Compensation Claims & Payments & the Capital Gains Tax Implications…
Where an individual receives a compensation payment, typically from an insurance company, for the loss or destruction of an asset, the amount received will be treated as a capital sum and a full disposal of the asset for Capital Gains Tax (CGT) purposes.
Where an asset is damaged but not destroyed, the compensation received for the damaged asset will be treated as a part disposal for CGT – more on this below.
In calculating the capital gain, we apply the usual CGT rules, with the proceeds equal to the capital sum received by way of compensation. The date of disposal will be treated as the date in which the compensation payment is received, rather than when the asset was lost or destroyed.
If an uninsured asset is stolen or destroyed, a disposal is still deemed to have taken place, however an allowable capital loss will arise. Assuming an asset is worthless, the capital loss will be claimed via a negligible value claim.
Where a capital gain has arisen because of a compensation claim on an asset lost or destroyed, an individual can claim ‘rollover relief’ to defer the gain where the asset is replaced within 12 months of receiving the compensation payment.
A rollover relief claim allows for the capital gain on the loss/destruction of the original asset to be rolled over and set against the base cost of the new asset.
The replacement asset does not necessarily have to be the same as the asset lost/destroyed, but it must however be a chargeable asset for CGT purposes.
When calculating the capital gain on the loss or destruction of the original asset, the proceeds of sale will consist of two elements; the compensation plus any residual/scrap value of the old asset.
Rollover relief must be claimed no later than 4 years from the end of the tax year of disposal.
Compensation for assets damaged
If an asset is damaged but not destroyed, and compensation is received from an insurance claim, a part-disposal for CGT purposes will take place.
To calculate the allowable cost on a part-disposal for CGT purposes, we use the following formula:
A/(A + B) x original cost
A = compensation received
B = value of remaining asset (“unrestored” value)
If the compensation received is used in full, or in part, to restore the asset, the expenditure will be treated as ‘enhancement’ expenditure for CGT purposes. Enhancement expenditure is deductible when calculating a gain or loss on an eventual sale.
Claims to Avoid this Part Disposal
In some instances, calculating a part disposal can be avoided where one of three conditions are met. The taxpayer can avoid a part disposal if:
- the full amount of compensation received is used in restoring the damaged asset.
- not all of the compensation received in restoring the asset, but the amount retained is “small”. Small is defined as not more than £3,000, or 5% of the total compensation received (whichever is higher).
- the capital sum received by way of compensation is itself “small” – i.e. either not more than £3,000 or not more than 5% of the value of the asset.
The claim must be made within 4 years from the end of the tax year of disposal. A capital gain will arise in the usual way where no claim is made.
If you require further information on any aspect of the above, please get in touch. Or read more about CGT below.