Exchange rate fluctuations and UK capital gains tax

Whilst the phrase “sterling… is the only permissible unit of account” may have a faintly anachronistic ring to it, it remains an accurate statement of the law relating to the calculation of capital gains for UK tax purposes. The recent case of Rawlings and another v HMRC [2022] UKFTT 32 (TC) illustrates the point, amongst several interesting features on how gains are to be calculated for tax purposes.

In 2006, UK resident taxpayers (T) bought a house in Switzerland with a Swiss franc-denominated mortgage. The house was sold in 2016. 

In calculating the UK capital gains tax due in respect of the gain on the sale (put by them at about £39,000), T deducted from the sale price (amongst other things) their mortgage repayments and transaction fees, in each case duly converted to sterling at the time these costs were incurred, at rates not challenged by HMRC. 

HMRC however disagreed with the calculation method as a whole, asserting that the gain must be calculated by deducting from the sale proceeds the purchase price and associated costs of both transactions, each assessed in sterling. HMRC reached a gain figure of just over £267,000, nearly seven times the self-assessed number and added penalties to boot.

T contended that, due to a substantial depreciation in the value of sterling between 2006 and 2016, the inflation (in sterling terms) in the value of their Swiss franc-denominated mortgage should be taken into account; otherwise, HMRC’s method of calculating the gain would give rise to an absurd charge to tax when the true economics of the transactions were considered.

Although the First-tier Tribunal expressed sympathy for T that the tax charge had been so significantly influenced by fluctuations in exchange rates, it concluded – comparing onshore cases which had reached the same result - that HMRC’s calculation method was correct, confirming (para. 40) that

“[T] find themselves in a similarly “unfair” position. However, the legislation is not predicated on a “fair” or even a “reasonable” basis of taxation. Capital gains are calculated in a mechanistic way by reference to actual consideration received and given at its sterling equivalent in respect of assets however the acquisition of those assets are funded”.   

The Tribunal (or, indeed, HMRC) had no discretion to reach a different result – "tax is collected by reference to the provisions as they apply even when the results in some situations appear absurd".

In a report published in May 2021, the Office for Tax Simplification asked the Government to consider whether gains or losses on foreign assets should be calculated in the relevant foreign currency and then converted into sterling. However, on 30 November 2021, the Government confirmed that it does not intend to make this change. UK taxpayers should therefore remain alert to this potential trap and, when disposing of foreign assets, remember that the UK capital gains tax charge may not reflect the true economic outcome of the transaction.