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TAXGUIDE 4/11
FOREIGN CURRENCY ISSUES
Guidance published by the Tax Faculty on 28 November 2011
Contents Paragraph
Foreword 1-7
Who we are 8-10
Overview 11-28
Section A - Foreign currency: notes and coins 29-34
Section B – Foreign currency bank accounts 35-81
Section C – Assets bought and/or sold in a foreign currency 82- 84
Section D – Income received in a foreign currency 85-111
Section E – Mixed funds 112-118
Section F – The automatic remittance basis
HMRC technical note setting down its settled position on foreign income received in non-sterling currency and the £2,000 threshold Support for the alternative view on foreign income received in a non-sterling currency and the £2,000 threshold
119-127 Appendix 1
Appendix 2
FOREIGN CURRENCY ISSUES DETAILED CONTENTS GUIDE
Contents Paragraph Foreword Who we are Overview 1-7 8-10 11-28
Section A – Foreign currency: notes and coins 29-34
Section B – Foreign currency bank accounts
Introduction
The basic CGT computation (for 2011/12 and prior years) The part disposal approach
Overdrawn accounts
SP10/84 and its application to UK resident domiciliaries
Determining the base cost of foreign currency bank accounts held by foreign domiciliares
The simplified method of computation The £500 de minimis
Practical issues when completing tax returns
Problems with information supplied by investment managers Gifts between spouses/civil partners
The section 16ZA, TCGA 1992 election Non-UK resident trusts
Non-UK resident companies
35-42 43-46 47 48 49-59 59-61 62 63-64 65-70 71-72 73-74 75 76 77-81
Section C – Assets bought and/or sold in a foreign currency 82-84
Section D – Income received in a foreign currency
The arising basis of taxation
Exchange rates for foreign tax credits
The remittance basis of taxation – HMRC’s view The alternative view
Which view is correct?
Finance Act 2010 - modification of legislation The section 37, TCGA 1992 issue
What to do when preparing a tax return
Practical concerns over the foreign currency income exchange rate conversion issue 85 86-89 90-92 93 94-96 97-101 102-105 106-108 109-111
Section E – Mixed Funds
Introduction
Tax Faculty’s comments on CG25392
General comments on the mixed fund issue and the difference in approach
112-113 114-115 116-118
Section F – The automatic remittance basis
Introduction
Initial HMRC approach Revised HMRC approach The problem for practitioners
119-120 121-122 123-125 126-127
FOREIGN CURRENCY ISSUES FOREWORD
1. Over the last two years TAXline has included a number of articles which have discussed some of the technical and practical tax issues relating to foreign currency income and capital gains.
2. This guidance summarises the current position and the main technical issues as we see them. It also sets out some practical examples of the problem areas. To avoid issues with respect to incorrect exchange rates in most of the examples the foreign currency used will be the imaginary Utopian dollar (Ut$).
3. It should be noted that this guidance covers the position for the current tax year (2011/12) and prior years. In the 17 June 2011 consultation document on the Reform of the taxation of non-domiciled individuals the government announced proposals to remove sums within foreign currency bank accounts from the scope of capital gains tax for individuals with effect from 2012/13.
4. We should emphasise that this guidance is not endorsed by HMRC and in some places it sets out views that differ from those expressed by HMRC. We highlight where this is the case and provide details of HMRC’s view. We also indicate where examples have been agreed by HMRC.
5. Information about the Tax Faculty and the ICAEW is given below.
6. This guidance builds on articles by Lynnette Bober published within TAXline during 2009 and 2010. Some of the passages within this guidance also build on work which was originally prepared for Taxwise 2010/11. We are grateful to LexisNexis for agreeing that the material can be used. The ICAEW holds the copyright in this TAXGUIDE and the terms on which it may be reproduced are set out on page 27.
7. The ICAEW and the author accept no responsibility for loss occasioned by any person acting or refraining from action as a result of this guidance.
WHO WE ARE
8. The Institute operates under a Royal Charter, working in the public interest. It’s regulation of its members, in particular its responsibilities in respect of auditors, is overseen by the
Financial Reporting Council. As a world leading professional accountancy body, the Institute provides leadership and practical support to over 136,000 members in more than 160 countries, working with governments, regulators and industry in order to ensure that the highest standards are maintained. The Institute is a founding member of the Global Accounting Alliance with over 775,000 members worldwide.
9. Our members provide financial knowledge and guidance based on the highest technical and ethical standards. They are trained to challenge people and organisations to think and act differently, to provide clarity and vigour, and so help create and sustain prosperity. The Institute ensures these skills are constantly developed, recognised and valued.
10. The Tax Faculty is the focus for tax within the Institute. It is responsible for technical tax submissions on behalf of the Institute as a whole and it also provides various tax services, including the monthly newsletter TAXline to more than 11,000 members of the Institute who pay an additional subscription, and a free weekly newswire.
OVERVIEW
11. Foreign currency problems can arise for all UK resident taxpayers regardless of their domicile. This guidance examines the UK income tax and capital gains tax implications of transactions that involve foreign currency and in particular the complex issues that can arise where transactions are carried out by UK resident foreign domiciliaries. There will be UK tax issues to consider where:
• there is a disposal of foreign currency;
• there is a disposal of foreign currency within a bank account;
• all or some of the amounts with respect to the capital gains tax (CGT) disposal computation for a chargeable asset are originally in a foreign currency; and • income is received in a foreign currency.
12. The Finance Act 2008 (FA 2008) changes to the remittance basis rules meant that from 2008/09 onwards UK-resident foreign domiciliaries have had to consider chargeable disposal calculations for withdrawals from foreign currency bank accounts far more than they needed to in earlier years. There are two reasons for this.
13. The first is that for many UK-resident foreign domiciliaries, the changes mean that the remittance basis is not going to be cost effective from 2008/09 onwards, so they will be subject to tax on the arising basis.
14. The second is that, generally, those for whom the remittance basis is still cost effective will not have the benefit of a CGT annual exemption. This means that a chargeable disposal calculation has to be carried out every time there is a remittance to the UK from foreign currency bank accounts.
15. In practice the position of foreign domiciliaries can be more difficult than that of UK domiciliaries because:
• foreign domiciliaries are likely to have more foreign currency accounts and more transfers between accounts denominated in the same foreign currency;
• there will often be more activity in foreign currency accounts belonging to foreign domiciliaries, and higher transaction amounts; and
• they may not have accurate base cost details.
16. Over the last two years a series of discussions have been held with HMRC with respect to the various problems. As a result of these discussions some practical measures have been announced that should make it easier to satisfy the compliance requirements. There are still, however, very significant practical problems.
17. Many of the CGT problems stem from the fact that the legislation was drafted at a time when the UK had exchange controls. With the lifting of exchange controls, these rules no longer provide a satisfactory basis for taxing foreign currency.
18. The Tax Faculty made representations calling for the rules to be modernised. We were pleased to see that one of the four proposed simplifications to the remittance basis that was announced in the June 2011 consultation document, Reform of the taxation of non-domiciled individuals, covered foreign currency bank accounts.
19. As noted in the foreword, from 2012/13 the Government proposes to remove sums within foreign currency bank accounts from the scope of capital gains tax for individuals.
Representations have been made by the Tax Faculty (and others) for the exemption to be extended to trusts and related vehicles. As this TAXGUIDE shows, this is currently a very difficult area with no agreement as to the correct treatment.
20. This TAXGUIDE looks at some of the technical and practical issues relating to the taxation of foreign currency income and capital gains. The CGT legislation deals separately with foreign currency (notes and coins) and foreign currency held within a bank account. Section A sets out the CGT rules as they apply to foreign currency (notes and coins).
21. Section B considers the CGT rules where there is a chargeable disposal as a result of withdrawing foreign currency from a bank account. It starts by looking at the basic CGT computation and the part disposal rules under s 42, Taxation of Chargeable Gains Act 1992 (TCGA 1992) which are to be used for 2010/11 onwards. The section continues by looking in detail at the particular problems faced by foreign domiciliaries who have foreign currency bank accounts (FCBAs). It then considers some of the practical issues that advisers may encounter when completing the tax return. The final part of the section highlights the potential problem in inter-spouse/partner transfers, reminds the reader of the need to consider FCBAs in the s 16ZA, TCGA 1992 capital losses election and looks at the position of non-resident trusts and non-resident companies who hold FCBAs.
22. It is a basic rule that in order to calculate UK tax all income and gains must be expressed in sterling. Where income is received or assets are bought or sold in a currency other than sterling this requires translating the foreign currency amounts into sterling. It is necessary therefore to identify a currency conversion date and ascertain the exchange rate for that date. 23. Exchange rates can be found on the HMRC website at www.hmrc.gov.uk/exrate/. Daily rates
can be found on commercial websites. It is understood that, provided a consistent approach is adopted, HMRC will accept rates taken from any reputable website. Guidance can be found in the HMRC manuals at BIM 39507 of the Business Income Manual and at SA4310 of the Savings Income Manual.
24. For CGT the position is clear. There have been a number of cases on this issue and Capcount Trading v Evans 65 TC 545 was determined by the Court of Appeal. Section C
sets out the CGT computation when assets are acquired and/or disposed of in a foreign currency.
25. Section D looks at the taxation of income received in a foreign currency. For those taxed on an arising basis the income tax position is clear and is set out in para 85. Where trading income is in point the position is discussed in SP2/02 (Exchange Rate Fluctuations) and it is felt that the same principles apply for property income.
26. A problem arises, however, where foreign income received in a foreign currency is taxable on a remittance basis. HMRC take the view that the conversion should be at the exchange rate on the date of remittance. The technical analysis supporting HMRC’s view is reproduced in full in Appendix 1. The Tax Faculty take the view that the conversion to sterling should be at the exchange rate prevailing when the income arose, support for this ‘alternative’ view is summarised in Appendix 2. Paragraphs 90-96 examine the two approaches and their relative merits. Section D continues by considering the requirement for a s 37, TCGA 1992
adjustment and concludes by offering guidance on what to do when preparing a tax return and considers some of the practical concerns on the timing of remittances.
27. This same problem can arise when considering the exchange rate to use for remittances of income from a foreign currency mixed fund. This issue is discussed in Section E.
28. Section F looks at the method for calculating the aggregate unremitted income and gains for those who qualify for the automatic remittance basis under s 809D, Income Tax Act 2007 (ITA 2007).
SECTION A - FOREIGN CURRENCY: NOTES AND COINS
29. The CGT legislation deals separately with foreign currency (notes and coins) and foreign currency within a bank account.
30. Any use of foreign currency can potentially give rise to a chargeable disposal, this means any disposal of foreign currency whether:
• to spend the funds;
• to convert the currency to a different currency; or
• to pay the funds into a bank account even if the account is denominated in the same currency.
31. The general rule is that foreign currency is a chargeable asset (s 21(1)(b), TCGA 1992). This means that any disposal, or deemed disposal, of foreign currency will give rise to a disposal or a part disposal.
32. There is a specific exemption at s 269, TCGA 1992 for foreign currency for personal expenditure. For the exemption to be in point the following conditions must be met: • the currency was acquired by the individual; and
• the reason for the acquisition was so the currency could be used for the personal
expenditure outside the UK of either the individual or the individual’s family or dependants (including expenditure on the provision or maintenance of any residence outside the UK). 33. The terms of this exemption are the same as for s 252(2), TCGA 1992. See the comments in
para 40 below for HMRC’s strict interpretation of these terms.
34. Notes and coins in the same currency are fungible assets and are subject to the pooling rules in ss 104–114, TCGA 1992. FA 2008 modified the identification rules as they apply to
individuals, trustees and personal representatives. For disposals from 2008/09 onwards, for the purposes of arriving at the base cost when a disposal has taken place, for each single asset class there is deemed to be one single cost pool (although s 106A, TCGA 1992 provides that the same day and the next 30 days matching rules take precedence).
SECTION B – FOREIGN CURRENCY BANK ACCOUNTS Introduction
35. A withdrawal of foreign currency from a bank account can potentially give rise to a chargeable disposal, whether it is:
• to spend the funds (either through a cash withdrawal, a cheque, a debit card transaction or a credit transfer);
• to convert foreign currency to a different foreign currency or to sterling;
• to make a transfer between one account to another account denominated in the same foreign currency (though SP10/84 may assist here see paras 49-58 below).
36. Individuals can therefore crystallise disposals both where they withdraw funds from a FCBA and when they spend the funds and/or convert the funds to sterling.
37. A UK resident foreign domiciliary who is a remittance basis user will only be subject to tax on foreign chargeable gains if there is a remittance to the UK (defined by s 809L, ITA 2007). However, where funds have been remitted one will have to trace through all chargeable disposals to establish the appropriate base cost to use for the remitted gain. Further, where a
remittance basis claim has been made, there is no CGT annual exemption so CGT calculations will be required even though the tax at stake may not be significant.
38. As noted in paras 49-58, the discussions with HMRC led to guidance providing some practical solutions to the technical problems of calculating gains where there are withdrawals from foreign currency bank accounts. The compliance task, however, remains onerous for both the taxpayer and any HMRC officer reviewing the tax return.
39. Legally, foreign currency within a bank account is a debt owed by the bank to the individual who deposited the funds. The general rule (s 251, TCGA 1992) is that such a debt (not being a debt on a security) would not be a chargeable asset for CGT purposes. However, s 252, TCGA 1992 specifically overrides this rule for foreign currency bank accounts (though not for any other foreign currency debts such as funds within a broker's account). The position is different for broker’s accounts where legally the position is that the fund manager has funds of the client under management. The tax analysis will depend on the way the funds are held with the fund manager being seen as the nominee/bare trustee of the client. If the funds are held in a bank account (typically through a client account arrangement) then it is suggested that there would be CGT issues.
40. There is an exemption at s 252(2) TCGA 1992 for sums within the bank account which are for personal use. The terms of the exemption are the same as that in s 269, TCGA 1992, see para 32 above. The conditions are strict. HMRC interpret them to mean that where an individual receives a credit (or makes a deposit) into a foreign currency bank account as a result of receiving income (such as remuneration from an employment, profits from an unincorporated business, interest and dividend income) the future withdrawal of that foreign currency (for CGT purposes the disposal of the bank debt) is outside the scope of the exemption.
41. Commentators have suggested that HMRC interpretations of these exemptions could be too narrow. This is particularly the case with respect to employment income where it could be argued that the reason the individual worked was to obtain funds to be able to pay for non-UK personal expenditure. It has been suggested that the relief should apply if an individual receives foreign currency income which is paid into a designated personal expenditure abroad account.
42. Where the individual is taxed on the remittance basis and remittance basis income and/or gains are used the exemption is not an issue, as using the funds for non-UK personal expenditure would not result in a UK tax liability.
The basic CGT computation (for 2011/12 and prior years)
43. The new pages of the HMRC Residence Domicile and Remittances Manual (RDRM), issued in August 2009, specify that the part disposal rules in s 42, TCGA 1992 (part disposal
provisions) should be used to compute gains and losses on withdrawals from foreign currency bank accounts. Prior to this the guidance in the HMRC Capital Gains Manual, at paragraph CG78332, stated that the share matching rules should be used to establish gains and losses on disposals from foreign currency bank accounts.
44. We appreciate the technical basis behind HMRC’s change of view but it gave rise to practical concerns given that many practitioners had followed the Capital Gains Manual guidance. HMRC accepted that any 2008/09 returns already submitted that had used the share matching rules did not have to be amended as a result of this change of view. Furthermore, where using the part disposal rules would cause practical difficulty for 2008/09, HMRC also accepted that the change to using the part disposal rules could be delayed (see the relevant section of the HMRC guidance at www.hmrc.gov.uk/cnr/remittance-basis.htm).
45. HMRC’s Capital Gains Manual refers to the position for 2009/10 and 2010/11 at CG78332A. HMRC expect the part disposal approach to be followed for 2010/11 onwards. However, for 2009/10, given the issues with the HMRC guidance (which was revised part way through the tax year), HMRC accept that the share identification rules may be used providing:
• the rules are applied consistently throughout the year in question and in all preceding years;
• it is not a practical proposition for computations to be prepared on the correct basis, or the taxpayer acted on the earlier understanding that HMRC considered that the share
identification rules apply; and
• for 2008/09 and 2009/10 the revised share identification rules introduced by FA 2008 are used.
46. Where the share identification rules are used for 2009/10 this should be made clear in the additional information section of the capital gains tax supplementary pages of the tax return.
The part disposal approach
47. For a foreign exchange disposal the values of A and B, in the CGT part disposal formula in s 42, TCGA 1992, are calculated by converting the foreign currency amount into sterling using the same exchange rate. One can also arrive at the correct base cost by using the following formula:
BC = TAC x (WFC/TFC)
Where BC = base cost, TAC = total allowable cost, WFC = withdrawn foreign currency and TFC = total foreign currency immediately before the withdrawal is made.
Example 1
Yulia withdrew Ut$500,000 from her Jersey deposit account on 25 October 2011. On the date of the withdrawal the exchange rate was Ut$1 = £0.6135. Immediately before the withdrawal the account broke down as follows:
Ut$ Utopian Dollars
to GBP Base Cost £ 13 April 2010 1,000,000 1.96850 508,000 17 May 2010 500,000 1.94970 256,450 28 July 2010 100,000 1.99124 50,220 24 December 2010 400,000 1.48038 270,200 17 March 2011 75,000 1.40626 53,333 28 August 2011 250,000 1,62180 154,150 2,325,000 1,292,353
The long hand method:
A= (Ut$500,000 x 0.6135) = £306,750
A+B = (Ut$2,325,000 X 0.6135) = £1,426,388
Base cost = (£306,750/£1,426,388) x £1,292,353 = £277,925 The short cut: BC = TAC x (WFC/TFC)
TAC = £1,292,353 WFC = 500,000 TFC = 2,325,000
£
Consideration 306,750
Base cost 277,925
Chargeable gain 28,825
Overdrawn accounts
48. Foreign currency within a bank account is different to other chargeable assets as an account can fluctuate between having funds and being in overdraft. It is understood to be HMRC‘s view (see CG78333 of the HMRC Capital Gains Manual) that the asset represented by a credit balance is wholly disposed of and ceases to exist should that balance become zero or negative.
Example 2 (Agreed with HMRC)
Carla opened a Utopian dollar current account on 29 August 2011 with a deposit of Ut$7,500. She had an overdraft facility of Ut$5,000. The following entries went through the account:
Date Narrative Amount Balance Chargeable disposal
29 August 2011 Deposit Ut$7,500 Ut$7,500 Not applicable – deposit
2 September 2011 Withdrawal Ut$(8,900) Ut$(1,400) Of the Ut$7,500 that takes the account down to a nil balance. 11 September
2011
Withdrawal Ut$2,800 Ut$(4,200) No disposal – overdraft 28 September
2011
Deposit Ut$4,000 Ut$(200) Not applicable – deposit
1 October 2011 Withdrawal Ut$4,750 Ut$(4,950) No disposal – overdraft
28 October 2011 Deposit Ut$7,500 Ut$2,550 Not applicable – deposit
2 November 2011 Withdrawal Ut$3,900 Ut$(1,350) Of the Ut$2,550 that takes the account down to a nil balance. The CGT computation with respect to 2 September 2011 disposal:
29 August 2011 Ut$1 = £0.54520 2 September 2011 Ut$1 = £0.55410 Sterling £ Consideration 7,500 x 0.55410 4,156 Base cost 7,500 x 0.54520 4,089 Chargeable gain 67
SP10/84 (Foreign bank accounts) and its application to UK resident foreign domiciliaries
49. A bank account with one financial institution is a separate asset to an account with another institution, even if it is denominated in the same currency. It is accepted that, strictly, a transfer from a Euro account with Bank 1 to a Euro account with Bank 2 will result in a disposal and an acquisition. The more contentious question is whether there is a disposal where the transfer is between accounts with the same financial institution and the accounts are denominated in the same currency.
50. HMRC’s published view is that for CGT purposes each bank account is a separate
chargeable asset, and it follows that transfers between bank accounts denominated in the same currency which are held with the same financial institution will result in a chargeable disposal. Accordingly, something as routine as a sweep facility between a deposit account
and a current account will be a chargeable disposal. Where a client has foreign investments or earned income the potential for a significant number of chargeable disposals is high. 51. HMRC published SP10/84 to provide a practical solution to this problem. Under SP10/84,
HMRC allows taxpayers to treat all bank accounts denominated in the same foreign currency as a single asset for the purposes of considering whether there has been a chargeable disposal of a sum of foreign currency within the account. For tax years up to and including 2007/08, however, SP10/84 does not apply to foreign domiciliaries transferring same currency funds to and from non-UK accounts (note the operation of SP10/84 is linked to domicile not whether the individual is a remittance basis user).
52. There were calls to extend SP10/84 to foreign domiciliaries following the FA 2008 changes which were resisted initially by HMRC (see the relevant section of the HMRC guidance at www.hmrc.gov.uk/cnr/remittance-basis.htm). In the last week of January 2010, HMRC announced (see www.hmrc.gov.uk/cnr/cgt-transfers-fc.htm) that it had decided to extend SP 10/84 to UK resident foreign domiciliaries (though not to put them on a par with the position for UK domiciliaries). The extension means that for transfers taking place in 2008/09 and onwards an individual who is not domiciled in the United Kingdom may, for the purposes of determining whether a chargeable disposal has been made, treat as one account all bank accounts which:
• are in the individual’s name;
• are in a particular foreign currency; and
• are not situated in the UK for the purposes of TCGA 1992 and are, therefore, not within the scope of SP10/84.
53. For chargeable disposal purposes, the taxpayer may thus disregard direct transfers among such same currency non-UK bank accounts. Once adopted the practice must be applied to all future direct transfers among those bank accounts.
54. Thus a UK resident foreign domiciliary who applies SP10/84 will have all UK situs accounts in the same currency viewed as one ‘aggregated account’ and all offshore situs accounts in the same currency viewed as one ‘aggregated account’. Transfers between different ‘aggregated accounts’ will be chargeable disposals whether they are:
• between a same currency UK situs account and a non-UK situs account; • between UK situs accounts in different currencies; or
• between non-UK situs accounts in different currencies.
55. Given the way SP10/84 applies to foreign domiciliaries a foreign domiciliary could choose to use SP10/84 just for UK accounts in a particular foreign currency or just for foreign accounts in a particular foreign currency. Once it is decided to adopt SP10/84 for either the UK or offshore accounts in a particular currency that decision can only be revisited:
• for the UK accounts in the particular currency if all the UK accounts in that currency are cleared down so that no debt is owed to the taxpayer; and
• for the offshore accounts in the particular currency if all the offshore accounts in that currency are cleared down so that no debt is owed to the taxpayer.
56. SP10/84 only applies to transfers between bank accounts; it does not cover transfers
between bank accounts and brokerage accounts or transfers of foreign currency from a bank account to repay a foreign currency loan.
Example 3
Louis is a UK resident foreign domiciliary. He has two Euro accounts in London, two in France and three in Switzerland. Prior to 6 April 2008, by applying SP10/84, Louis was able to treat the two UK-based accounts as a single account, but the non-UK accounts had to be treated as separate assets in their own right. Under the extended SP10/84 from 6 April 2008, Louis may continue to treat his two UK-based accounts as one account and may treat his five non-UK accounts as a different single account so that direct transfers between the UK Euro accounts will be disregarded and direct transfers between the non-UK accounts will also be disregarded. However, transfers from the French or Swiss accounts to one of the London accounts, or to any other account not denominated in Euros, will be a disposal for capital gains tax purposes as will any withdrawals from the account other than transfers between bank accounts.
Example 4
Hilary is domiciled in Illinois but is resident in the UK and has the following bank accounts: Euro accounts in London (2), the Channel Islands (2) and Switzerland (2); and
US dollar accounts in London (3), the US (5), Switzerland (3) and Channel Islands (2)
In addition periodically both her funds in Switzerland go on same currency fiduciary deposit for periods of between one and three months.
Prior to 6 April 2008, by applying SP10/84, Hilary was able to treat the two UK-based Euro accounts as a single account and the three UK-based dollar accounts as a single account. Each non-UK account had to be treated as a separate asset in its own right.
From 6 April 2008, by applying SP10/84 as well as being able to treat all UK based accounts in the same currency as one account, Hilary may treat all non-UK based accounts in the same currency as one account. That is rather than each account representing a separate asset, she can choose to perform capital gains tax calculations as if she holds four distinct ‘aggregated accounts’
comprised as follows:
• the two UK situs Euro accounts; • the three UK situs dollar accounts;
• the four non-UK situs Euro accounts (that is the two Channel Islands accounts and the two Swiss accounts) and the periodic fiduciary deposit accounts; and
• the ten non-UK situs accounts (that is the five US accounts, the three Swiss accounts and the two Channel Islands accounts) and the periodic fiduciary deposit accounts.
57. The extension to SP10/84 only applies to transfers between bank accounts effected in 2008/09 or later years. Where, for example, a withdrawal and remittance to the UK from a non-sterling and non-UK account occurs on 17 June 2010 the SP10/84 extension cannot be applied so as to disregard all transfers between same currency bank accounts prior to 6 April 2008. However, the individual could, to ease the compliance burden, opt to determine the 6 April 2008 base cost using the averaging method, see para 60 above, with the SP10/84 extension applying from 6 April 2008 onwards.
58. The effect of the extension of SP10/84 is to allow two or more foreign currency bank accounts to be treated as a single account solely for the purposes of CGT. So where a UK resident foreign domiciliary chooses to apply SP10/84 to transfers between same currency bank accounts this is not an election for various same currency foreign bank accounts to be seen as the same asset for any other purposes (such as the mixed fund rules).
Determining the base cost of foreign currency bank accounts held by foreign domiciliaries
59. For 2007/08 and prior tax years use of the share matching rules, together with the availability of the CGT annual exemption will have meant that many UK resident foreign domiciliaries did not need to have full details with respect to the base cost of the currency within their foreign offshore bank accounts. For these foreign domiciliaries there may be difficulties in calculating the base cost of FCBAs at 6 April 2008. The necessary records may not have been available at 6 April 2008, or the work involved in establishing the base cost may be unduly onerous. 60. For 2008/09 and later tax years HMRC has agreed to accept computations where the base
cost of foreign currency within a bank account at 6 April 2008 is calculated by means of an average exchange rate over a period of time up to April 2008. Note this practice is only available to UK resident foreign domiciliaries. For the full text of the HMRC guidance see the relevant section of the HMRC guidance at www.hmrc.gov.uk/cnr/remittance-basis.htm, the key parts are as follows:
‘Under this method, individuals can establish the base or acquisition cost of their non-sterling bank accounts by reference to the average foreign currency exchange rates which were in force over the six years up to April 2008. These rates can be found on the HMRC website at http://www.hmrc.gov.uk/exrate/index.htm.
Where such an account has been established for less than six years at 6 April 2008, HMRC will permit individuals to calculate the base or acquisition cost by reference to the average exchange rates in force over the number of years, to the nearest year, that the account has been established.
This simplified averaging approach is entirely optional: individuals can still calculate base or acquisition costs by using the actual exchange rates which were in force at the date on which the currency was deposited into the bank account in question. However, any approach will always need to be followed on a consistent basis.’
61. The following example has been agreed by HMRC and illustrates how the averaging method is applied.
Example 5 (agreed with HMRC)
Part A
Joyce Non-Dom is a UK resident foreign domiciliary with a number of non-UK foreign currency bank accounts. She has been UK resident from 5 July 2004. In 2010/11 she made remittances for the first time from her non-UK foreign currency accounts. Given the heightened complexity she used the services of a tax adviser for the first time in 2010/11 and it became apparent that there was a significant problem as no base cost records had been kept with respect to the foreign currency accounts. A schedule of movements on the accounts since 6 April 2008 could be compiled but going back beyond then would involve significant work and the information was not available to go back as far as would be necessary to arrive at accurate base costs. It was decided to use the averaging method to arrive at an acceptable base cost for the funds within the accounts as at 6 April 2008 and to go forward from that point.
As at 6 April 2008 she had two US dollar bank accounts held abroad (a current and a deposit account). The closing balance on 5 April 2008 on the current account was $6,345 and on the deposit account $112,356. She is not sure exactly when these accounts were opened but her recollection is that they date back to when she was eleven (tax year 1993/94). Using the averaging method what will her base cost be at 6 April 2008?
Analysis
To arrive at an estimated base cost for use for CGT purposes the balances on the two accounts at the start of 6 April 2008 need to be translated to sterling using the average foreign exchange rate. The account has been opened for in excess of six years so in line with the HMRC announcement we use the average exchange rate for the six years to April 2008.
The average exchange rate for the six years to April 2008 for US dollars is US$1 = £0.560275917 (as per the HMRC announcement quoted above). Applying this average rate to the balance in Joyce’s bank accounts as at the start of 6 April 2008 her base costs are as follows:
Account $ Balance Average fx £ Base Cost Current $6,345 0.560275917 £3,555 Deposit $112,356 0.560275917 £62,950 Part B
As at 6 April 2008 she also had two Euro bank accounts held abroad (a current and a deposit account). The closing balance on 5 April 2008 on the current account was €5,075 and on the deposit account €117,105. The accounts were opened in July 2004. Using the averaging method what will her base cost be at 6 April 2008?
Analysis
To arrive at an estimated base cost for use for CGT purposes the balances on the two accounts at the start of 6 April 2008 need to be translated to sterling using the average foreign exchange rate. The average exchange rate is computed by averaging the HMRC average exchange rates for the tax years from 2004/05 to 2007/08 (inclusive).
HMRC average rates for the relevant tax years:
Average for the year to Sterling
value of currency 31 March 2008 0.70532 31 March 2007 0.6779661 31 March 2006 0.681956 31 March 2005 0.68166326 2.74690536 Average of the average FX
rates
0.68672634
Applying this average rate to the balance in Joyce’s bank accounts as at 6 April 2008: Account $ Balance Average fx £ Base Cost Current €5,075 0.68672634 £3,485 Deposit €117,105 0.68672634 £80,419
The simplified monthly method of computation
62. HMRC accept that there could be many transactions on a foreign currency bank account in a tax year. Providing it is followed consistently and produces a reasonable overall result, a simplified method of computation will be allowed when computing foreign exchange gains and losses on withdrawals from accounts denominated in a currency other than sterling. Details are provided in the HMRC Capital Gains Manual with narrative at CG78333 and a worked example at CG78333A.
The £500 de minimis
63. In January 2010, HMRC announced (see the relevant section within
www.hmrc.gov.uk/cnr/res-dom-tax-amends.htm) the following additional measure to ease the compliance burden for remittance basis users:
‘HMRC recognise that an individual's CGT liability in respect of the gains and losses arising on such accounts may be limited, but the cost of establishing the liability may be high, for instance where there are many transactions to take into account. In these circumstances, where the amount of net gains from transfers from overseas non-sterling bank accounts which an individual remits to the UK is less than £500 in any tax year in which they are taxed on the remittance basis, they will not be required to report such gains on their tax returns. This practice will apply for 2008-09 and subsequent tax years.’
64. Given the need to calculate net gains and the low level of the de minimis its usefulness will be limited, but HMRC’s acknowledgement of the problems was welcome.
Practical issues when completing tax returns
65. There may be cases where it is impossible in the timeframe, or within the fee budget, to carry out the necessary calculations to arrive at the correct position with respect to foreign currency gains. Where it appears that the amount of tax at stake is insignificant, and likely to be less than the professional time that it would take to ascertain the correct answer, a pragmatic solution that will arrive at a reasonable figure could be utilised. Full disclosure is required and the client should be made aware that HMRC might enquire and insist on the full calculations being carried out.
66. Where assumptions are made in the preparation of a tax return, and the assumptions are made carelessly, there will be penalties if, as a result of this carelessness, the return
understates the tax due (in addition to interest which is due if tax is understated irrespective of whether there has been carelessness). It is, therefore, important to document why it is felt that the approach taken is reasonable so that, should there be an HMRC enquiry into the tax return, it would be possible to demonstrate that reasonable care was taken.
67. The following wording could be used for the white space where the UK resident foreign domiciliary is taxed on the arising basis in the relevant tax year or comes within s 809D, ITA 2007 such that the annual exemption is available:
‘I have foreign bank accounts denominated in a foreign currency. For the purposes of this return I have assumed that any gains or losses on such accounts balance out or are within my unused annual exemption and consequently gains or losses have not been calculated. Having reviewed the transactions that took place in the year this assumption appears reasonable to me.’
or where the bank statements have been reviewed:
‘I have foreign bank accounts denominated in aforeign currency. Having had my tax agent review the relevant statements the total amount of aggregate foreign currency capital gains
proceeds does not exceed £X and so I believe that it is reasonable to assume that any gains or losses on such accounts balance out or are within my unused annual exemption.
Consequently foreign currency gains or losses in the year have not been calculated.’ 68. Where the remittance basis has been claimed the annual exemption will not be available.
Gains will not, however have to be disclosed where the £500 net gains de minimis
concession applies (see para 63 above). Where it is thought the concession should apply, but detailed work has not been carried out, the white space note suggested above could be adapted as follows:
‘I have foreign bank accounts denominated in a foreign currency. For the purposes of this return I have assumed that any gains or losses on these accounts balance out or are within the £500 net gains de minimis and consequently gains or losses have not been calculated. Having reviewed the transactions that took place in the year this assumption appears reasonable to me.’
or where the bank statements have been reviewed:
‘I have foreign bank accounts denominated in a foreign currency. Having had my tax agent review the relevant statements the total amount of aggregate foreign currency capital gains proceeds does not exceed £X and so I believe that it is reasonable to assume that any gains or losses on such accounts balance out or are within the £500 net gains de minimis.
Consequently foreign currency gains or losses in the year have not been calculated.’
69. Where a pragmatic solution has been employed the disclosure will need to be tailored to the situation. Where one or more of the pragmatic solutions endorsed by HMRC (and discussed above) have been used this should be stated.
70. It is important to explain to a client who does not want to incur the fees required for you to review the bank statements that without seeing the statements you are not in a position to assess whether or not it is reasonable to proceed on the basis that there are no gains to report on their tax return. In such a situation the client would have to judge whether or not this is reasonable and in the event of an HMRC enquiry finding that there has been a tax
underpayment in order to avoid penalties (in addition to the interest that would be due regardless) would need to be able to demonstrate that he or she had taken reasonable care when making the assumption.
Problem with information supplied by investment managers
71. We are aware of there being problems in obtaining the necessary information where investment managers use several currencies and neither calculate the currency gains or losses on changes of investments nor provide sufficient information for the taxpayer to be able to calculate the gains and losses. There are also problems with some of the more unconventional investments where reports from investment managers only provide the foreign currency gain, with no information available about acquisition costs or sales proceeds to enable the appropriate CGT computation to be completed.
72. Where there are problems with the information provided, and it is not possible to complete the return in strict accordance with UK tax principles, we would suggest that appropriate white space disclosure is providing setting down the basis on which the figures had to be prepared given the lack of information.
Gifts between spouses/civil partners
73. There is a possible trap where gifts are made between spouses/civil partners where the gift is effected through a transfer from a foreign currency bank account. There is no restriction on s 58, TCGA 1992 to only apply where there is a disposal of an entire asset. As such it can
apply regardless of whether the transfer to the spouse/civil partner is a partial disposal of an asset or the transfer of the entire asset. This means that s 58, TCGA 1992 applies if (i) the actual account in the donor spouse/civil partner’s name is changed into the name of the donee spouse/civil partner; or (ii) if the account holders are changed so that it is now an account in joint names.
74. The concern is that the nil gain/nil loss transfer rule may not apply where there is a transfer of foreign currency from the donor’s account to the donee’s account because it can be said that the donee spouse/civil partner does not receive the chargeable asset disposed of by the donor spouse/civil partner (as the transfer is not of the debt owned by the bank to the transferor spouse/civil partner). It seems unlikely that Parliament intended for s 58, TCGA 1992 to be denied in such cases and one would hope that both HMRC and (if necessary) the Courts would take a purposive approach when construing the legislation such that the
transfer is accepted as falling within the s 58, TCGA 1992 no gain and no loss provisions. Interpreted literally, however, s 58, TCGA 1992 would not apply and given the uncertainty in this area clarifying legislation to make it clear s 58, TCGA 1992 can apply in such cases is desirable and we will be making representations for such a change.
The section 16ZA, TCGA 1992 capital losses election
75. Where a remittance basis claim is made the taxpayer has to decide whether or not to make the s 16ZA, TCGA 1992 election to have their foreign losses treated as allowable losses. In determining whether the taxpayer’s situation is such that making the election is desirable, it is important that one does not forget about transactions with respect to foreign currency and foreign currency bank accounts.
Non-UK resident trusts
76. Where s 86, TCGA 1992 (for settlor-interested trusts where the settlor is UK domiciled) or s 87, TCGA 1992 are in point all of the above problems apply to non-resident trusts with funds in currencies other than pounds sterling. Unfortunately, despite the reference to ‘a taxpayer’ in SP10/84, HMRC has stated (in response to queries we submitted) that, in its view, SP10/84 only applies to individuals. This is a significant concern.
Non-UK resident companies
77. Section 13, TCGA 1992 can attribute a gain realised on the disposal of chargeable assets. The question is, therefore, whether for the purposes of s 13, TCGA 1992 foreign currency is a chargeable asset.
78. Since 1998 for CGT purposes there have been two distinct sets of rules with respect to chargeable disposals: one set for individuals, trustees and personal representatives (where as explained above disposals of foreign currency are classified as chargeable disposals) and one set for corporate entitles.
79. Section 13(11A), TCGA 1992 was inserted by FA 1998 and specifies that for disposals effected on or after 6 April 1998 for the purposes of s 13, TCGA 1992 one uses the rules that apply to companies subject to UK corporation tax. For UK resident companies the loan relationship rules mean that foreign currency gains and losses are not within the CGT regime (under the rewritten legislation the legislative references to support this conclusion are s 295, s 328 and s 464, Corporation Tax Act 2009). Therefore s 13, TCGA 1992 cannot attribute foreign currency gains.
80. We are aware that in this context s 13(5)(c), TCGA 1992 causes confusion. The fact that the sub-section specifically disapplies the attribution mechanism for foreign currency held for trading purposes has been cited as meaning that s 13 must in general apply to foreign
currency. This overlooks the unequivocal nature of s 13(11A), TCGA 1992 and that s 13(5)(c) predates the FA 1998 insertion of s 13(11A). In effect since the FA 1998 amendment s 13(5)(c) has been superfluous.
81. There may be concern that, as the s 13, TCGA 1992 provisions do not result in a foreign currency gain being attributed to participators, the transfer of assets abroad provisions will attribute a gain. Income for the purposes of the transfer of assets abroad legislation is
deemed to arise in accordance with the normal income tax rules (see Lord Chetwode v Inland Revenue Commissioners [1977] STC 64). Therefore foreign currency gains would not be attributed under this legislation as in a non-trading situation the income tax provisions do not apply to tax appreciation in foreign currency.
SECTION C – ASSETS BOUGHT AND /OR SOLD IN A FOREIGN CURRENCY
82. For UK tax purposes, CGT computations must always be computed in sterling. Where foreign currency is involved the sales proceeds, costs of acquisition, enhancement costs and any incidental expenses must be translated into sterling at the exchange rate prevailing on the appropriate date.
83. Authority for the above comes from Bentley v Pike [1981] STC 360 and the Court of Appeal case of Capcount Trading v Evans 65 TC 545.
84. It is accepted that this approach is used regardless of where the individual is domiciled or whether they are taxed on the arising or remittance basis in the tax year of the disposal.
Example 6
Jasper Non-Dom is a UK resident foreign domiciliary in 2010/11 and will make a remittance basis claim for that year. He came to the UK for the first time in 2004/05. Prior to coming to the UK he had acquired a holding in Wow Ltd a Utopian company. He paid 150,000 Utopian dollars (Ut$) for the holding at a time when 1 Ut$ was equivalent to £1.5.
Jasper sold his entire holding in Wow Ltd on 21 April 2010 for Ut$750,000. At this time Ut$1 was worth £1.4. The Ut$ proceeds were paid into a specially opened bank account with interest being paid into a separate account.
Jasper transferred the entire Ut$750,000 to his UK account on 21 June 2010. On this date Ut$1 was equivalent to £1.43. What are the tax consequences of the remittance?
ANALYSIS
The Ut$750,000 that Jasper remitted on 21 June 2010 represents 2010/11 remittance basis foreign chargeable gains (the gain on the shares and the currency gain with respect to the period the proceeds were in the Utopian bank account) and pre 6 April 2008 clean capital.
Foreign chargeable gain on the disposal of the Wow Ltd shares:
Utopian $ Foreign Exchange rate
Ut$ to £ Pounds Sterling £ Proceeds 750,000 1:1.4 1,050,000 Base cost 150,000 1:1.5 (225,000) Chargeable gain 825,000
Foreign chargeable gain on the disposal of the Ut$750,000 debt (the transfer to the UK strictly representing the disposal of the debt owed to Jasper by his bank):
Ut$ to £ £ Proceeds 750,000 1:1.43 1,072,500 Base cost 750,000 1:1.4 (1,050,000) Chargeable gain 22,500
The transfer to Jasper’s UK bank account results in foreign chargeable gains of £847,500 being remitted (that is £825,000 resulting from the disposal of the shares and £22,500 arising on the closure of the Ut$ bank account). The two gains are remitted together before 22 June 2010 meaning that both are taxed at 18%.
SECTION D – INCOME RECEIVED IN A FOREIGN CURRENCY Introduction
The arising basis of taxation
85. Foreign domiciliaries who are taxed on the arising basis will be subject to income tax on foreign income arising in the tax year in the same way as any other UK taxpayer. The applicable foreign exchange rate will be that on the date the income arises, or the average rate for the year where the income arises frequently throughout the year (eg dividend and interest income). HMRC has confirmed that although the guidance in the RDRM only refers to the foreign exchange rate on the date that the income arises, this should not be construed to mean that they will not accept the use of the average rate where appropriate (the exchange rate used should be disclosed in the additional information section of the relevant tax return supplementary pages).
Exchange rates for foreign tax credits
86. HMRC states in the International Manual (INTM162160) that the tax credit relief for foreign tax is converted into sterling at the date the foreign tax is payable. We put the following example to HMRC for their comments.
Example 7
Chloe Non Dom is a UK resident foreign domiciliary. She received a Utopian dollar dividend on 17 May 2011 of Ut$148,750 with Ut$26,250 having been withheld (in accordance with the DTC). Her gross dividend is thus Ut$175,000. She remits the entire Ut$148,750 on 16 June 2011.
What sterling amount is Chloe deemed to have remitted and what is the sterling tax credit she is entitled to if:
• on 17 May 2011 the exchange rate is £1 = Ut$0.61 and on 16 June 2011 the exchange rate is £1 = Ut$0.71; or
• on 17 May 2011 the exchange rate is £1 = Ut$0.71 and on 16 June 2011 the exchange rate is £1 = Ut$0.61
HMRC commentary
As stated in HMRC’s guidance in the International Manual (INTM162160), the tax credit relief or foreign tax is converted into sterling at the date the foreign tax is payable:
For the purpose of computing tax credit relief, foreign tax, payable directly or by deduction, should be converted into sterling at the rate of exchange obtaining on the date when the foreign tax for which credit is to be allowed becomes payable.
In the example above, assume that the payable date for the Ut$26,250 foreign tax withheld at source is 17 May 2011 and that this is the minimum foreign tax payable under the DTA. In scenario (a), Chloe remits cash of Ut$148,750 on 16 June 2011.
The Ut$148,750 is grossed up to Ut$175,000 and is translated into sterling using the exchange rate on the date of remittance (£1 = Ut$0.71) = £246,478.
Chloe claims Foreign Tax Credit Relief, and assuming a UK tax rate of 40% on this income, Chloe’s UK tax liability is:
40% x £246,478 = £98,591
Less FTCR (Ut$26,250 / 0.61) = (£43,033)
Net UK liability = £55,558
In scenario (b), Chloe remits cash of Ut$148,750 on 16 June 2011.
The Ut$148,750 is grossed up to Ut$175,000 and is translated into sterling using the exchange rate on the date of remittance (£1 = 0.61) = £286,885
Chloe claims Foreign Tax Credit Relief, and assuming a UK tax rate of 40% on this income, Chloe’s UK tax liability is:
40% x £286,885 = £114,754
Less FTCR (Ut$26,250 / 0.71) = (£36,971)
Net UK liability = £77,783
87. In the above example the Tax Faculty accept the view set down in HMRC guidance with respect to the rate of exchange to use for the foreign tax credit. We do not agree, however, that the income should be grossed up using the rate of exchange on the date of remittance, as HMRC have done in this example.
88. Where there is withholding tax the amount remitted is always taken as the net amount. Moving on from this accepted fact we suggest that the following steps should be followed where there is a situation involving a foreign currency tax credit.
Step 1: determining the gross income figure
The foreign currency amount remitted should be grossed up in line with the actual tax paid to the source state to determine the gross foreign income amount to convert to sterling. We believe (for the reasons set down in para 93 and Appendix 2) that this income amount should then be converted to sterling using the rate of exchange on the date that the income arises. It is this sterling amount that is subject to UK tax and one then moves on to calculate the available foreign tax credit.
Step 2: determining the allowable foreign tax credit
The foreign tax credit available has to be in accordance with the terms of any double tax convention – for example if 35% withholding tax was deducted at source but the treaty only allows the source state to deduct 15% the foreign tax credit is restricted to 15% of the gross amount. The available foreign tax credit is calculated in the original foreign currency. Once the available foreign currency tax credit has been determined taking into account any treaty restriction, this figure is converted into sterling using the exchange rate at the time that the foreign tax credit is treated as paid (that is when it is deducted). In most cases the date the foreign tax credit is treated as paid will be taken to be the same time as when the income arises so the same exchange rate as in step 1 will be used.
89. We believe that the approach above is the better view as it is more in keeping with the general scheme of the legislation and the case law authority in this area.
The remittance basis of taxation- HMRC’s view
90. HMRC’s view is that where a non-domiciled individual is taxable on the remittance basis and that individual withdraws funds from an FCBA situated outside the UK the whole, or part, of the amount withdrawn represents foreign income taxable on the remittance basis. The foreign income transferred will be liable to income tax at the time of remittance and the amount on which income tax is due is the sterling value of the income at the time it is remitted.
91. The withdrawal of funds, however, also represents a chargeable disposal of the whole, or part of, the FCBA for CGT purposes, the deemed consideration being the sterling equivalent of the amount withdrawn. From 16 December 2009 HMRC has stated that s 37, TCGA 1992 applies in this situation to exclude from the calculation of the capital gain or loss arising on disposal (or part disposal) of the FCBA the whole, or the relevant part, of the withdrawal that is taxable as remitted income (see HMRC guidance at www.hmrc.gov.uk/cnr/fcba-technical-note.pdf).
92. In summary HMRC’s view is that where foreign currency, other than sterling, is remitted the taxable sterling amount is determined by using the exchange rate on the date of remittance for the currency. There will therefore be no CGT on the remittance of the currency as a result of the s 37, TCGA 1992 adjustment.
The alternative view
93. The alternative view is that where foreign income is received in a currency other than sterling the exchange rate to use is that on the date the income arises (or, where reasonable, the average for the tax year in which the income arises).
Which view is correct?
94. HMRC has taken legal advice to arrive at its view. We have not seen Counsel’s Opinion but we have seen a summary of the technical analysis supporting HMRC’s view (reproduced in full in Appendix 1). HMRC draws on case law to support its view. Supporters of the
alternative view, however, make the points that the case law is (i) prior to the enactment of FA 2008 (which introduced s 809L, ITA 2007 (meaning of ’remitted to the UK’)); and (ii) does not in any event directly address this specific point (see Appendix 2).
95. We would argue that the alternative view is consistent with the remittance basis legislation at Chapter A1, Part 14, ITA 2007. For capital gains, following Capcount v Evans, conversion takes place when a gain is realised (with the base cost being converted at the exchange rate at the time the acquisition took place), with a further gain or loss accruing when the foreign currency is exchanged for sterling. There are no special rules for remittance basis users where foreign currency and chargeable gains are in point. Section 809L, ITA 2007 contains no suggestion that different rules apply to income. As such it seems to us that as a matter of construction s 809L, ITA 2007 requires conversion at the time income arises.
96. In addition to the technical points summarised above it is suggested that the alternative view gives rise to fewer anomalies than the HMRC view.
Finance Act 2010 – modification of legislation
97. Schedule 9, Finance Act 2010 (FA 2010) contains legislation HMRC advised was necessary to correct the interaction between the income tax and capital gains tax rules where foreign
currency, representing or derived from a remittance basis user’s foreign income, originally received in a foreign currency, is remitted to the UK.
98. The legislation was drafted based on instructions assuming that HMRC’s settled view on the conversion rate is correct. Should HMRC be incorrect then the legislation will either be irrelevant (if the view that s 37, TCGA 1992 is not applicable is correct) or not adequate to deal with the problem identified (if s 37, TCGA 1992 does apply then the HMRC correcting legislation has not gone far enough to remove the interaction anomalies if the alternative view is found to be the better interpretation).
99. The HMRC technical note which accompanied the legislation, and contains detailed examples, can be found at www.hmrc.gov.uk/cnr/fcba-technical-note.pdf.
100. In brief, the specific issue was the s 37, TCGA 1992 adjustment, which (accepting that it applies) resulted in the computation of artificial losses and a distorted base cost when applying the partial disposal (A/(A+B)) formula. The legislation in FA 2010 disallows the capital loss. With respect to the base cost, this broadly means that where there is a remittance which is wholly or partly matched to foreign income, and there is also a part disposal, the normal rule to determine the base cost of the remainder is disapplied with the cost being apportioned pro rata instead. The legislation applies to disposals after 15 December 2009.
101. Where either (i) the HMRC settled view is adopted on both the exchange rate to use and the s 37, TCGA 1992 issue; or (ii) the alternative view is adopted on the exchange rate to use but it is accepted that s 37, TCGA 1992 should apply with respect to the CGT computation, it is suggested that transactions prior to 16 December 2009 are reviewed to see if capital losses can be claimed. Where such losses are claimed it is suggested that it is made clear that reliance has been placed on the HMRC technical guidance on the subject (with appropriate qualifications made where the alternative view on the exchange rate is taken but one agrees with the HMRC view on the applicability of s 37, TCGA 1992).
The section 37, TCGA 1992 issue
102. The decision to make as to which view to follow with respect to the exchange rate to use when converting foreign currency remittance basis income has no effect on the question of whether s 37, TCGA 1992 should apply where there is a disposal of the foreign currency representing that income. As discussed above HMRC has accepted that s 37, TCGA 1992 does apply and that the CGT computation should be adjusted accordingly.
103. Some commentators have, however, criticised both the HMRC settled view on the exchange rate to use and also suggested that there should be no s 37, TCGA 1992 adjustment. The argument for there being no s 37, TCGA 1992 adjustment is that the proceeds of the bank account are not charged to any more income tax than if the receipt had been taxed on the arising basis. If this is accepted then there can be no grounds for a s 37, TCGA 1992 adjustment where one adopts the alternative view on the exchange rate to use.
104. Others who support the alternative view on the rate of exchange date argue that s 37, TCGA 1992 does apply and that any remittance on the sale of the foreign currency leads to a capital gains tax computation.
105. The three views can best be explained through a simple example.
Example 8
Katie Non-Dom is a UK resident foreign domiciliary who in 2010/11 is a remittance basis user. She receives Ut$75,000 of Geneva bank interest (at a time when that equates to £100,000). The funds
are paid into a separate account with no additional funds being added. She sells the entire Ut$75,000 for £120,000. The £120,000 is remitted to the UK.
HMRC’s view – a UK income tax liability on £120,000 (no CGT to pay). No CGT liability as a result of the s 37, TCGA 1992 adjustment (and no capital loss due to the FA 2010 legislation).
The alternative view without a s 37, TCGA 1992 adjustment – (1) £100,000 subject to income tax; and (ii) £20,000 subject to CGT.
The alternative view where it is felt the s 37, TCGA 1992 adjustment applies – (i) £100,000 subject to income tax; and (ii) no CGT liability. With respect to the CGT there would be proceeds of
£120,000 less the £100,000 s 37, TCGA 1992 adjustment leaving adjusted net proceeds of £20,000. From this figure one would then deduct the £100,000 base cost to arrive at a computed loss of £80,000. This capital loss would be disallowed as a result of the FA 2010 legislation.
What to do when preparing a tax return
106. The final decision as to whether to follow the HMRC view, or to use the alternative view (and if so whether to apply the s 37, TCGA 1992 adjustment or not), has to be made by the tax adviser after discussions with the client. Once a decision has been reached it must be followed consistently (until there is a Court decision clarifying the law). It is not acceptable to use a pick and mix approach so that the more favourable method is used for each tax year or for different remittances in the same tax year. Whatever method is used pragmatism may be required in complex mixed funds where the currency has gone on a long and multi-layered journey (note that where the HMRC view is used the way to deal with mixed funds is understood to be to translate to sterling right at the end).
107. HMRC’s view is not free from doubt. If the issue comes to Court and HMRC loses, it could require a taxpayer to amend an open return. In order to support a claim to legitimate expectation we suggest the following:
• a white space note is included on the return stating explicitly that the issue is one where there is no one accepted technical view and that the return has been prepared relying on current HMRC guidance; and
• the fact the taxpayer chose to have the return prepared relying on current HMRC guidance is recorded in writing in a letter between the client director and the client (the covering letter that is sent out with the tax return being a suitable place for this to be recorded). 108. Where the alternative view is adopted full white space disclosure must be given in the same
way as would be done for any technical disagreement with HMRC.
Practical concerns over the foreign currency income exchange rate conversion issue
109. HMRC points out that its interpretation allows an individual to choose not to remit at a time when the exchange rate would result in a significant income tax charge (and is more favourable to the taxpayer where sterling appreciates). This is not always practical (the individual may not have any other funds to draw on to meet UK needs), but where HMRC’s view is followed care must be taken to advise the client about the timing of remittances and the impact that this can have on the client’s UK tax liability.
110. A practitioner who decides to adopt the alternative approach will also need to make their client fully aware of their potential tax liability if the HMRC view is correct. Where possible it would be advisable to avoid remittances at a time when the transaction would give rise to significant avoidable liabilities under either view. Proposed remittances should thus always be reviewed for foreign exchange issues.
111. The following examples, which we put to HMRC, illustrate the potential problems. Example 9 looks at the situation where foreign income, received in a foreign currency, is used to acquire an asset which is then brought to the UK. Example 10 considers the situation where foreign income, received in a foreign currency, is converted into a different currency on receipt and later remitted to the UK.
Example 9
Clara Non-Dom is a UK resident foreign domiciliary. She received Ut$2.5m of relevant foreign income on 17 May 2008 (when it was worth £1,375,000) which she uses to acquire a painting. She remits the painting in 2010/11 and it remains in the UK for the entire tax year such that she cannot claim exemption under s 809X, ITA 2007.
At the time the 275 day temporary importation exemption is breached such that the remittance becomes chargeable Ut$2.5m is worth £2m. The actual painting has declined somewhat in value being worth £1,350,000.
What sterling amount has Clara remitted? HMRC’s answer
This is dealt with in Chapter 5 of the RDRM:
Conditions A and B – remittances derived from foreign income or gains
Where, as in most cases, the property, service or consideration derives from a foreign currency, the taxable amount is the pounds sterling equivalent value (at time of remittance) of the amount of foreign currency…used to acquire or pay for the property or service
Therefore, in the example above, Clara has used Ut$2.5m RFI to purchase the painting; this is translated into sterling on the date on which the painting is treated as having being remitted tothe UK. This would mean that £2m income is brought into charge in the UK: the fact that the painting has depreciated in value by the time it is remitted is not relevant.
Example 10
Heidi Non-Dom is a UK resident foreign domiciliary who will make a remittance basis claim for 2008/09 to 2010/11. She receives a bonus offshore with respect to her foreign employment (all duties performed overseas) of €1,000,000 on 14 July 2008. She immediately converts the sum to $1,100,000 and deposits it in an offshore US dollar account. Clean capital of $3,750,000 is added to the account on the same day, so balance is $4,850,000. On 17 March 2011, Heidi transfers $4,000,000 to a US dollar account in the UK.
For the purposes of this example assume that the relevant exchange rates are as follows: 14 July 2008 £1=€1.55=$1.705
17 March 2011 £1=€0.25=$1.71
What sterling amount has Heidi remitted? HMRC’s answer
Step one is to analyse the mixed fund in the offshore US dollar account. There is no need to translate into sterling at this point.
Credit Debit Balance Category (s 809Q(4)) 2008 (Tax year 08/09)
14 July Deposit of bonus (€1,000,000) $1,100,000 $1,100,000 Para (b)
14 July ‘Clean capital’ credit $3,750,000 $4,850,000 Para (i)
2011 (Tax year 10/11)
17 March Withdrawal $4,000,000 $850,000
Step 2 is to apply the ordering rules in s809Q:
Step 1 – Identify the ‘amount of transfer’ in the relevant year (2010/11) $4,000,000 Analyse mixed fund to identify the separate
amounts of income, capital gains and capital present for each tax year immediately before the date of the transfer.
In this case only Tax Year 08/09 needs to be analysed as there are no other deposits.
Para (b) Relevant foreign earnings (not subject to a foreign tax)
$1,100,000
Para (i) income or capital not within another
paragraph of this subsection
$3,750,000
Step 2 – Identify the earliest paragraph above for the relevant year, which has an amount of income or gain in the mixed fund
Para (b) $1,100,000
Step 3 Where the amount transferred is greater than the amount identified at Step 2 the amount transferred is treated as reduced by the amount identified in Step 2.
$4,000,000 less $1,100,000 = $2,900,000 Step 4 – Find the next paragraph/amount for that tax year. In the order of
preference listed above repeat Steps 2 and 3.
Step 2 – repeated Para (i) $3,750,000
Step 3 If the amount at Step 2 is equal to or more than the remaining amount of the transfer (the last time step 3 was completed) treat the whole of the remaining amount of the transfer as coming from that item of income or gain
£nil
Heidi has therefore remitted $1,100,000 from paragraph (b) which is derived from her relevant foreign earnings of €1,000,000. This €1,000,000 is regarded as having been remitted to the UK, and translated into sterling on the date of remittance (17 March 2011) at the exchange rate of £1 = €0.25. Heidi is therefore subject to UK tax on £4,000,000 of her foreign earnings.
SECTION E – MIXED FUNDS Introduction
112. The application of the mixed funds rules to foreign currency bank accounts is fraught with difficulty (both intellectual and practical).
113. The HMRC approach to mixed funds is best explained by reproducing an example from the Capital Gains Manual.
‘CG25392 – Remittance basis: accounts denominated in foreign currencies
To analyse an account at a specific date you must convert the figure of capital gain in sterling back into an amount of foreign currency using the spot rate of exchange at the date of the remittance. From the total balance in the account you can then deduct this figure and any amount of income held in the account to arrive at a net balancing figure. This balancing figure is normally called capital but when there have been movements in exchange rates it is not normally possible to reconcile it with the amount that was originally treated as capital in the foreign currency.
