Rob Noble-Warren, founder of Independence Financial Planning, explains how to protect your assets from a costly divorce
The couple walked into the office and announced their impending marriage. "What are the rules in this country on a divorce?" the lady said. She was from Iceland. He, a British management consultant trained at Insead, was more precise: "What we want to do is make sure that if we divorce, we can have a clean break. So how can we do that?" "I don't think you can," I said. "You might have considered this before you met - if you wanted this kind of planning to be effective."
I explained that the divorce courts in the UK are subject to what the lawyers call the 'whims of the judge'. A nuptial settlement is one made for the benefit of the parties to a marriage during a marriage or in contemplation of it. Whether a settlement is ante-nuptial or post-nuptial, the divorce court has jurisdiction under section 24 of the Matrimonial Causes Act 1973 to vary it in whatever way it wishes.
From the point of view of the courts, a marriage is not so much a partnership where both parties agree to do certain things, but a merger where no person can sue for lack of performance.
A pre-nuptial agreement is not binding in UK courts, but is good evidence of a couple's intentions. Unless this is renewed every two or three years, though, you can expect a pre-nuptial to fade in importance in a divorce court.
Putting assets into trust just before a marriage is no answer, either. In the first case, as already pointed out, the terms of the trust can be adjusted by the courts. Only if the trust had been in place for some time before the two parties ever met could one reasonably expect the courts to exclude the assets of the trust from any divorce settlement. In the second place, under the new rules for trusts, there will potentially be immediate amounts of tax to pay upon the setting up of an arrangement.
Moving money offshore has been a popular strategy in the belief other jurisdictions will not respond to a UK court's request for information. With money laundering and anti-terror laws having an effect, however, this is a shaky long-term tactic.
In the Jersey Fountain Trust case (2005 JR C099), the trustee of a Jersey law trust sought directions in Jersey as to how to respond to an English High Court judgment setting aside the trust as a sham and ordering the trustee to transfer the trust assets to the wife. The Jersey court found it would be appropriate to give effect to the High Court order because the trustee had submitted to the jurisdiction of the High Court and had failed to protect the trust assets. Furthermore, transfers to an offshore trust would not be eligible for capital gains tax holdover relief and the settlor-interested provisions - in Schedule 5 and section 86 of the Taxation of Chargeable Gains Act 1992 (TCGA) - are much more widely drawn than those in the UK, although a 'grandchildren-only' trust is still outside these.
The faces of the pair in front of me were getting longer. "Which assets do you want to protect, and why?" I asked. "My father does not want there to be a problem with the family business," said the husband-to-be. "If there is a divorce, he does not want to be held to ransom by some party that is not part of the family." "But obviously," said his fiancée, "we want to share in the assets of the marriage."
There is nothing to prevent a family company changing the rules regarding the transfer of its own shares. Companies can adjust their articles of association so that every shareholder must offer the shares for sale to the existing shareholders first.
These restrictions would need to be abandoned if the company went public - and just how the rest of the family felt about that would have to be considered. In effect, this only works if the family works together. An option is to confine a spouse's potential beneficial interest in company shares to an income interest only. There would usually be no tax effect on making this kind of change.
"The other way of dealing with the problem is not to inherit at all," I said. "Make sure your father never gives you assets directly. Let your father's assets skip a generation. Or, since the shares in the family company qualify for business property relief, in effect you can still create discretionary trusts, but he needs to be careful."
The father could create a wide discretionary trust for everybody in the family, excluding the spouses. There should be no inheritance tax charge on the creation of the trust - to the extent business property relief is available - and there should be no capital gains tax.
Provided the trust is run as a genuine discretionary trust - for example, make some payments to any grandchildren, from time to time - it may escape being categorised as nuptial. It would also help to create a letter of wishes expressly stating the primary purpose of the trust is to hold capital for the benefit of future generations, not to appoint it to the next generation, and for the trustees then to follow those wishes.
Or the father could create a protective life interest trust for his son, followed by accumulation and maintenance trusts for the next generation but again expressly excluding spouses. The gift to the trust would be a potentially exempt transfer for inheritance tax purposes, but the only capital gains tax relief potentially available would be that under section 165 of the TCGA 1992, and so there could be a tax charge in relation to any excepted assets.
There may also be a future inheritance tax exposure on the death of the son. One suggestion here would be to give the trustees power in the future to add beneficiaries, without restriction, so that in later years they could bring his wife in and, for example, confer a successive revocable life interest on her, but this would again be a matter of fine judgment at the time.
Or the father might consider setting up an immediate accumulation and maintenance trust for his existing and any future grandchildren. However, these are no longer income tax effective, following the withdrawal of repayable tax credits.
Of the three, perhaps the second choice might be the best for the family.
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