Love, marriage and tax planning

01.01.06

Love, marriage and tax planning

First comes love, second comes marriage, then third often comes financial restructuring to minimise tax. Not the familiar song but something people frequently seek to do after getting married. Scott Cochrane considers the challenges in pre-nuptial tax planning.

The ultimate tax planning is of course to get married, as any transfer between spouses is exempt from Inheritance Tax and has Capital Gains Tax advantages too. However, how these plans are put together could have a significant bearing on what may happen in the future if the happy couple decide to go their separate ways.

The farm

A farm can be made up of several units, including land and houses. Where the bulk of these assets are inherited, in Scotland, they are not considered to be matrimonial property. If, however, there is a restructuring of the partnership and redistribution of land or properties amongst family, assets previously considered non-matrimonial property could become matrimonial property due to their change in nature during the course of a marriage. This is significant as the law states that upon the breakdown of a marriage the other spouse is entitled to a cash payment equivalent to half of the matrimonial property. While there are often ways round this, as well as scope for restructuring this liability, it is better to prevent the risk of this occurring in the first place.

Divorce can wake up sleeping partners quickly

Historically the advice was to put a half share of inherited assets into the other spouse's name or make their spouse a partner for tax purposes, as the consequences in the event of a marriage breakdown can be dramatic for the land or the business. What do you do when a sleeping partner suddenly takes an interest in the running of the business and refuses to allow you extension of the business overdraft? Or worse, insists on enforcing that old clause in the partnership agreement that states that both parties should countersign all cheques?

When good advice turns bad

If a shareholder of 50% of the shares of a successful private company acquires further shares while living with his future wife, the shares are not matrimonial property. If however the marriage breaks down, the wife's financial settlement will be, on one view, quite reasonable but, when looked at in the context of the value of the shares, paltry. Meanwhile, the husband and his business partner seek advice to address their mutual tax liability, the solution being to restructure the company. This would potentially, in the long term, give them a considerable saving of Capital Gains Tax. However, the shares in the restructured company are deemed to have been acquired during the course of the marriage. The husband's share of the business has therefore been converted from non-matrimonial to matrimonial property.

Gifts and the shifty son-in-law

As part of an Inheritance Tax planning exercise elderly parents are advised to start gifting their assets to their children. For example, they gift two buy-to-let flats to their daughter, but they don't trust their son-in-law. A condition of this gift is that the daughter and son-in-law sign a post-nuptial agreement, whereby he will have no claim on these properties or any capital or income that derives from them. But what if the daughter later sells the flats and buys a large house as a buy-to-let investment? That house has been acquired during the course of the marriage and is therefore matrimonial property. However, as the son-in-law has signed a post-nuptial agreement, agreeing that he will have no claim on the two original flats or anything derived from them, his claim for financial provision upon divorce is considerably less than it would have been.

The moral of the story

So when there are suggestions that it may be a good idea for tax planning purposes to gift or otherwise change the nature of an asset (for example by creating a new parent company) this advice can also have its downside. The ultimate decision is down to the individual but it must be an informed one and, as the advert used to say "it's never too early to call your solicitor." Otherwise, though the tax man may not benefit, there may be very expensive alternative consequences without careful and extremely un-romantic planning.

For further information, contact Scott Cochrane, Partner in Brodies' Family Law team.