Capital Gains Tax and Whisky Investments: Too Good To Be True

The blog aims to clarify the misconceptions surrounding capital gains tax on whisky investments and their supposed tax-free status, particularly regarding capital gains tax (CGT) exemptions.

What is CGT, and why is CGT important?

CGT is a tax on capital gains arising on the disposal of an asset. A disposal can be done by way of a sale or gift of an asset, and the tax is charged on the person disposing of the asset. In simple terms, a chargeable gain arises when you dispose of an asset and what you receive (or are deemed to receive, if you dispose of the asset otherwise than under a bargain made at arm’s length) exceeds the cost of the asset plus the cost of any permanent improvements to the asset.

CGT applies to investments and other forms of intangible assets such as shares and securities and contractual rights whether or not those rights can be assigned or transferred or have a market value. 

Some assets are exempt from CGT, and these include tangible moveable property, that is, chattels such as household goods and personal effects, which are sold for no more than £6,000 and chattels with a predictable life of 50 years or less (unless used for the purposes of a trade, profession or vocation).

Knowing whether an investment attracts CGT is obviously important not least because a tax liability on the disposal of the investment affects your overall investment return from the asset and needs to be factored into the decision whether to invest in that particular asset in the first place. CGT is currently charged on most assets at the 10% or 20% rates, depending on whether the taxpayer is a basic rate or higher/additional rate taxpayer. Chargeable gains on disposals of residential property that do not qualify for, or are not fully covered by principal private residence relief are subject to the 18% or 24% rates. The annual exempt amount for 2024/25 is £3,000.

Are Whisky Cask Investments Capital Gains Tax-Free?

There is a widespread belief that investment in cask whisky is automatically exempt from CGT as a wasting asset i.e., as having a predictable life of 50 years or less. This is based on the assumption that the “angel’s share”, or reduction in volume, on average of 1% to 2% per year due to natural evaporation in the porous oak barrel will mean that the whisky in the cask will have evaporated totally within 50 years of storage in the barrel therefore resulting in the cask whisky being a wasting asset and therefore exempt from CGT. But is this true in all cases?

The physics of the “angel’s share” is fascinating, and I am indebted to Mark Littler for the following explanation of how whisky evaporates in a cask: 

• The ABV (or level of alcohol-by-volume) for a cask of whisky 

as well as the bulk liquid is reducing each year.

• The ABV starts at c. 63.5% per year and loses around 0.5% pa depending on warehouse conditions
• If the ABV drops below 40% then it is no longer legally scotch whisky, simply ‘spirit dink’ and has almost no value.
• As such the theoretical life would be 47 years
• The need for whisky to be above 40% is legally defined and is non-negotiable – i.e. 39.99% = not whisky = worthless
• But – this also does not take into account another factor

• The angels share/evaporation increases exponentially
  • The more air that is in a cask, the faster the rate of evaporation
  • This is due to the fact that the air/surface ratio is increasing exponentially
  • As such the rate of evaporation is slower at the start and faster as time moves on
  • As such the maths is one thing, the reality is another, and you would likely see much higher evaporation rates as time goes on
• Warehouse position has a big impact on what is lost from the cask
  • A cask of whisky contains both water and ethanol
  • Temperature and humidity have an impact on what is evaporating
  • In a hot and dry environment (like some parts of the United States where bourbon is produced), evaporation rates are high, and the ABV of the whisky can actually increase over time.
  • In a cool and moist environment (such as Scotland), the evaporation rates are lower, and the loss of alcohol might be more pronounced than water, possibly decreasing the ABV more slowly.
• Not all casks make it!
  • The casks you see bottled on the market are the exception to the rule
  • Lots of casks do not make it past 30 years old owing to the ABV drop
    There are many examples of where casks have not even made it to 20 years old
  • If you change the average ABV drop just 0.1% from 0.5% to 0.6% the lifetime is only 39 years – not 47.

On this basis, many cask whiskies will therefore have a predictable life of 50 years or less and so will be exempt from CGT. However, there are many examples of whiskies that have been matured in a cask for more than 50 years and then bottled, as this example shows

This means that whisky does not always automatically have a predictable life of 50 years or less, and even when bottled, it may not individually fall within the exemption for chattels sold for no more than £6,000.

Of course, the whisky concerned must, at the start, have had a predictable life of 50 years or less, and so there will be many whiskies that, on distillation, can be predicted as lasting less than 50 years, as the above explanation shows. However, as HMRC say in their published guidance : “…where the facts justify it, we would normally contend that wine is not a wasting asset if it appears to be fine wine which not unusually is kept (or some samples of which are kept) for substantial periods sometimes well in excess of 50 years.” [for “wine” of course, here read “whisky”].

It is, therefore, unsafe to believe the hype from some whisky sellers and brokers that HMRC always view whisky as a wasting asset and is therefore always tax-free. A more discriminating approach to the question of CGT on your particular whisky investment is needed if you are to properly understand the true CGT liability on your whisky investment.

What Factors Should You Consider When Investing in Whisky

In order to check the position with tax on whisky investments, you need to ask the seller what records exist to demonstrate that the whisky concerned had a predictable life of less than 50 years when distilled and require copies of such records to support your own tax position should HMRC enquire. Are there any other surrounding circumstances that prove or disprove that the whisky concerned is a wasting asset? For example, has the whisky been put down as a special batch that could last more than 50 years? 

The implication that sellers and brokers like to give is that whisky is exempt from CGT and sometimes this will be put forward as a significant advantage over other investment assets such as real estate or shares and securities which of course, do attract CGT. Therefore, to make a valid comparison of after-tax returns, you must establish whether or not the particular whisky you are acquiring had a predictable life of 50 years or less and was therefore tax exempt or not. Indeed, the types of whiskies that are considered investment grade may well be, by definition, whiskies that can last more than 50 years and so are less likely to be exempt from CGT.

The other matter to consider is the possibility that you might be considered to be trading in whiskies instead of investing and are therefore liable to income tax on your profits instead of CGT. This could arise if you routinely buy and sell whiskies, especially over a short period of time, intending to profit. There is also case law that suggests that even a one-off purchase and sale at a significant cost using a loan over a short period yielding a profit can be treated by HMRC as trading, therefore leading to an income tax liability of up to 45% instead of the top rate of CGT of 20%.

HMRC

Why then are some sellers and brokers getting away with sales patter that prominently describes whisky investment as tax free when it may not be? It’s often in the advertisement headline on-line or on Instagram and is used as a lure to make whisky investment sound more attractive than it is. This may well amount to mis-selling.

In my experience, HMRC are not actively policing this area and looking to tax whisky or whisky cask investment. Sales of whiskies don’t get reported to them on investors’ tax returns because taxpayers choose to believe the hype or at least think that because the ads say that whisky is tax free, they have a credible fall-back explanation, should HMRC ever tackle them over this.

However, if you are under tax investigation for other matters then it is much more likely that if you have been investing in whisky, HMRC will, as part of any tax investigation, pay close attention to any disposals of whisky that you may have made and will challenge any claim that your disposal was tax exempt where appropriate. This could lead not only to the payment of historic CGT (or even income tax) but also to interest and penalties.

It would, therefore, be sensible to consult an experienced tax adviser whenever there can be any doubt over the whisky broker’s claim that a batch of whisky is CGT exempt so that you establish the true position before investing in a whisky cask. This should also ensure that if HMRC comes calling, you can produce the tax advice you received at the time to show that you acted with care and had a reasonable excuse should HMRC later allege that the whisky was not tax-exempt.

Conclusion

The headline is don’t believe the hype that whisky investment is automatically a tax-free investment as a wasting asset. It might be but then it may not be especially if you are looking at the types of whisky that are investment grade. If in any doubt about the tax treatment of investing in a whisky cask, contact Patrick Cannon and ask for his advice.

26 April 2024