Lee Sharpe looks at how the perennial issue of trading status stacks up today.
Recently, the issue of whether somebody is trading has conjured to mind images of toilet paper, and lots of it (i.e. due to a well-known and long-established case on whether a trade existed; see below).
While loo roll is not perhaps the most totemic of images representing earnest toil, footage from earlier this year, of people doggedly engaged in hand-to-hand combat in the aisles of their local Sainsbury’s is hard to shake. Toilet paper acquired celebrity status as the must-have accessory to surviving COVID lockdown. No amount was too much, and ‘TP’ was being rationed before eggs and flour – even chocolate!
Why do we care?
Attaching trading status to a transaction or activity can make a big difference to an individual’s tax bill. A capital gain enjoys its own annual exemption and a maximum rate of 20% (except, largely, on residential property). The trading alternative is at least double in terms of income tax rates and with National Insurance contributions to boot.
However, trading status can be helpful. For example, the loss reliefs for trading sources is generally much more generous and flexible (being able to carry losses back to previous periods is almost exclusively the preserve of trading activities). Numerous IHT and CGT reliefs are available only to trades (e.g. business asset disposal relief – previously known as entrepreneurs’ relief; and business property relief for IHT purposes).
A single transaction?
Even a single sale can be a trade. A property developer might take two years to design, build and sell a single house, but that would practically always be considered a trading activity.
Likewise, the case Marson v Morton [1986] 59 TC 381 involved the sale of one piece of land.
Badges of trade
The ‘Badges of trade’ are useful indicia that an activity amounts to a trade, or at least ‘an adventure in the nature of a trade’. They are considered to originate from the 1955 Royal Commission on the Taxation of Profits and Income, but really they are derived from numerous legal cases stretching back long before. They are not binding, but almost all considerations of whether an activity constitutes trading will refer to them.
The original six badges of trade were:
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Motive – A clear motive to profit (particularly in the short term) indicates trading. The purchase of a bonded consignment of whisky for sale through an agent at a profit was held to be trading (CIR v Fraser [1942] 24 TC 498).
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Nature of the asset – One might buy a work of art for personal enjoyment and perhaps as a long-term investment. Alternatively, there is a famous case wherein a taxpayer bought a million toilet rolls and then sold them at a profit (Rutledge v CIR 1929 14 TC 490). You might think that this case definitively answers the question ‘how much toilet paper is too much?’ but what is less well known is that he sold them all to a single individual; which perhaps goes to prove that for some, it’s not love but toilet paper, for which too much is never enough.
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Length of period of ownership – Buying and selling in quick succession would be indicative of trading intent. A well-known case involved the purchase of silver bullion, as a short-term hedge against the value of sterling. Purchase and sale followed in quick succession, and the court held that there was certainly at least an adventure in the nature of a trade (Wisdom v Chamberlain CA 1968 45 TC 92).
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Frequency or number of similar transactions – Buying one industrial mill and selling its assets for a gain would generally be considered a capital transaction in isolation, by most people – and understandably so. But doing it three more times…one might begin to sense a pattern (Pickford v Quirke (1927) 13 TC 251).
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Reason for/method of sale – Originally focusing on the specific reason for the sale, this has developed (in HMRC’s eyes) into looking at how the operation was organised, and whether this was typical of established trades in the sector.
A liquidator selling the whisky stock of a ‘former’ company is not of itself a trade, even if it would clearly have been trading if sold by the company itself in the normal course of events (IRC v Old Bushmills Distillery Co Ltd [1928] 12 TC 1148). The purchase of 40 million yards of linen, which then required a sophisticated organisation of its sale involving a sales team and advertising campaign, was held to be a trade (Martin v Lowry [1926] 11 TC 297).
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Subjecting goods to a process – The classic case here involved the blending and re-casking of brandies for a profit (Cape Brandy Syndicate v CIR [1921] 12 TC 358).
Notably, the aforementioned Marston v Morton case proffered a few more badges:
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Financing the transaction – If an asset has been funded by short term, expensive finance (and particularly if the finance can be repaid only by selling the asset) this will be indicative of a trading activity.
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Similar trade – Is the particular sale being carried on alongside a similar trading activity of the taxpayer? Here, it will commonly be people in the building trades who might need to be careful that a one-off capital property transaction does not get ‘lumped in’ with their self-employment.
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Method of acquisition – An asset acquired by way of gift or inheritance is unlikely to be the subject of trading activity, unless a ‘supervening trade’ develops (see HMRC’s Business Income manual at BIM20315) or statute intervenes (e.g. ‘Profits from dealing in or developing UK land’ – ITA 2007, Pt 3 Ch 13; CTA 2010, Pt 18).
Moving with the times?
It is difficult to look at Mr Wisdom’s meagre two transactions in silver bullion and not conclude he was pretty hard done by. Certainly, if he’d had the misfortune to make a substantial loss, I’d wager the Inland Revenue would have insisted they were capital transactions – or gambling, even, along the lines of Graham v Green [1925] 9 TC 309, or more proximally, Lewis Emanuel & Son Ltd v White [1965] 42 TC 369.
In Salt v Chamberlain [1979] 53 TC 143, the taxpayer made over 200 transactions in stocks and shares over three years and was denied relief as trading losses. In Ali v HMRC [2016] UKFTT 8 (TC), the First-tier Tribunal effectively dragged HMRC ‘kicking and screaming’ to accept that the taxpayer’s practically full-time occupation as a ‘day trader’ over almost a decade was, in fact, a trading activity and not capital investment so he was entitled to those significantly better loss reliefs.
One can see the logic applied in all three cases, and it could be argued that Mr Wisdom’s source of short term finance and specific choice of investment did not help, but his circumstances do not ‘feel’ particularly distinctive today.
HMRC hedging its bets?
When cryptoassets such as Bitcoin first gained recognition, HMRC published Business Brief 09/2014, which included:
“Whether any [trading] profit or [capital] gain is chargeable or any loss is allowable will be looked at on a case-by-case basis taking into account the specific facts... Therefore, depending on the facts, a transaction may be so highly speculative that it is not taxable or any losses relievable. For example gambling or betting wins are not taxable and gambling losses cannot be offset against other taxable profits.” (emphasis added)
Just five years later, in December 2019, HMRC published the comprehensive ‘Cryptoassets: Tax for Individuals’, which says: ‘HMRC does not consider the buying and selling of cryptoassets to be the same as gambling.’ Well, not any more. HMRC thinks individuals will almost always be investors subject to CGT unless they are mining, getting cryptoassets as earnings, (naturally), or are receiving ‘Airdrops’ (I have no idea).
There is also a ‘Cryptoassets for Businesses’, where HMRC tries very hard to route individuals back to the previous ‘Cryptoassets for Individuals’ guidance.
Conclusion
The badges of trade are useful but not binding, nor a checklist simply to tick off, nor are they exhaustive – it has been argued by some that there should be more such badges, such as an element of ‘speculation’ (careful!) or even a requirement for a customer. Me? I am gambling that a garage full of Andrex that toilet paper is 2021’s Bitcoin.
