Currency gain or currency pain?
Whilst other industries are suffering as the effects of the financial crisis take hold, things are looking up for the UK tourist industry. Not only did the UK enjoy one of its drier summers in recent years, but the cost for those living in the UK of taking a holiday abroad is now a far more expensive prospect than it was only a few years ago following the drop in value of pound sterling. Similarly, it is far cheaper now for those living in the Euro zone or the United States to visit the UK.
The pound dropped from a high of EUR1.75 in May 2000 (via EUR1.50 in January 2007) to a low of EUR1.02 in December 2008. It is a similar story for the pound in US dollar terms, having dropped from USD2.12 in December 2007 to a low of USD1.35 in January 2009.
But while the UK tourist industry may be rubbing its collective hands with glee, those individuals and trustees with holdings of non-sterling currency or assets denominated in a currency other than sterling must be wary of the UK tax consequences that may arise from such holdings. This article will explore both the UK capital gains tax (CGT) and inheritance tax (IHT) issues that may trap the unwary.
Capital gains tax
Although sterling currency is not treated as an asset for CGT purposes (regardless of whether or not an account is situated in the UK), currency other than sterling (for the purposes of this article, and with apologies to the non-UK readers of this publication, ‘foreign currency’) is treated as an asset (s. 21(1) Taxation of Chargeable Gains Act 1992 (TCGA)). As a consequence, disposals of foreign currency can give rise to CGT.
Billy British (who is both UK resident and UK domiciled) purchases USD300,000 at a time when GBP1=USD2. He then sells this at a time when GBP1=USD1.5.
- Acquisition cost = GBP150,000
- Disposal proceeds = GBP200,000
- Gain realised = GBP50,000
However, ‘disposal’ in a CGT context can include not just sales of assets (or exchanges of currency) but also gifts, transactions at an undervalue and, as we now move on to discuss, mere withdrawals from accounts.
Foreign currency bank accounts
Withdrawals from foreign currency accounts are treated as disposals for CGT purposes (s. 252(1) TCGA). Transfers between foreign currency accounts may also be treated as disposals for CGT purposes (and, arguably, so may transfers between accounts held with the same bank, depending on the circumstances). There are two exceptions to this:
- A withdrawal from a foreign currency account is not treated as a disposal if the account represents currency acquired by the taxpayer for their personal expenditure abroad (or that of their family or dependents). Note that the foreign currency must be acquired for such personal expenditure; if it is acquired for another reason then this exemption will not apply (ss. 252(2) and 269 TCGA).
- By Revenue concession, a UK domiciliary may treat all bank accounts held in a particular foreign currency as one account and disregard transfers between such accounts.
In addition, assuming the second exemption referred to above does not apply (because the taxpayer is not a UK domiciliary), the Revenue has stated that it will accept a net figure for deposits and withdrawals, computed on a monthly basis, to determine the value of any disposals.
Neville Nondom (who is UK resident but not UK domiciled) buys EUR165,000, which he immediately deposits with a non-UK branch of Dodgy Bank at a time when GBP1 is worth EUR1.5. Concerned about the security of deposits held with Dodgy Bank, Neville later transfers the deposit to a non-UK branch of Better Bank at a time when GBP1 is worth EUR1.1.
- Acquisition cost = GBP110,000
- Disposal proceeds (transfer from Dodgy Bank to Better Bank) = GBP150,000
- Gain realised = GBP40,000
If Neville is a remittance basis user (and, if appropriate, has paid his GBP30,000 levy), he will only pay tax on the gain to the extent that it is remitted to the UK. If, as a result of the transfer, Neville realises a loss, he may, depending on the circumstances, from the tax year 2008/2009, be able to set off this loss against any other gains realised by him.
Simultaneous gains and losses
It is possible that an individual may realise a loss in one jurisdiction on the disposal of an asset whilst at the same time realising a gain in the UK because of currency fluctuations. This raises practical difficulties as illustrated by the following example:
Sally Sunlover (who is UK resident and UK domiciled) buys a holiday apartment in Spain for EUR360,000 at a time when GBP1 is worth EUR1.5. The value of Sally’s property falls and she sells her apartment for EUR330,000 at a time when GBP1 is worth EUR1.2. Although she has made a loss of EUR30,000 in Spain, the CGT analysis in the UK (leaving aside the deduction of allowable expenditure or any other reliefs) will be as follows:
- Acquisition cost = GBP240,000
- Disposal proceeds = GBP275,000
- Gain realised = GBP35,000
Although Sally has made a loss in Spain, in the UK she has realised a capital gain. If Sally can immediately convert the sale proceeds into sterling then there will be no actual loss to her (as she will have the GBP275,000 disposal proceeds). However, if Sally cannot convert the money back into sterling (e.g. because she needs to repay a loan in Spain), she will be treated in the UK as having realised a gain, but will not have the proceeds of sale to pay any tax due!
The traps described above can also apply in relation to the rules which attribute to beneficiaries capital gains realised by non-UK resident trusts (under s. 87 TCGA). Trustees of trusts to which these rules apply will need to bear in mind these traps when acquiring and disposing of assets and ensure that their gains log is both kept up-to-date and takes account of these sorts of issues.
Where holdings of foreign currency are concerned, one must also take care to ascertain whether such holdings may be caught by IHT.
The general rule is that, for IHT purposes, bank accounts are situated in the territory of the branch with which the account is held. This applies to both foreign currency accounts and accounts denominated in sterling. Therefore, regardless of the currency denomination, accounts held with a branch that is outside the UK will not be treated as being situated in the UK for IHT purposes. Such accounts held with a UK branch will, however, be situated in the UK for IHT purposes.
There is a limited relief from IHT for foreign currency accounts held with a UK branch under s.157 Inheritance Tax Act 1984. Where an individual is not UK resident and is not domiciled (or deemed domiciled for IHT purposes) in the UK then, on the death of that individual, a ‘qualifying foreign currency account’ is left out of that individual’s estate on death for IHT purposes. A ‘qualifying currency account’ is any account not denominated in sterling with a ‘bank’ as defined in s. 991 Income Tax Act 2007. In this case the term ‘bank’ will cover most institutions that one might ordinarily recognise as a bank, but will not include, for example, building societies, friendly societies or credit unions. This relief can also apply, in certain circumstances, where the deceased was beneficially entitled to an interest in possession under a trust.
It should be noted that this relief is limited to individuals on death and, in particular:
- The relief will not apply to a transfer of a UK situate foreign currency account by the individual during his or her lifetime.
- The relief does not apply to trustees. If the trustees of a trust directly (i.e. not through an offshore company) hold a foreign currency account with a UK branch of a bank, IHT ten-year anniversary or exit charges can apply. This is regardless of the residence or domicile (actual or deemed) of the settlor at any particular time.
Oscar Offshore (who is not and never becomes UK resident or UK domiciled/deemed domiciled) establishes the Emmy Trust in 2009, a discretionary trust the trustees of which are not UK resident. Oscar settles EUR2 million, which he holds in an account with the UK branch of a bank into the trust. Although this would not be included in Oscar’s taxable estate if he died, it will be a chargeable lifetime transfer and Oscar is likely to have to pay IHT on the transfer into trust. In addition, if the trustees continue to hold the account in 2019 (the date of the first ten-year anniversary of the trust), the trustees will be subject to an IHT ten-year anniversary charge of up to 6 per cent.
As will be seen from this article, there are a number of traps to watch out for. The following tips may help to avoid or mitigate these.
- When acquiring assets denominated in a foreign currency, keep a record of the value of the purchase price in pounds sterling and/or a record of the exchange rate at the date of the purchase. It will then be easier to calculate the gain on a subsequent disposal.
- In the case of trustees, if it is possiblethat payments will be made to UK resident beneficiaries, also keep a record of the disposal proceeds in pounds sterling and note any gain realised on the log of trust gains.
- Keep in mind that the general rule for IHT is that accounts are situated where the branch with which the account is held is located, regardless of the denomination of the currency. If IHT may be an issue, ensure that accounts are held with non-UK branches.
If all else fails, remember that, in broad economic terms, it is better to have made a currency gain than a loss. There just may be some awkward tax consequences!
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