Lee Sharpe looks at the tax implications of joint ownership, inside or outside a formal marriage or civil partnership.
Much tax planning orients around distributing assets and (where possible) income between a couple. This is usually considered in reference to a married couple or civil partnership. This article considers some of the key differences between those who are legally ‘a couple’ and those who are merely co-habiting.
As a general rule, the aim is to balance income between both individuals. Typically, this is to maximise the use of the available tax-free personal allowance and lower tax rate bands – so that as much income as possible is taxed at 0%, 20%, etc.
Common law marriages
There is a concept of ‘common law marriages’ such that long-term cohabitation will suffice. This is not recognised in tax law.
I have occasionally encountered couples who referred to themselves as ‘married’ for many years, and where previous advice has been founded on their being legally married when actually they were merely cohabiting. This has not ended well.
Benefits/child benefit clawback
Having warned that tax law does not recognise so-called ‘common law marriages’, note that state benefits legislation commonly restricts income-based entitlement where couples cohabit, whether married or in a civil partnership or not. Proving whether or not you are in a couple can be quite challenging (and intrusive) – there was even a case reported in the press where HMRC withdrew tax credits because it thought a claimant was cohabiting with the post office at her local newsagent!
Unfortunately, the high-income child benefit charge claws back the benefit from whoever has the higher relevant income in the couple, regardless of whether they are married or in a civil partnership, or merely cohabiting; and regardless of who in the couple actually claimed the benefit in the first place. From a property income perspective, note that the increasing disallowance of tax relief on mortgage interest for residential lettings means that many landlords’ deemed taxable incomes are increasing, even if their real incomes are broadly static.
Marriage allowance
The transferable tax allowance, or ‘marriage allowance’, effectively transfers 10% of one individual’s tax-free personal allowance to the other, so that the beneficiary enjoys a £1,250 x 20% = £250 tax reduction (using 2019/20 rates). However, it is available only where both individuals are not taxable at higher rates; so here again, the ongoing add-back of interest on loans for residential lettings could impose an artificial restriction.
Where both spouses or civil partners are already receiving income into their respective basic rate bands, there is generally no advantage to using the transferable tax allowance.
Capital gains tax exemption
Most readers will be aware that capital gains tax (CGT) permits the transfer of property between spouses and civil partners who are living together as a couple, without triggering a CGT charge.
Note that more generally, gifts and transfers at undervalue will trigger a CGT charge on the market value of the transfer, regardless of actual proceeds (if any). So gifting an interest in a property to a child, or to a cohabitant (where not married, etc.) will usually trigger a CGT charge.
Inheritance tax exemption
Spouses and civil partners can generally transfer assets between themselves during life or on death largely without an inheritance tax charge. Note that there are special rules where one of the spouses is not domiciled in the UK, although the regime is more permissive than it used to be; the issue of domicile is becoming increasingly common, as individuals tend to be more internationally mobile.
Having established that being married or in a civil partnership can make life much easier from a tax perspective, we should also consider where it can make life more complicated.
Deeming rules for joint incomes
Where a couple or civil partnership owns property jointly, tax law by default assumes that income therefrom will be split equally, and actual ownership proportions are irrelevant. While it is possible to displace the 50:50 split, this can usually be achieved only by joint notice to HMRC and then only by reference to the actual underlying beneficial ownership split between the couple.
This is quite different for unmarried couples, who can basically split their income entitlements however they agree, without having to follow the underlying beneficial ownership in the property.
Example 1: Co-habiting couple
Bill and Ben are a couple but not married or in a civil partnership. They have an interest in a single rental property, owned 3:1 in Bill’s favour. However, Ben tends to earn a little less from other sources than does Bill, so without changing the underlying ownership, they agree to split the income 90% to Ben and 10% to Bill.
So, even though Bill actually owns most of the property, Ben gets most of the income (but see also ‘settlements legislation’ below).
Example 2: Married couple
Phil and Sam are married. Phil is already a 40% taxpayer from his employed income, while Sam earns £45,000 and is a basic rate taxpayer. So, Phil transfers a 10% stake in his rental property, which generates £10,000 net income a year, to Sam (which will trigger no CGT charge as they are married). Tax law will assume that the property income is split £5,000 each per year unless Phil and Sam jointly notify HMRC that Sam has only a 10% stake in the property.
Initially, there is no benefit in doing so because Sam’s default £5,000 share takes her just up to the £50,000 threshold at which 40% tax is payable. But then Phil has an accident and cannot work so his non-rental income falls to £nil. At that stage, it makes sense to make the joint election and have Phil in receipt of 90% of the income, reflecting the underlying split of beneficial income.
In fact, it might be a little more tax-efficient to transfer Sam’s 10% share back to Phil, giving Phil all of the £10,000 annual rental income, which would be fully covered by Phil’s tax-free personal allowance (£12,500 in 2019/20) and for Phil to elect to ‘transfer’ 10% of his tax-free personal allowance to Sam, so that Sam will get a £250 reduction in her tax bill; this minimises Phil’s spare personal allowance, which would otherwise be wasted.
Settlements legislation
There is anti-avoidance legislation, commonly referred to as the ‘settlements legislation’, that acts where someone diverts income to another taxpayer but continues to benefit from that income. Where this is considered to arise, basically the income is deemed to belong to the donor for tax purposes, even if the gift is legally effective.
There are two important restrictions to the settlements legislation:
- Basically, where the gift from one spouse or civil partner to the other is not just a right to income but also of the underlying capital; this actually ties in fairly neatly with the above rule that deems income to be split 50:50 unless the couple elects to have it split in accordance with underlying beneficial ownership. If one spouse transfers a 20% stake in their rental property to the other, they can deviate from the 50:50 equal income split but only to 80:20, but not (say) 30:70 or 60:40.
- At first glance, the settlements legislation might appear to undermine Example 1 of Bill and Ben above. But so long as Bill does not subsequently benefit from the income transferred to Ben, then there is no settlement, e.g. the funds go to an account only in Ben’s name, and Ben spends the money entirely on himself.
Conclusion
While the potential trap of the settlements legislation should not be overlooked, couples who are not married or in a civil partnership should generally find it easier to split joint incomes as they like. Where the business is a partnership, spouses and civil partners do not have to follow the 50:50 rule above (although HMRC generally argues that property is merely jointly owned, rather than run as a partnership).
Of course, spouses can benefit from a more favourable tax framework when it comes to transferring the underlying ownership of property, although in all cases, it is recommended that advice be sought beforehand – stamp duty land tax (or its local equivalent) may be in point, depending on the circumstances.
