Time test for tax exemption upon spouses’ community property settlements

Under private law, the community property of spouses also includes a spouse's share in a business corporation if the partner- or membership arouse during the marriage. At the same time, the acquisition of such share does not establish the other spouse’s participation in that corporation. Shareholding thus has two dimensions: the first one is the personal, ‘non-property’ value,  i.e. the rights and obligations arising from being a partner/member in the business corporation; the second one is the property value, which is common to the spouses and is part of their community property. This property value is subsequently also subject to a community property settlement, for instance, in the event of divorce.

A paper recently issued by the Coordination Committee of the General Financial Directorate (GFD) and the Chamber of Tax Advisers aims to clarify the ambiguity regarding the application of the time test for the exemption of income from the sale of shares in the context of community property settlements. Under the time test, income from the sale of a share shall be exempted from personal income tax as long as the individual held the share for at least five years prior to the sale. While for income from the sale of real property the Income Tax Act clearly stipulates that the time test shall not be interrupted by community property settlements, there is no such explicit regulation for shares and securities. 

A practical example might look like this: during the marriage, a husband became a member of a business corporation, therefore his share became part of community property. However, for the entire duration of the marriage, only the husband was registered as a member in the Commercial Register. Subsequently, after 10 years, the marriage was divorced and, under the concluded agreement on the settlement of community property, the share was transferred to the sole ownership of the wife. Two years after the settlement, the wife decided to sell the share in question. Should only the two years of the wife’s exclusive ownership of the share be taken into account for the purposes of the time test, meaning that the income would not be tax exempt? Or should also the previous 10 years during which the share was part of the community property but the wife was not in the position of a member (i.e. could not exercise the rights and duties of a member and was not registered in the Commercial Register) be taken into account, meaning that the income would be tax exempt?

The paper proposes a unifying conclusion: community property settlements do not interrupt the running of time tests as they do not constitute new acquisitions. This approach is also proposed for other cases where the Income Tax Act does not explicitly regulate the running of the time test in the context of community property settlements. E.g. for motor vehicles, the time test for tax exemption is one year, and here too, only one of the spouses is registered as the owner in the relevant register (technical licence), although the vehicle was acquired during the marriage and constitutes a part of community property. Following discussion in the Coordination Committee, the General Financial Directorate confirmed the proposed conclusions. Community property settlements thus should not cause unexpected tax complications through the interruption of time tests.