Swiss Franc mortgage losses – Double tax whammy?

by Readers Question

11:22 AM, 10th October 2018
About 2 months ago

Swiss Franc mortgage losses – Double tax whammy?

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Swiss Franc mortgage losses – Double tax whammy?

I have a question regarding losses due to currency fluctuations and capital gains tax.

I bought several apartments in Poland during the period 2006 to 2008 using Swiss franc mortgages. As is well known to those involved in the Eastern European property market at the time, the Swiss franc subsequently strengthened significantly against the Polish Zloty, leaving some apartments in negative equity, and me with significant annual negative cash flow.

I have finally decided to sell off these apartments, and although I am making losses on redeeming the Swiss franc mortgages due to the exchange rate, I am making profits in Polish zloty terms, and hence it seems that I am liable to capital gains tax in the UK! It is quite a double whammy! Is there any way that I can mitigate this CGT liability, for example any tax legislation that allows for unexpected and adverse conditions given that the Swiss franc literally more than doubled against the Zloty?

As a side note and in hindsight, clearly taking out mortgages in non native currencies is highly risky and foolish, but in that era and market it was hyper-normalized, and pre 2008, one simply did not see currency swings of over 100% in Europe – my model stress tested to 25% !

Many thanks for any comments

Max



Comments

Neil Patterson

11:30 AM, 10th October 2018
About 2 months ago

I am not sure if this helps, but in HMRC capital gains manual >> https://www.gov.uk/hmrc-internal-manuals/capital-gains-manual/cg78310

"Foreign currency: assets acquired or sold for currency

A transaction in which an asset is disposed of for some consideration which is not sterling cash, but which takes the form of some other asset, is a barter transaction. Where the bargain is at arm’s length, the measure of the consideration is the sterling worth, at the date of the acquisition or disposal, of what is given or received. This rule must be followed when the `other asset’ is foreign currency.

For example, if US shares are bought for US dollars in a bargain at arm’s length for full consideration

the acquisition cost of the shares is the sterling equivalent of the dollars given at the exchange rate in force at the date of acquisition of the shares;
the consideration for disposal of the dollars is the sterling value of the shares received in exchange.

Since the transaction was a bargain at arm’s length for full consideration, the sterling equivalent of the dollars is likely to be the same as the sterling value of the shares.

On a later arm’s length sale of the shares for (say) French francs, the consideration for the disposal of the shares will be the sterling equivalent of the francs at the exchange rate in force at the date of disposal. The acquisition cost of the francs will be the sterling value of the shares at the same date. Again, the sterling value of the shares and francs is likely to be the same.

If in computing the gain on disposal of the shares it is appropriate to adopt in place of the acquisition cost the value of the shares at some other date, for example at 31 March 1982, that value must be in sterling terms at that date.

You should not accept a contention that the gain or loss on an asset acquired and disposed of for foreign currency should itself be computed in foreign currency and then converted into sterling at the rate ruling at the time of the disposal of the asset. The decision in Bentley v Pike, 53TC590, that the capital gains computation had to be worked in sterling was confirmed in the case of Capcount Trading v Evans, 65TC545."

Full section: Capital Gains Manual: Chattels and other assets: Foreign currency: contents >> https://www.gov.uk/hmrc-internal-manuals/capital-gains-manual/cg78300p

Mark Alexander

21:37 PM, 10th October 2018
About 2 months ago

I don’t think you can offset the currency loss against the capital gain.

You took two separate bets, won on one but lost more on the other unfortunately. They were separate bets. Profits and losses on the property deal are treated as capital but the currency bet you made isn’t.

If the Zloty had appreciated against the Swiss Frank you would not pay CGT on that gain so far as I am aware, and on that basis I cannot see why the exchange rate loss could be offset against your capital gain.

I’m very sorry that will not be the answer you were hoping for

sam

7:37 AM, 12th October 2018
About 2 months ago

How should the currency loss/gain be accounted for ?

Paul T. Guest

8:01 AM, 12th October 2018
About 2 months ago

I'm certain the currency loss IS a claimable capital loss (unless you're a very frequent currency trader taxed as a earning a trading income from it). But the first post explains "arm's kength" transactions anyway. Buy asset but convert to the Sterling price, then later sell the asset and convert to Sterling - book this as a gain or loss. Separately you then have the currency transactions from Zwoty to Swissy and back. You also have the deductible interest cost on the loan to account for somehow. Probably worth paying a pro for accurate advice.

steve watt

8:44 AM, 13th October 2018
About 2 months ago

To compute the capital gain for tax purposes (in brief) you take the sterling equivalent of the proceeds at the exchange rate at the date of sale less the sterling equivalent of the cost of the asset at the exchange rate at the time of acquisition. If all this was in sterling then there is no issue here.
Since the mortgage is part of the asset you do the same in converting the mortgage at the two dates taking historical rates.
This is the rule and it can produce perverse results: If you have an asset in a foreign currency and that foreign currency increases massively against sterling the offsettable cost for CGT purposes is pegged (you can't take the original cost at today's rate to deduct from the proceeds). However if you have a liability, as in the case here, the rule is to your advantage.
These funny rules arise because you cannot submit tax returns in foreign currencies.
I'm a CTA(fellow) in practice, and a landlord.

steve watt

9:00 AM, 13th October 2018
About 2 months ago

Reply to the comment left by steve watt at 13/10/2018 - 08:44
My comment above was a draft but it ended up getting posted.
Although the property and the mortgage are linked economically, for the purposes of CGT the mortgage is ignored. This is because the mortgage is not an asset and not subject to any CGT rules. There could be a capital gain or loss on the mortgage, but because this is a liability it is not subject to or allowable for tax.

sam

21:08 PM, 13th October 2018
About 2 months ago

Reply to the comment left by steve watt at 13/10/2018 - 09:00
Mortgage is a debt. A liability to the borrower or an asset to the lender.

My take on this example :

If I had borrowed CHF3m to buy a CHF9m Swiss villa n exchange rate was CHF3 to £1 at the time ie CHF6m or £2m investment. If I then sold the villa for CHF12m n exchange rate was CHF2 to £1 ie CHF3m or £1.5m gain which is subject to CGT.
But if I had converting the entire nett sale proceed into Sterling, I would have received the Sterling equivalent of CHF9m or £4.5m against an original investment of £2m. I guess I would have to pay CGT on £2.5m - £1m of which is forex gain.
But if I had Kept the entire CHF9m in Swiss Franc n later converted to Sterling at an exchange rate of CHF5 to £1. I would hv received £1.8m. Since my original investment was £2m plus £2.5m which I had paid tax on, I guess I would hv incurred a loss of £2.7m which I can off set against my other gains.

Anybody care to comment please.

Paul T. Guest

0:49 AM, 14th October 2018
About 2 months ago

This could get interesting from a tax arbitrage perspective!

Max

11:56 AM, 23rd October 2018
About 2 months ago

Thanks for the comments - pretty much as I had thought but worth putting it out there!


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