Marriage split could be costly for small traders

Divorce and separation will always be painful. Picture: Jon Savage

Separation and divorce are always painful and disruptive whatever the circumstances. But they can cause even more upset if you or your family own a business.

In this situation, business decisions taken for taxation or commercial reasons may lead to unintended (and expensive) consequences in the event of relationship breakdown.

As always, it is more effective to anticipate these issues beforehand than try to remedy them amidst divorce or separation.

A common example of business decisions having unintended consequences is a sole trader being advised by his accountant to set up a limited company.

As well as gaining tax advantages, the trader would benefit from limited liability for any debts incurred in connection with the business.

The decision seems simple, but the trader’s wider circumstances should also be considered. What if he had set up as a sole trader before getting married and then converted to being a company after getting married? The decision to incorporate would convert the non-matrimonial asset – his sole trader business – into matrimonial property.

The shareholding in the new company would then be part of the matrimonial pot, and would have to be valued in any subsequent divorce. The spouse could potentially have a claim on at least 50 per cent of the value of the shareholding, whereas had the trader not incorporated, there would be no claim at all.

The trader might argue that, as the shareholding is derived from non-matrimonial property, its full value should not be taken into account.

However, such arguments are all about fairness, and the court would exercise discretion. The case would turn on individual facts and circumstances, with a degree of uncertainty about the outcome.

In addition, there tend to be high costs associated with the exercise of valuing the shareholding as specialist forensic accountants have to be instructed.

In a case like this, the company owner would feel particularly frustrated if the tax advisor has not raised this possibility before the decision to incorporate was taken.

Many clients will feel the advantages of incorporation far outweigh any perceived risk but it is important that the client makes the decision having had all the relevant advice.

Another common example concerns a family business jointly owned by parents and their son or daughter. On marriage, the child’s new spouse may be gifted shares in the family company. But later, if the marriage founders, there can be disagreement about whether the spouse’s shares were part of the matrimonial pot and how much the shareholding is worth.

Since family businesses tend to be private companies and shares are therefore difficult to value, independent forensic accountants have to be instructed. The bill can run into thousands. In addition, the spouse can “hold the shares to ransom” by refusing to transfer them back without getting the financial deal he or she wants on separation.

There are plenty of other possible disputes involving business and family breakdown, and many are avoidable if the business owners take advice. An agreement regulating what should happen in relation to the restructured business if the marriage breaks down can save much strife and expense.

It’s probably not the best commercial sense to base all your business decisions on ring-fencing your assets in case of marriage breakdown. Nevertheless, if you are involved in a family business, it is wise to have your business and tax planning decisions checked by a family lawyer. Similarly, if you are a tax advisor, it is important to point your client toward legal advice before implementing any changes.

l Nina Taylor is a Partner in Lindsays’ Family Law team, winner of Family Law Team of the Year at the Scottish Legal Awards 2016.