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UK residents are liable for UK capital gains tax (CGT) on any profits above and beyond losses and the yearly CGT exemption unless they opt to be taxed on a remittance basis and don’t bring the gain back into the UK.
In simple terms, profits or “gains” are the difference between the original cost of an asset and the sale proceeds. However, when it comes to foreign assets traded in currencies other than GBP, taxable gains can be exaggerated or sometimes even created from a loss in the base currency due to foreign exchange (FX) rate fluctuations.
Consider an example: A US investor, residing in the UK for over seven years* buys shares in a US firm. The shares, bought on 1st February 2006 for $100,000, were sold on 31st January 2022 for $110,000, making a profit of $10,000 in the base currency. (*The importance of seven years is that if the remittance basis were selected, a £30,000 charge would apply)
Suppose this gain of $10,000 is transferred to a UK bank account on the sale date and converted into GBP at a rate of 0.714. This results in £7,140 being added to the account balance. The investor might think they’ve realised a capital gain of £7,140, which falls under the annual CGT exemption, so no CGT is payable.
However, when reporting this transaction to HMRC, the story changes.
On the purchase date, the exchange rate was $1 = £0.50, and on the sale date, it was $1 = £0.714 (These are actual rates, not hypotheticals!). HMRC demands that we convert the initial buying price into GBP using the purchase date’s FX rate (£50,000) and the selling price into GBP using the selling date’s FX rate (£78,540), resulting in a gain of £28,540.
The investor now faces a predicament. They’ve made a real gain of £7,140 yet are obliged to report a pre-exemption gain of £28,540 to the HMRC!
The HMRC’s method of calculating gains was challenged in Bentley v Pike and Capcount Trading v Evans. However, in both instances, the courts supported the HMRC’s approach. Also, if you’re disposing of a foreign asset that is a non-reporting offshore fund, the potential tax implications could be more significant. The inflated gain may be taxed at income tax rates, usually higher than CGT rates, with no exemption or offsetting of losses. If you need help regarding tax calculation and compliance, please contact Tax Accountant at 0800 135 7323 or email info@taxaccountant.co.uk for expert advice.