The higher a divorcing couple’s net worth and shared asset value, the more complex the process is likely to be. As a result, divorce costs follow this trajectory, leading couples to find ways to lower the overall cost of their divorce. In this article, we look at whether divorce costs are tax deductible and if VAT can be claimed back.
What are the general principles?
The general principle for deciding whether a legal fee is tax deductible is whether it passes the “wholly and exclusively” test? This means were the legal fees spent wholly and exclusively for the purposes of the business. For example, fees relating to a trade dispute are deductible, but those in relation to a private dispute are not.
VAT on divorce-related expenses cannot generally be reclaimed, as these costs are considered personal and not related to the operation of a business. HMRC only allows VAT to be reclaimed on expenses that are incurred for business purposes. Since divorce expenses are personal, the VAT on them is typically not recoverable.
The general principle is considered alongside case law, which can make it difficult to resolve.
Can I claim my divorce lawyer’s fees as a taxable expense?
In almost every case, divorce lawyer’s fees cannot be filed by an accountant as part of the tax return. This is because such expenses are not tax deductible, being inherently personal as opposed to corporate. His Majesty’s Revenue and Customs (HMRC) has a very strict regime, and if they can argue that the expenditure is not wholly and exclusively a business expense because it only benefits one individual, then it will be a taxable benefit in kind. This is particularly relevant if it has been included as a taxable deduction for corporation tax.
The facts of each case must be weighed to ensure that it is not a benefit in kind, but a genuine concern that has led to the advice being taken. If specific advice is sought through a divorce lawyer or the company solicitors regarding how the other party’s shares can be dealt with to cause the least impact on the business, then this may be a deductible expense. The business’s accountant should look at the facts, however, during this process must not assume they will automatically be accepted as such.
Any decision to put through such expenditure must be made with the express agreement of all other shareholders as long as the accountant advises it is appropriate for the individual company to do so.
Is it possible for the divorce to be more tax efficient?
Divorce can be structured in a more tax-efficient manner by considering the timing and nature of financial settlements. Proper tax planning, ideally with the help of a financial adviser, accountant, or tax specialist, can help reduce tax liabilities:
- Transfers of assets between spouses are exempt from CGT while they are still married and living together. After separation, this exemption usually lasts until the end of the tax year of separation. Coordinating the division of assets, such as properties or investments, within this period can reduce or avoid CGT liabilities.
- Maintenance payments between ex-spouses are generally not tax deductible, and the recipient does not pay tax on them. However, child maintenance is tax-neutral. Structuring settlements to ensure that income-generating assets are transferred to the spouse with a lower tax rate could reduce the overall tax burden.
- Divorce does not affect inheritance tax directly, but it is important to update wills and estate planning. Transfers between spouses are inheritance tax-exempt; once divorced, this exemption no longer applies.
What costs relating to a divorce or family case could be claimed back, written off, or offset?
Divorce-related costs typically cannot be claimed back, written off, or offset against tax. However, there are a few limited circumstances where certain costs may be tax deductible or result in financial relief:
- Divorce legal fees themselves are typically not tax deductible for either personal or business tax purposes. Costs associated with personal matters, such as disputes over child custody or the division of assets, are considered private expenses and cannot be written off.
- If the divorce has an impact on a business, such as legal costs associated with defending ownership of business assets, those specific legal fees might be deductible as business expenses. This is because they could be seen as necessary to preserve business interests. However, this depends on the nature of the costs and HMRC’s interpretation of whether they are directly related to the business.
- While legal fees related to negotiating spousal or child maintenance are not deductible, spousal maintenance payments themselves are not taxable to the recipient and cannot be deducted by the payer. However, child maintenance is entirely tax-neutral.
Overall, divorce and family law-related costs rarely offer tax relief, except in narrow, business-related cases. Seeking advice from a tax adviser is essential to navigate these complexities.
Can I claim expenses for a forensic accountant or other expert?
Whether forensic accountant expenses or other expert fees can be claimed as a deductible business cost depends on the expense in question and its direct relation to the business.
If a forensic accountant is engaged to value a business as part of the divorce, the tax treatment depends on whether the costs are incurred to preserve or protect the business. If the forensic accountant is needed to assess the business for purposes such as determining ownership, safeguarding the business’s future, or ensuring its correct valuation for settlement, these costs may be deductible as business expenses. This is because they are directly related to the operation or continuation of the business.
For instance, if you, as a business owner, incur costs to defend your ownership of the business or to secure its fair value in a settlement, those specific costs might be allowable business expenses.
However, if the forensic accountant’s work relates purely to the valuation for the purposes of dividing personal assets in the divorce (not directly linked to the business’s operation or financial survival), the fees would typically be classified as personal and not tax-deductible.
In relation to valuing property held within the marriage (such as the family home, investment properties, or other personal assets), these costs are considered personal expenses related to the divorce. They cannot be claimed as tax deductible or written off. However, if the property being valued is a business asset (such as commercial property owned by a company), and the valuation is required for purposes related to the business (e.g., assessing business worth or ensuring a fair division of business assets), then these fees may be allowable as a business expense.
To ensure the correct treatment, consulting with an accountant or tax adviser is advisable, especially if business and personal interests are intertwined.
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