Separation and divorce:
Taxation of the settlement

The final settlement will include one or more of the following:

A lump sum payment from one party to the other

A lump sum payment for any children

Periodic maintenance payments from one party to the other

Periodic maintenance payments for any children (provided the parties agree, if not it is dealt with separately by the Child Support Agency)

The transfer of property from one spouse to the other

The sale of property (for example investments or the family home)

A share in a pension fund.

Periodic maintenance payments do not form part of the taxable income of the recipient for income tax purposes, nor is there any tax relief for the payer.

Payments of maintenance (including lump sums) are exempt from inheritance tax.

Transfers of assets between the parties are exempt from inheritance tax if the transfer occurs before the decree absolute. If the transfer occurs after that, then the person making the transfer must survive for 7 years for it to be exempt from inheritance tax (unless it qualifies for another exemption or relief).

After the end of the tax year following separation, any transfers of assets between the parties may be liable to capital gains tax. From separation to the decree absolute, the parties remain connected(see Jargon buster) to each other and any transfer is deemed to take place at market value. Whether capital gains tax arises will depend on:

Jargon buster: Connected persons

For capital gains tax purposes you are connected with your spouse, an relative (sibling, ancestor or lineal descendant) of you or your spouse and with the spouse of any such relative. There are also rules in respect of trustees, business partners and companies and the circumstances in which you may be connected to them.

Any transaction with a person (or body) you are connected with is treated for tax purposes as being made at the market value, even if no money changes hands.

For example, if you are married and give your spouse shares worth �15,000 there is no capital gain, as transfers between spouses are treated as made at a value giving rise to no gain/no loss.

If, however, you are separated and give (following the end of the tax year) your soon-to-be-ex spouse shares worth �15,000, you are treated as though you had sold the shares for �15,000 (and your spouse is treated as though he or she had bought them for �15,000). This could result in a chargeable gain and a capital gains tax liability.