“This is going to hurt” – potential implications of the forthcoming Budget on financial arrangements on divorce

With the government’s focus on expectation management in overdrive, the past several weeks have brought repeated headlines signalling how “painful” the forthcoming Budget on 30 October will be.  And with “death, divorce and taxes” often cited as some of the most painful aspects of life, the impact of the anticipated “painful” tax increases on family finances that may already be under considerable strain from divorce, will be a double hit. Fittingly, just in time for Halloween.

Beyond confirming there would be no increase to the rates of income tax, national insurance or VAT (aside from imposing it on private school fees), the government has held its tax cards close to its chest.  However, speculation is rife about how it plans to plug what it says is a £22bn black hole in public finances. Alongside spending cuts and increased borrowing, some tax changes are inevitable and the expectation is that the heaviest burden is likely to fall on wealthier individuals and corporations.

Already, when a single “joint matrimonial economy” is required to cover two separated households after divorce, it almost invariably puts finances under strain. With the anticipated fiscal measures likely to be so significant, that may add further strain to a family economy already under stress (not only from divorce but also the impact of inflation and mortgage rates) and raises potential issues in the context of financial arrangements on divorce. 

Much of the process in financial remedy proceedings is an accounting exercise to consider what net capital and net income is available for distribution between the parties and what each party “needs”.  The theoretical assumption is that all assets available to the parties will be liquidated and all applicable costs of sale and taxes deducted. And so, of course, it follows that any changes to capital gains tax rates and reliefs will have an impact on the net asset position.  The introduction of VAT on school fees will have an impact on their affordability from net income. Stamp duty land tax changes will have an impact on the cost of rehousing. The tax treatment of pensions impacts on retirement planning and income needs in later life. Ongoing maintenance orders (including for the payment of school fees) may also need to be reviewed if new tax changes and increased outgoings makes them increasingly unaffordable. The incidence of tax and reliefs can also be highly relevant when looking at the timing and structure of settlement options. 

So what are the expected changes and how might these impact on family lawyers and their clients?

VAT 

It is already established that VAT will be applied to school fees with effect from 1 January 2025.  Although many private schools have already announced they will do what they can to mitigate the impact of a full 20% increase, by setting off the VAT they pay on their outgoings, the affordability of school fees orders (either in the making or long since sealed by the court) may be called into question and need to be reviewed. English matrimonial law allows scope for such review at any point where substantial changed circumstances require. Consequently, we may see an increase in applications to vary school fee payments and applications for specific issue orders to change a child’s school. This looming issue is discussed further by my colleagues here.

Capital gains tax

From a family law perspective, quite sweeping beneficial changes were made last year to the no gain/no loss CGT rules on transfers between separating spouses.  Previously, in order for a transfer between spouses to take place on a no gain/no loss basis without triggering an immediate charge to CGT, transfers were required to take place within the tax year of separation.  The window within which to make such transfers has now been increased to three years, or even without deadline if the transfer is made pursuant to a court order. No more hurried and potentially premature asset transfers prior to 5 April….

But what of the rates of CGT and other potential changes that might impact divorcing couples? Sir Keir Starmer pledged during the election campaign that the sale of the main home would not attract CGT, as has long been the case, but there is still plenty of scope for other changes to CGT rules and commentators appear to be focussing on this. Many anticipate a return to taxing capital gains at income tax rates which are typically higher than CGT rates, and this could lead to a doubling of estimated CGT liabilities in circumstances where the applicable rate increases from 20% to 45%. That could have a material impact on the net asset position of a couple. Other possibilities include raising the current flat rates of CGT (currently 20/24/28% according to asset type) which, again, would have an impact on the net assets available.

Changes also seem to be afoot at some stage for private equity investments with the tax on carried interest payments also under the spotlight. The government has pledged to “close the loophole” that currently allows “carry” to be taxed as capital gains and therefore at much lower rates than income tax rates if fund managers put their own capital at risk. The counter-argument is that carry is performance-related pay that ought therefore to attract (what are currently higher rates of) income tax. Again, changes to the tax treatment will impact on available capital/income available for separating spouses if one of them is in that sector.

Colleagues have commented elsewhere on the impact of potential changes to the CGT and non-dom tax rules (for the latter see further below).

To the extent that these predictions may be correct and wealthy individuals choose to relocate to other jurisdictions for tax purposes, might this also lead to an increased number of cases where jurisdiction disputes arise and/or claims for financial support in England following an overseas divorce?

Inheritance tax

There is a widespread expectation of changes to inheritance tax. Amongst suggestions are changes to: the rate of inheritance tax; the residence nil-rate band and/or nil-rate band; inheritance tax reliefs, including the lapse of time required for potentially exempt transfers to qualify as exempt, or introducing a ‘double death tax’ by charging both capital gains and inheritance taxes simultaneously rather than permitting a CGT rebasing upon death as currently.

Anecdotally, with these potential changes on the near horizon, many families are looking to pass down generational wealth in some haste before any changes on 30 October. Where wealth is passed down to a married child, the gifting parents may be concerned about the risk of swapping a potential 40% saving of inheritance tax charge for a potential 50% divorce claim should the receiving child subsequently suffer a divorce and a spousal claim. The law on the treatment of “inherited” wealth on divorce is complex and beyond the scope of this article, but in certain circumstances it may already attract a degree of protection by being classified as “non-matrimonial property” to which the “sharing principle” does not apply.  However, it is still likely to be taken into account as a resource of the inheriting party and risk remains where such inherited wealth may have been “mingled”, for example invested in the matrimonial home and/or where there is otherwise insufficient available to meet the other spouse’s needs. It will be important to take advice prior to making such a gift to understand the potential risks and it may be sensible to consider a post-nuptial agreement and/or some form of deed recording the basis upon which the gift has been made. 

Pensions

The government has pledged not to reintroduce the lifetime allowance on pensions, but they have promised a pension review.  Again, this seems fertile ground for changes which may impact on the 25% tax free lump sum that can be drawn, the age at which a defined contribution pension can be drawn, or changes to income tax relief on pension contributions. 

Whatever changes are or are not made, it will be interesting to see whether they create any scope for unlocking potential efficiencies by the creative sharing of pension assets on divorce. In any event, it will remain important to give consideration to the impact of pension changes on cashflow modelling and retirement planning. 

In the family law realm, it is also worth considering that if changes to the income tax relief on pension contributions lead to adjusted payments into a private pension scheme, this may have an impact on the formulaic Child Maintenance Service calculation which takes such contributions into account.

Council tax

Reform of council tax has not been ruled out.  To the extent that this may increase council tax, it will impact on both parties' income needs and the disposable income available to meet those needs.

Non-dom reforms

The Labour government has picked up the baton from the former Conservative government in making radical changes to the tax treatment of non-domicilliaries. Again, the detail and scope of these plans is far beyond the remit of this article but see here for further details.

Suffice to say for these purposes that such sweeping changes may also impact on divorcing couples. For example, it may reduce the net assets and income available for division between parties on divorce and, if the changes trigger a relocation of either of the parties and/or their assets, it may also increase jurisdiction disputes and/or make orders more difficult to enforce. 

However, the changes may also offer one rare possible ray of light: in the short-term, transitional rules will offer a complete exemption from tax on foreign income and gains remitted to the UK over the next four tax years.  Might that offer a chance to take advantage of a potential increase in net asset position if planned carefully?

Summary

It is clear there is a veritable menu of potential tax changes that may be implemented in the Budget.  The government’s warnings of “pain” mean that none of the potential changes look particularly appetising. What does seem clear is that the finances of divorced or divorcing couples that are already strained and requiring careful calibration on divorce are likely to receive an as-yet-unclear further hit; one that family lawyers will need to be mindful of when balancing both parties’ available resources and needs.