Introduction

Where there are significant movements in the value of sterling compared to foreign currencies, these affect the calculation of foreign income and the value of assets in sterling terms, which in turn can affect UK tax liabilities. This note is intended to clarify how foreign exchange is dealt with in calculating capital gains and taxable income for individuals and trustees. It also covers how the rules affect non-UK domiciled individuals who are taxed on the remittance basis.

The law does not provide for a particular exchange rate basis to be used for tax purposes. HMRC publish the following:

• Monthly currency exchange rates (deloi.tt/3QGzMmN)
• Average currency exchange rates (deloi.tt/3QFyk4a) - published on 31 March and 31 December every year for the 12 month period preceding the aforementioned dates.
• Spot currency exchange rates (deloi.tt/49jwxZK) - published on 31 March and 31 December every year reflecting the exchange rate at midday of that day. 

These rates are not mandatory; taxpayers can use alternative rates from reputable sources if so desired. The basis chosen should be used consistently to ensure a just and reasonable result.

Capital gains

For capital gains tax purposes, the base cost of an asset acquired using foreign currency is determined by converting the price into sterling at the spot rate on the date of acquisition. Similarly, proceeds are determined by converting into sterling at the spot rate on the date of disposal. This means that an asset can be sold for no economic gain in the foreign currency, but foreign exchange movements could give rise to a capital gain or loss. For instance, if an individual purchases an asset for $100,000 when the exchange rate was $1.80:£1 and sells it for $100,000 when the exchange rate is $1.35:£1, the cost and proceeds are expressed as £55,555 and £74,074, respectively. Although there is no gain in dollar terms, there is a capital gain of £18,519 in sterling terms. As proceeds are converted on the disposal date, any movements in exchange rates between the disposal date and an actual conversion into sterling do not affect the calculation of the gain on the asset sold. If the currency moves further before being converted into sterling, this may of itself give rise to a gain, but gains or losses on actual currency or foreign currency bank accounts are normally exempt (see below).

Foreign currency itself (i.e. non-sterling cash) is a chargeable asset for capital gains tax, so gains and losses can arise. Exemptions apply for foreign currency which is: 

• Acquired for personal expenditure abroad, including expenditure on the provision or maintenance of a non-UK home. 
• Held in a foreign currency bank account. 

In practice, these exemptions mean that gains and losses on cash are rare. Capital gains and losses can arise on other foreign currency-related assets, such as options, futures and offshore funds. Further detail on offshore funds is below.  

Offshore funds

Some offshore collective investment schemes are cash based and can be denominated in foreign currency (e.g. liquidity or money market funds), but the units are not actually cash and so do not qualify for the foreign currency bank account exemption. This means that taxable capital gains can arise on these funds. 

Gains on certain non-UK collective investment schemes (‘non-reporting funds’) are subject to income tax rather than capital gains tax. These are known as ‘offshore income gains’. Offshore income gains are calculated using capital gains principles. Like capital gains, offshore income gains can arise in sterling terms on foreign currency-denominated units even if there is no gain in foreign currency terms.

Income tax

Generally, income denominated in a foreign currency should be converted to sterling based on the spot rate for the date of receipt. However, it is acceptable to use an average exchange rate (monthly, annual or some other basis) for regular income receipts and deductible expenses that arise evenly over time (e.g. in respect of a business conducted in a foreign currency), provided the result is reasonable. This approach may not always be appropriate, such as years in which there are sharp exchange rate fluctuations.

Non-UK domiciled individuals

Specific rules apply to non-UK domiciled individuals who have paid tax on the remittance basis. Income that is taxed on the remittance basis is converted into sterling on the date of remittance rather than the date of receipt. If foreign denominated income has grown in value between receipt and remittance, the taxable income therefore grows accordingly.

Non-UK domiciled individuals are taxed on the remittance basis automatically where unremitted foreign income and gains for the year are £2,000 or less. In determining whether this limit is breached, foreign denominated income is converted based on the spot rate on 5 April at the end of the relevant tax year.

In contrast to foreign-denominated income, the calculation of a capital gain that is taxed on the remittance basis is not directly affected by the exchange rate on the date of remittance. The gain is calculated based on the normal principles set out above. However, the calculation of the remittance itself may be be affected. Following on from the example above, and assuming the proceeds are in an offshore account that does not contain any income or other gains, a remittance of $20,000 to the UK at a time when the exchange rate is $1.25:£1 would give rise to a taxable gain of £16,000 (the remaining £2,519 of gain would remain in the offshore account).