It’s certainly no secret that divorce is an expensive proposition, and the mathematics behind it are fairly simply to explain: the higher the couple’s net worth and shared asset value, the more expensive the divorce is likely to be.
Naturally there are divorce lawyers serving the niche market of high net worth individuals, but even those clients are keen to find ways of lowering the overall cost of their divorce. One frequently asked question which gets posed of divorce lawyers and accountants alike is whether or not divorce lawyers’ fees are tax deductible.
In this article, we’re going to take a closer look at divorce lawyers’ fees and their relationship with expenses that can be claimed against income tax.
So, can I claim my divorce lawyer’s fees as a taxable expense?
In virtually every case divorce lawyers fees cannot be filed by your accountants as part of your tax return since the divorce lawyer fees are not tax deductible. Our advice is that you should carefully look to see whether there are any exceptional circumstances and must take specific advice from a qualified and established accountant for this reason. The Revenue now have a very strict regime and if they can argue that the expenditure is not wholly and exclusively a business expense because it may be of benefit to one of the individuals then it will be a taxable a benefit in kind. This is particularly so if it has been included as a taxable deduction for corporation tax.
Many accountants will no advise in any circumstances to allow this as a deductible expense. This may be taken in the background due to the fact that the partners in the company may take advice generally together with your client in relation to the impact of any divorce proceedings on the company generally. The facts of each individual case must be carefully considered to ensure that it is not in any way a benefit in kind but a genuine concern that has led to the advice being taken in the first instance. If specific advice is sought through the divorce lawyer or company solicitors as to how the wife’s shares can be dealt with to cause the least impact to the business, then these may well be a deductible expense. Again, each case must be carefully looked at by the accountant and no one should assume that these will automatically be accepted as deductible expenses. Please note that any agreement to put such expenditure through must be with the express agreement of all other shareholders provided that the accountant advises that it is appropriate to the individual company to do so.
Can we at least be more tax efficient?
Whilst divorce is a costly business, there are often situations where a husband and wife have started a business together. Once the relationship has turned and its conclusion is inevitable, it’s important that they agree upon what is to be done with the business.
We’re going to take a look at a few simple scenarios which each offer a different way of looking at each other’s tax liability when going through a divorce.
Shares are usually used as a powerful bargaining tool when working toward a divorce settlement, and a deep analysis of those here would take this article in way too much of a tangent from its original intention. The important point being made here is that, once a settlement is reached, attention must be turned to the Capital Gains Tax of any share transfer that takes place. The Capital Gains Tax will vary, based on nothing more complicated than the date on which the shares are transferred.
Before we break down a few scenarios, the overall message here is that it’s prudent to arrive at an agreement quickly to avoid over complicating anything related to tax. Put simply, the longer it takes to arrive at an agreement, the more complicated the tax implications will be.
Our case study concerns Mark and Stephanie, who started a business together 8 years ago and have enjoyed a good level of success. At the time of incorporation, the business had a value of £20,000 and it’s now worth £200,000, with Mark and Stephanie each holding a 50% stake in the business.
In the first scenario, Stephanie agrees to transfer her shares to Mark during the same tax year in which they separate, but before they divorce. Whatever Mark pays for those shares is not relevant in terms of Capital Gains Tax because it is regarded as a transfer between husband and wife. Mark acquires the shares at Stephanie’s original base cost and will then pay Capital Gains Tax on the profits he makes when he eventually sells his shares. At the same time, Stephanie is left with no Capital Gains Tax liability.
They may well agree for Stephanie to make a contribution to Mark’s Capital Gains Tax bill, but this would be strictly a private arrangement and there is no legal requirement for them to do this – it simply comes down to how amicable their divorce settlement is.
In the second scenario, Mark and Stephanie separate but do not reach an agreement on the distribution of assets until well into the following tax year. Capital Gains Tax will need to be considered on the share transfer because the shares are not transferred in the same tax year as their separation.
This is a key point because Mark and Stephanie are still regarded by HMRC as a married couple, and that means that they are treated as connected for tax purposes. Regardless of what Mark pays for his shares, HMRC will substitute their market value, which is £100,000. Therefore, Stephanie will be showing a capital gain of £90,000. If she takes no action, she’ll be looking at a Capital Gains bill set at her marginal rate of tax. If she is a higher bracket taxpayer, then the current rate is 20%
However, if Stephanie has a minimum 5% shareholding and voting rights, and is an officer or employee of the company, or if she has applied for entrepreneur’s relief, then it is possible that her Capital Gains Tax liability can be lowered to 10%.
In the third scenario, Mark and Stephanie are unable to agree upon a share transfer until after their decree nisi is granted. At this point, they are no longer connected for tax purposes and therefore the Capital Gains Tax will be a simple calculation of the profit earned once either Mark, Stephanie or both of them sell their shares.
Naturally, these three scenarios work on the premise that the couple will be unable to work together once the divorce has been finalised. However, this is not always the case, and there are many divorced couples who remain on as shareholders and active participants in the business, because they recognise that whilst their relationship as husband and wife no longer works for them, their business partnership is a solid one and their business truly benefits from their both being a part of it.
In this final scenario then, Mark and Stephanie remain on and simply assume their own, individual tax liabilities.
Where one party either gives away assets or sells them for less than they’re actually worth, they may be able to claim gift hold-over relief. This means that no Capital Gains Tax is payable at the point that the assets are transferred and the person to whom the shares are given pays this tax when they sell the shares.
We mention this here because such a claim must be made jointly by both parties, so we’d really need to be looking at an amicable settlement here. In this scenario, Stephanie can claim holdover relief, which means she avoids a Capital Gains Tax liability. Mark will pay tax when he sells his shares, and then the whole thing plays out very much as it did in our first scenario.
Once again, we would advise that sound advice is sought from an accountant in order to bring about the most tax efficient scenario.