Penelope Lang, tax partner at Smith & Williamson, advises how to account for different types of insurance payments
Lost stock, crops and animals or use of temporary facilities or land
Insurance payments of this type count as income, making them taxable as part of trading profits/losses.
This applies even where the amount received is greater than income would have been had no damage occurred.
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Loss of capital items, such as property — for example, farm buildings in general use
Insurance payment for this type of loss are treated as if a sale had taken place, so there is a potential capital gains tax (CGT) liability.
The impact for CGT purposes varies where:
- The asset has been completely lost, in which case 100% of the payout will be assessed for CGT, subject to eligibility for any reliefs
- The money received counts as capital
- The monies are reinvested to repair the asset or replace it with an item of similar function and type to the original.
Rollover relief is available if the insurance payment is reinvested in a replacement within one year of receiving the funds, in which case the gain if deferred.
Immediate tax liability arises where funds are used for a purpose other than replacing the property lost.
Loss of plant and machinery on which capital allowances (tax equivalent of depreciation) have previously been claimed
The asset is treated as having being “sold” for no more than its original cost.
Sale proceeds are deemed to be the insurance payout plus scrap value received.
Insurance claims to repair damage to capital assets
There is a choice of whether to treat insurance payouts as an immediate part-disposal.
Where only some of the insurance proceeds are reinvested, the CGT liability depends on how much is kept back. Where this is “small” (the higher of 5% of the capital sum received and £3,000), no CGT liability arises. The original cost of the asset is reduced by the amount not reinvested, creating a higher gain in the future.
If not small, an immediate CGT liability occurs on a part-disposal. In such cases, it can be capped to correspond with available cash.