor a loss, regardless of actual consideration (or none) between the parties. Since the abolition of indexation allowance for individuals, however, we tend simply to say that the donee spouse ‘inherits’ the donor spouse’s base cost. Transfers to or from a spouse’s trading stock, and gifts on death, make the rare exceptions.

Separation and divorce can be problematic. The ‘no gain/no loss’ transfer rules continue to apply during the whole of the tax year that separation occurs. Here, separation is recognised only if the couple cease living together in circumstances deemed likely to be permanent, or under a Court Order or Deed of Separation (ITA 2007, s 1011, by reason of TCGA 1992 s 288(3)). So, living apart for (say) several years for reasons of work should not be an issue; likewise, where separation in dispute reasonably looks to be temporary.

Where separation and divorce drag on for a year post-separation, the couple may no longer transfer assets effectively free of CGT, and yet remain connected for CGT purposes until legally divorced (or subject to a deed of separation) such that any transfer is automatically deemed to take place at market value. See HMRC’s Capital Gains manual at CG22000C for more on this.

Inheritance tax

Spouses and civil partners basically enjoy full exemption when transferring assets either during their lives or on death (IHTA 1984, s 18). This also allows the surviving spouse to benefit from the transferred nil rate band (NRB) for IHT purposes, and hopefully greater flexibility in optimising use thereof. In the past, transfers to spouses who were not domiciled in the UK were subject to a cap of £55,000 free of IHT; since 2013, the lifetime limit has been extended to the standard NRB of £325,000. The surviving spouse (or their PRs) can elect to be treated as UK-domiciled for IHT purposes – although this does then bring their non-UK assets into the UK IHT net (IHTA 1984, s 267ZA). 

Unfair burden?

The quite recent case R (on the application of Steinfeld and Keidan) (Appellants) v Secretary of State for the International Development (in substitution for the Home Secretary and the Education Secretary) [2018] UKSC 32 has prompted the government to propose that it will allow civil partnerships for ‘opposite-sex’ couples as an alternative to marriage, so that civil partnerships may apply in broadly all cases. Readers may, however, recall the older case of Burden and Burden v The United Kingdom EHCR 13378/05, [2008] ECHR 357, which held that two sisters could not be in a civil partnership (and they were, therefore, unable to benefit for IHT purposes) because the nature of their relationship was one of siblings rather than that of a couple.

There arguably remains some difference, and siblings may not marry, so the extension of civil partnerships to opposite-sex couples does not necessarily mean that siblings must also be able to enter into civil partnerships. However, given the broad spectrum of relationships that will ultimately fall within either marriage or civil partnerships (or both), it may well prove that previous resistance to sibling civil partnerships is deemed anachronistic. In fact, there is already a Private Members’ Bill to amend the Civil Partnership Act 2004, to accommodate siblings.  

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