HMRC Enquiry into the use of a capital loss - transfers to a connected person

This article is based on a Taxation Magazine readers’ forum question and our response was published on 10 June 2024.

In brief, the query was that a client was being investigated by HMRC in relation to tax due on a gain on disposal made in 2021/22. In computing the tax due, losses generated from a disposal in 2012/13 were deducted from the capital gain. However the loss had arisen as a result of a disposal to a the client’s brother. The reader asked whether HMRC had the right to ask questions relating to the loss given that the enquiry window for that year had closed. The reader also asked of the relevance to this situation of the time limits pertaining to HMRC’s powers and whether the client should have notified HMRC that the initial loss had been generated as a result of a transfer to a connected person, at the time the loss was claimed. Our response was published in Taxation on 10 June 2024.

There are specific rules relating to capital gains where assets are transferred to connected persons. For capital gains tax purposes, a connected person is

• the individual’s spouse or civil partner,
• a relative (brother, sister, ancestor or lineal descendant) of the individual
• the spouse or civil partner of a relative of the individual
• a relative of the individual’s spouse or civil partner
• the spouse or civil partner of a relative of the individual’s spouse or civil partner.

A loss made on disposal of an asset to a connected person is ring-fenced and can only be offset against gains made on transfers of assets to the same person. In this case, the loss was not ring-fenced and it was offset against a gain on disposal of the property to a third party. The loss was incorrectly used to reduce the taxable gain, resulting in an under-declaration of tax, i.e. that a (self)-assessment to tax is insufficient.

Does HMRC have the right to enquire into a loss where the loss was made nine years before it was utilised?
Under Sch 36, Finance Act 2008, HMRC is permitted to ask any reasonable question relevant to determining a person’s tax position, either where the person is under enquiry or if there is no enquiry, where the officer has reasonable suspicion of an under-declaration of tax.

In this case, the officer is asking a reasonable question (to determine whether the loss has been correctly calculated and applied) to determine the client’s tax position – i.e. the taxable gain – in 2021/22, which is under enquiry. Since the computation and application of the capital loss directly affect the client’s 2021/22 tax position, HMRC is within its rights to request the information.

Time limits will become relevant should HMRC seek to raise assessments. If (for example) it arises during the course of the enquiry into the 2021/22 tax return that your client made a capital gain for tax purposes in 2012/13 – say the shares were transferred at significantly below market value and the loss was incorrectly calculated based on the actual proceeds instead of deemed proceeds at MV per s18, TCGA 1992 – HMRC can only raise an assessment if it can show deliberate behaviour. This is because the transfer of shares took place more than six years ago.

There is no requirement to notify HMRC that the loss was generated by disposal to a connected party. However, in order to ensure the tax legislation on ring-fenced losses is applied correctly, transferors should ensure they keep a record of such transactions.

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