What is the capital gains tax treatment?
Compensation received by an individual for the loss or destruction of an asset is treated as a disposal for CGT purposes.
This rule can be found in sections 22 to 24 of Taxation of Chargeable Gains Act 1992.
The date of disposal is not the date that the asset was lost or destroyed, but the date on which the compensation is received.
If compensation is received because the asset was damaged but not destroyed, the capital sum received is treated as a part disposal. For CGT purposes we use the following formula:
A / (A+B) x original cost
where A is the compensation received and B is the ‘unrestored’ value of the asset.
Example 1
David bought an investment property for £200,000 in 1997. In July 2016 the property was damaged by fire. The insurance company paid David £50,000 in December 2016. The value of the ‘damaged’ house at that time was £300,000.
The gain made by David in December 2016 (the date the compensation was received) is calculated as follows:
Amount received |
£50,000 |
Less allowable cost (200,000x50,000/(50,000+300,000) |
(£28,571) |
Chargeable gain |
£21,429 |
The base cost of the asset for future disposal is £171,459, being the original cost (£200,000) less the amount used for the partial disposal computation (£28,571).
If David uses £40,000 to restore the house, this will be treated as ‘enhancement expenditure’ for future CGT purposes.
Example 2
After restoring the asset, David sold the property in July 2017 for £400,000.
The gain is calculated as follows:
Amount received |
£400,000 |
Remaining original cost |
(£171,459) |
Enhancement |
(£40,000) |
Chargeable gain |
£188,541 |
a) The compensation will not be treated as part disposal if any of the conditions below are satisfied:
*This is only possible if the amount retained (ie not reinvested) is not more than £3,000 or 5% of the compensation received, whichever is the higher.
*s.23 claims can always be made if the capital sum received is either not more than £3,000 or not more than 5% of the value of the asset.
If a claim is not made under s.23, the receipt will be treated as a part disposal.
Note that s.23 does not extinguish the gain, but simply defers it to a later period.
Example 3
Using the amounts in example 1, let’s assume that David reinvested £48,000 (out of £50,000 received).
As the amount not reinvested is not more than £3,000, David can make a claim under s.23 for partial disposal not to apply. David will not have a capital gain in December 2016; instead HMRC will take the compensation received of £50,000, roll it over and deduct it from the cost of the asset. The base cost for future capital disposal will be £150,000, which is the original cost of £200,000 less £50,000. The £48,000 reinvested can be claimed as enhancement expenditure on a future disposal.
b) Partial claim
A deferral claim can still be made under s.23 if the compensation proceeds not spent are not small. HMRC will tax only the proceeds retained.
The base cost will be calculated by using the following formula:
A/(A+B) x original cost,
where A is the compensation not used and B is the ‘restored’ value of the property.
HMRC will also allow a proportion of the enhancement expenditure incurred, as follows:
A/(A+B) x enhancement
Example 4
Using the amounts in example 1, the proceeds not spent by David were £10,000 and let’s assume that the market value after restoration is £350,000.
Proceeds retained |
£10,000 |
Less allowable cost–original: 200,000x10,000/(10,000+350,000) |
(£5,555) |
Less allowable cost–enhancement: 40,000x10,000/(10,000+350,000) |
(£1,111) |
Chargeable gain |
£3,333 |
Where an asset has been entirely lost or destroyed, it is treated as a deemed disposal of the asset.
The sales proceeds for CGT purposes will be the insurance money received.
The capital gain or loss will be calculated by deducting the original cost of the asset from the sales proceeds, in the normal way:
Insurance money |
A |
Less cost |
(B) |
Gain/(Loss) |
C |
If the individual replaces the asset with a new one, within 12 months, the insured party can claim roll over relief (under section 23(4) of TCGA 92) so that there is no tax on receipt of insurance money.
For capital gains tax purposes, the base cost of the replacement assets is reduced by any scrap value of the old asset and any ‘excess’ insurance proceeds. Excess being the extent to which insurance compensation is greater than the original cost of the old asset.
Roll over means that instead of the compensation being taxed in the tax year of receipt, it is reduced from the value of the property subject to capital gains tax on eventual disposal.
Any insurance proceeds not reinvested are immediately subject to CGT. The base cost of the replacement assets is not reduced by the amount already taxed.
If the asset was not insured and the asset was chargeable to tax, the loss is an allowable loss. Any scrap value will reduce the loss. If the asset was not chargeable to tax (such as main residence or cars), the loss or destruction will not create a loss.
There is no specified form that must be used in order to make a claim under s.23 TCGA92. The claim may be made in any form the claimant chooses provided that it is made in writing and identifies:
If a satisfactory and correct claim is made before the self-assessment return is filed, the chargeable gain does not need to be declared in the self-assessment return.
If the self-assessment return is filed before a satisfactory and correct claim is made, any gain arising from the deemed disposal under s.22 TCGA92 should be declared in that return.