Spouses and cohabitees: Tax issues

The withdrawal of the married couple’s allowance from 2000/01, together with the uniform personal allowance for all individuals irrespective of marital status, has meant that married and cohabiting couples are now on a par with each other for income tax purposes (although this changed, once again, from 2015/16 with the introduction for eligible married couples and civil partners of an election to transfer part of the personal allowance of one spouse/civil partner to the other).

In a similar fashion, for CGT purposes, the annual exempt amount (up to £12,300 for 2020/21) is available to all taxpayers (and hence as much to the advantage of both husband and wife as to each of a cohabiting couple), whilst for IHT purposes, the general exemptions (ie £3,000 per annum, gifts in consideration of marriage and normal expenditure out of income) are available to all.

State benefits

No distinction is made between married and cohabiting couples for the purposes of working tax credit and child tax credit (CTC): both credits are available irrespective of whether a couple are married or living together as husband and wife. They are also available to lone parents. These credits (which are gradually being replaced by universal credit), particularly CTC, are concerned mainly with children; it is the children who make up the family, and it is the children who should be supported irrespective of whether their parents or carers are married or not.

It was believed by some that to treat cohabitation on a par with marriage for taxation purposes would be impractical in cases where that relationship was likely to be transitory; in other cases (notably situations falling within the old idea of ‘common law marriage’) a different argument could be thought persuasive, albeit that deciding when a temporary arrangement had become permanent could be far from easy. These concerns are no longer critical when it is the child of the relationship that is being supported rather than the relationship itself.

Capital taxes issues

That having been said, the distinction in tax law between a married couple and those living together as husband and wife (and those living together as civil partners) persists in other important areas. Crucially, special reliefs are available to a married couple that enable assets to be transferred inter se without the risk of any tax charge.

For IHT purposes, this relief is unlimited in amount save for the situation where the donee spouse is a non-UK domiciliary (and therefore potentially outside the UK tax net).

For CGT purposes, disposals between spouses are treated on a no gain/no loss basis (see TCGA 1992, s 58). As some (limited!) compensation, it may be noted that various anti-avoidance rules based upon a ‘connected persons’ test will not normally apply to cohabitees. In such cases transactions between the cohabiting couple will be taxed in the same way as transactions between strangers.

Take, for instance, IHTA 1984, s 10, which is intended to ensure that IHT does not catch a transfer that is a bad bargain. In the case of a transfer between cohabitees, in order to avoid any question of an IHT charge, it is only necessary to show an absence of gratuitous intent on the part of the transferor. It is not necessary to go further, as is the case when the transferee is a connected person, and to show the transfer in question is one that would have been entered into with a third party. Admittedly, this is small beer in the majority of cases where the crucial point in any case where property is transferred between a couple (whether married or otherwise) will be the exemption from charge for inter-spouse transfers.

Consider, however, as a second illustration the CGT rules which tax the settlor on the gains realised by his trustees in cases where he has retained an interest in his trust. For UK trusts, TCGA 1992, ss 77, 78 limit the charge to situations where the settlor or his spouse (no mention of other members of the family, nor of cohabitees) can benefit directly or indirectly from property in the settlement. The legislation on offshore trusts goes further: a settlor has an interest if a benefit may be enjoyed by a category of ‘defined persons’ which includes children (plus their spouses), stepchildren, grandchildren and companies controlled by such persons (including any company controlled by that company). Still no mention of the cohabitee!

Disadvantages for cohabitees

Those small advantages aside, it is the absence of any capital tax relief for transfers inter se which is the greatest disadvantage facing cohabitees. Elementary tax planning schemes are, as a result, fraught with difficulties. For income tax purposes, for instance, ensuring that a couple take full advantage of their individual allowances and of the basic rate tax band will frequently involve an outright transfer of an income-producing asset.

In the case of cohabitees, care must be taken to ensure that if that transfer is of a chargeable asset it falls within the transferor’s annual CGT exemption whilst, for IHT purposes, if that transfer exceeds the £3,000 annual exemption it will constitute a potentially chargeable transfer. Will drafting for the cohabitor is likewise a problematic exercise: if everything is left to his cohabitee, the estate will be subject to a 40% tax levy once the £325,000 nil rate band has been exhausted. There is no exempt transfer to shelter behind in such cases: no simple channelling operation which can be performed to make any tax liability disappear as in the case of married couples.

A common trap which may arise is illustrated below.

Example: Co-habiting couple: Death and intestacy

Terry and June cohabit in No 44 Railway Cuttings, a house which they own as joint tenants. Terry dies without having made a will (a negligent death) with the result that his free estate (ie his property other than his share of Railway Cuttings) passes to his parents. June is not entitled to any property on his intestacy although she could bring an action for reasonable financial provision under the Inheritance (Provision for Family and Dependants) Act 1975 provided she can show that she was financially dependent on Terry. In cases where both cohabitees have had full-time jobs this is unlikely to be the case.

The total value of Terry’s estate exceeded the IHT nil rate threshold: Terry’s half share in the house is worth £200,000 and his free estate is likewise worth £200,000 (it may in passing be noticed that in valuing Terry’s half share in the house a discount on the basis of the joint occupation should be allowed. Such a discount is not, of course, available in the case of a half share owned by husband and wife because of the related property rules in IHTA 1984, s 161).

The IHT bill (ie £30,000 assuming that Terry had an intact nil rate band) will result in an estate rate of 7.5% and June will be accountable for the £15,000 attributable to Terry’s share in the house since the burden of IHT charged on joint property falls on that property. She has received nothing under Terry’s intestacy and given that his parents may be unwilling to make any contribution towards the IHT charge on Railway Cuttings, the end result is that unless she can afford to raise a mortgage or alternatively to pay the tax in instalments (with interest) she will end up being forced to sell the house.

 

Successive governments have made it very clear that they will not entertain the idea of equating cohabitation of couples with marriage, although an exception has been made in part of the statutory residence test (ie the family tie).

Moreover, a Special Commissioner has explained (in an obiter dictum: see (Holland (executor of Holland, deceased) v IRC [2002] SpC 350) that the treatment of cohabitees is not in breach of the European Convention on Human Rights and that it is permissible for Parliament to legislate for different tax provisions to apply to married persons, since this reflected the mutual rights and obligations brought about by marriage. The later decisions of the ECtHR in Burden and another v United Kingdom [2008] All ER (D) 391 (Apr), a case concerning two elderly sisters who had lived together for all of their lives, and Courten v United Kingdom [2008] ECHR 1546 (concerning a co-habiting same-sex couple) confirm this view (the outcome of the later appeal in Burden to the Grand Chamber of the ECtHR was the same, but the court reached its conclusion on a different ground that would not be relevant to cohabitees).

Further information

The above article is based on an extract from Revenue Law: Principles and Practice (37th Edition). For further information and ordering details, please visit our website

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Mark McLaughlin

Written by Mark McLaughlin

Mark McLaughlin CTA (Fellow) ATT (Fellow) TEP is a consultant to professional firms with the TACS Partnership LLP (www.tacs.co.uk). Mark is also co-founder of TaxationWeb (www.taxationweb.co.uk).

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