Client Background

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David sold a portfolio of shares in a private trading company to his brother's wife, Catherine, for £45,000. David had originally acquired the shares in 2018 for £72,000, and at the time of the sale, he genuinely believed £45,000 represented fair market value given the company's recent trading difficulties.

David was hopeful that the resulting capital loss of £27,000 could be used to offset gains arising from a separate property disposal he completed earlier in the tax year. He sought our advice on the availability and utilisation of this loss.

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The Issue

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When an asset is disposed of to a "connected person," the transaction is subject to special rules under capital gains tax legislation. These rules can significantly impact both the calculation of any gain or loss and the manner in which losses may be utilised.

The key questions we needed to address were:

• Is Catherine a "connected person" in relation to David?
• What are the implications for the disposal proceeds?
• Can David utilise the resulting loss against his other capital gains?

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Who is a Connected Person?

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The legislation provides a comprehensive definition of connected persons, which encompasses several categories of relationships:

• An individual's spouse or civil partner
• A relative of the individual (being a brother, sister, ancestor or lineal descendant)
• The spouse or civil partner of any such relative
• A relative of the individual's spouse or civil partner
• The spouse or civil partner of such a relative
• Certain trustees, partners, and companies under common control

In David's case, Catherine is his brother's wife. As a spouse of David's relative (his brother), Catherine clearly falls within the definition of a connected person.

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The Market Value Rule

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When a disposal is made to a connected person, the transaction is deemed to take place at open market value, regardless of the actual consideration paid. This rule applies even where the parties genuinely believe they have transacted at market value.

We commissioned an independent valuation of the shares, which concluded that the open market value at the date of disposal was actually £52,000. This meant that for capital gains tax purposes, David's disposal proceeds were deemed to be £52,000, not the £45,000 he actually received.

The revised calculation therefore showed:

Deemed proceeds (market value)   £52,000

Less: Original cost                         (£72,000)

‍Capital loss                             £20,000

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Restriction on Loss Utilisation

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Here lies the critical issue for David. Where a loss arises on a disposal to a connected person, that loss is "ring-fenced" and may only be offset against chargeable gains arising on future disposals to the same connected person, whilst both parties remain connected.

This means David's £20,000 loss cannot be set against:

• The gain from his property disposal earlier in 2024/25
• Any other gains arising from disposals to unconnected parties
• Gains from disposals to other connected persons (even other family members)

The loss can only be utilised if David makes a subsequent disposal to Catherine that generates a chargeable gain, and only whilst they remain connected. Given that family relationships are typically enduring, this connection would persist unless, for example, David's brother and Catherine were to divorce.

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Limited Exception

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There is a narrow exception to this restriction. The ring-fencing rules do not apply where the disposal is by way of gift and the asset, together with any income derived from it, is primarily applicable for educational, cultural or recreational purposes, with most beneficiaries being unconnected persons.

This exception has limited practical application for most private transactions and was not relevant to David's circumstances.

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Reporting Requirements

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Despite the restriction on its use, David must still report the capital loss to HMRC. This is normally accomplished by including the loss in the Capital Gains Tax supplementary pages of his Self Assessment tax return for the 2024/25 tax year.

Importantly, a capital loss may be notified to HMRC at any time, provided the notification is made within four years from the end of the tax year in which the loss arose. Should David not otherwise be required to file a tax return, he could notify the loss by writing to HMRC within this time limit.

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Our Advice

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We advised David as follows:

• The disposal to Catherine is deemed to be at market value of £52,000, resulting in a loss of £20,000
• This loss is ring-fenced and cannot be used against his property gain or any other gains from disposals to unconnected parties
• The loss may only be offset against future gains arising on disposals to Catherine whilst they remain connected
• The loss should still be reported to HMRC in his 2024/25 tax return to preserve the ability to use it in future
• For future transactions, we strongly recommend obtaining professional valuations in advance and considering whether connected person rules will apply

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Key Takeaways

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• Market value applies: Disposals to connected persons are always deemed to be at market value, regardless of actual consideration
• Losses are restricted: Losses arising on connected person disposals can only offset gains from future disposals to the same person
• Wide definition: The connected persons definition is broad and includes in-laws and other extended family relationships
• Still report: Restricted losses should still be reported to HMRC within the normal time limits
• Plan ahead: Professional advice and independent valuations should be obtained before transacting with family members

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Disclaimer: This case study is provided for illustrative purposes only and does not constitute tax advice. The names, circumstances and figures used are entirely fictional. Tax legislation and rates are subject to change. Always seek professional advice tailored to your specific circumstances.