28 Feb 2009

Fair exchange

Insights, Publications

Astute readers may have noticed that the rest of the world doesn’t seem to place as much value as it used to on their hard-won £1; which brings into focus the treatment of exchange gains (and losses) on foreign currency.

It might well surprise you to hear that foreign currency is an asset for capital gains tax purposes and exchange gains or losses will be taxed or allowed respectively. So if you’d bought £100 worth of dollars at $1.80 a year or so ago and you sell them today at $1.46, you’ve made a capital gain of £23.

But does that mean that every time you go abroad on holiday you should be reporting a gain or claiming a loss?

No of course not – the reason is TCGA 1992 s269, which provides that a gain on currency acquired by an individual for the personal expenditure outside the UK of himself and his family is not a chargeable gain. (This includes expenditure on the provision or maintenance of a residence outside the UK).

So what’s the problem? Mainly, it’s that the let-out applies only to currency acquired specifically for personal use. It does not apply to currency acquired as (for example) remuneration, dividends, interest or from sale of assets – even if it is subsequently applied for personal use.

For example, John is resident and domiciled in the UK and works here for a US employer. In 2007 he is paid a bonus of $100,000. He is subject to employment tax on the Sterling equivalent of this at the date it is paid. The rate was £1:$1.80 and he was taxed on £55,555. John decides to keep the bonus in a dollar bank account and some time later withdraws the money to help buy a holiday home in Florida. He does not convert the money to Sterling but the exchange rate at the time he withdraws it is £1: $1.50.

The withdrawal from the bank account is a disposal of dollars despite not being converted to Sterling. (Technically there is a debt due from the bank and the withdrawal is a part-disposal of that debt; non-Sterling debts are not exempt). As a result John has Sterling-equivalent proceeds of £66,666 and a taxable gain of £11,111.

As another example, Jane sells her villa in Spain in 2008 for €2,000,000 and keeps her proceeds in a Spanish bank account. At the time of the sale the exchange rate is £1: €1.40 so the Sterling equivalent is £1,428,571. She pays capital gains tax on the disposal based on these proceeds. In 2009 she buys a new villa and takes the money out the account. Now the exchange rate is £1: €1. She has a capital gain of £571,429.

Each bank account is treated as a separate asset and so every withdrawal is a part disposal. This means that foreign currency accounts need to be constantly monitored for gains or losses.

Although in both these examples the money was used for personal expenditure abroad it was not acquired for this purpose and so the gains are taxed.

Bizarrely, had John or Jane converted the foreign currency they received into Sterling immediately on receipt and then used that Sterling amount to buy foreign currency kept in an account to use for holidays or the provision or maintenance of a residence abroad, exchange gains on that account would not have been taxable.

As so often in tax, its not what you do it’s the way that you do it.

This article was also published on TaxationWeb.