When Does A Trade Start?

• A look at the interaction of trading, capital gains, hobbies and pastimes

• Andrew McKenzie-Smart FCCA CTA – Smart Solutions

A Seminar for theSouth London & Surrey Branch

Chartered Institute of Tax

The legislation…

• “Income Tax is charged on the profits of a trade, profession or vocation” ITTOIA 2005 Part 2 Chapter s5

• Not much help really as …s989 Income Tax Act 2007

“TRADE” includes any venture in the nature of trade

• So that means we are left with case law precedents..

• Summarised by the 1955 Royal Commission on the Taxation of Income & Profits identified 6 features of trading activities. These have been termed the “badges of trade”….

The badges of trade…

• Profit seeking motive…

• Frequency of transactions…

• Nature of the Assets acquired….

• Subject matter…

• These need to be applied to the hobbies and pastimes as much any other trading activity…

• Work done…

• Taxation of similar activities

The legislation…[continued] ITA 2007

• s66 : “Restriction on [Loss] Relief unless trade is commercial”

(2) the trade is commercial if it is carried on throughout the basis period for the tax year—(a) on a commercial basis, and(b) with a view to the realisation of profits of the trade.

(3) if at any time a trade is carried on so as to afford a reasonable expectation of profit, it is treated as carried on at that time with a view to the realisation of profits.

(7) this section applies to professions and vocations as it applies to trades

• Effect of s66 ITA 2007, ITTOIA & case law is that the intention to trade is the key determinant

The legislation…[continued] ITA 2007

• s67 : “Restriction on [Loss] Relief for farming and market gardening

1) this section applies if a loss is made in a trade of farming or market gardening in a tax year (“the current tax year”).2) trade loss relief against general income is not available for the loss if a loss, calculated without regard to capital allowances, was made in the trade in each of the previous 5 tax years (see section 70).3) this section does not prevent relief for the loss from being given if

—(a) the carrying on of the trade forms part of, and is ancillary to, a larger trading undertaking,(b) the farming or market gardening activities meet the

reasonable expectation of profit test (see section 68), or(c) the trade was started, or treated as started, at any

time within the 5 tax years before the current tax year (see s 69, as well as section 17 of ITTOIA 2005).

• Different test applied for farming and market gardening trade – the 5 year rule only applies to these activities…

The legislation…[continued] ITA 2007

• s68 : “Reasonable expectation of profit”

• Competent market gardener or farmer– In the current year would be expected to make a profit– In the prior period to the loss, they could not reasonably be expected

to be profitable

• Consider the whole activities undertaken and the way the activities were undertaken

• Ignore capital allowances

• Remember this is a different test only applied for farming and market gardening trades – normally only applies to one year…

The legislation…[continued] Corporation Tax 2009 & 2010

• CTA 2009 s54 : Expenses not wholly and exclusively for trade and unconnected losses

In calculating the profits of a trade, no deduction is allowed for—(1) expenses not incurred wholly and exclusively for the purposes

of the trade, or(2) losses not connected with or arising out of the trade.

• CTA 2010 s44 : Trade must be commercial or carried on for statutory functions

• relief under s37 is not available for a loss made in a trade unless for the loss-making period the trade is carried on—

(a) on a commercial basis, and(b) with a view to the making of a profit in the

trade or so as to afford a reasonable expectation of making such a profit.

• references in subsection (1)(b) to a profit in the trade include references to a profit in any larger undertaking of which the trade forms part.

The legislation…[continued] Corporation Tax 2009 & 2010 - Groups

• CTA 2009 s99 & s100 : Group Relief for CT losses on hobbies

Group relief is only available for trading losses if s44 doesn’t apply

• The net effect being that losses on hobby companies are only eligible for tax relief if they make profits….

• When a hobby company is identified by HMRC, they then scrutinise subsequent receipts it makes to ensure that the “trading receipts” are on an arms length basis – Use s54 CTA 2009 to add back in the paying company…

• Losses on hobby trading companies are therefore only allowed to be offset against future trading profits from the same business

Hobbies & Pastimes…

• Musicians • Writers• Painters• Actors• Online retailers

• Paul McCartney• J.K. Rowling• Banksie• John Wayne• Using Ebay as a Reseller

• Obviously these are now all “trading businesses”, but when would you think that they started to trade…?

• Some practical examples follow

Musicians…an example…The scenario….

Paul • Buys a guitar• Writes some songs• Meets with some mates to jam, continues to book venue• Mates form a band & plays a gig at a friend’s wedding• Which is then available online via Youtube• Sets up a facebook page• Booked 3 months later for a gig at a local pub• Hires a recording studio• Recording available to download on the net slow uptake at first• After 8 paying gigs at roughly 2 a month he takes unpaid

leave from his job to “go on tour” with his mates• After a successful “tour” of various pubs, clubs and venues one

of the band leaves his job to act as the band’s manager..

• So when did trade start and become taxable?

Writers…an example…The scenario….

Joanne• Leaves University with a degree in English• Starts job in local newspaper• Does part time course in professional writing • Starts to write a weekly blog• Drafts the outline/ synopsis of a screenplay• Engages an agent – discusses future projects• Writes the first chapter of a novel and the

outline of the remainder of the book• BBC likes screenplay but want amendment of

the synopsis• Random House start to discuss terms for the

novel• Advance received from Random House• Leaves job

• So has a trade started and become taxable?

Painters…an example…The scenario….

Mark • Enjoys drawing and painting and spends 2 weeks each

summer on holiday where he paints various scenes• Also has occasional weekends away painting harbours

and countryside scenes• Paintings are hung in his house and given away to friends

and relatives• Joins local art group and shows some of his best work in

an exhibition in the local village hall. • Offered £200 for one of his paintings• Made redundant• A month later a local gallery owner offers to exhibit some

of the paintings for a commission• Sells 5 new paintings for £2,500 via the gallery• “Holidays” cost £3,500 per annum

• So has a trade started and become taxable?

Actors…an example…The scenario….

John:• Appears in friend’s Youtube sketches• Joins Amateur Dramatic group• Auditions for X factor but fails to gain a place

(although appears on TV …)• Succeeds in becoming an extra in East enders

in a crowd scene (earning £150 for the day)• One year later is asked to accompany friend

to a televised awards ceremony starts to appear in gossip columns

• Decides to become an actor & engages agent• Lands minor role in Eastenders• Auditions for Big Brother succeeds• Stars in pantomime as Widow Twankey

• So has a trade start and become taxable?

Online Retailers…an example… An Example

Margaret,• collects toby jugs, buys a few from various shops, as well as receiving

a couple as gifts from family and friends• Starts to attends car boot fairs & antiques fairs throughout the

summer buying various pieces to add to the collection• Having registered for an EBay personal account, Sells duplicates and

“cheaper” toby jugs via Ebay• Has collection valued and its worth £10,000• Notices that there is a lot of very nice “carnival glass ware” which is

fairly reasonable at car boot sales but selling for far greater sums from Ebay

• Starts to buy carnival glass from car boot sales and immediately puts them on ebay for sale

• Has a burglary and collection of glassware and toby jugs is stolen

• What are the tax issues affecting Margaret – has she started to trade?

The scenario….

Online Retailers…an example… Ebay says…

• EBAY Tax policy– “As a seller on eBay, you agree to comply with

all applicable domestic and international laws, statutes, ordinances and regulations regarding your use of our service and your listing, solicitation of offers to purchase, and sale of items.

– You are also responsible for paying all fees associated with using our service and our website and all applicable taxes.”

– http://pages.ebay.co.uk/help/policies/business.html

– VAT advice provided by links to HMRC website

• Difficulty is that many people don’t understand the difference between “being in business” and “a personal supplier”

• The tax rules apply to all traders in the UK..

Online Retailers…an example… The guidance….

Ebay says…

• How do I decide whether I'm operating as a business?For most business sellers it should be obvious – if you're operating as a business in the real world, and your eBay selling activities are connected with this business, then you should register as an eBay business.

• Choose a business account if you:– sell items that you have bought to resell – make items yourself and sell them, intending to make a profit – are a Trading Assistant – buy items for your business on eBay

• Choose a private account if you:– sell items that belong to you and that you don't need anymore – buy things for your personal use

• A business account means taxable on the profits• A private account means possibly taxable on the profits

HMRC ManualsBusiness Income Manual: BIM 20090

• You should be consistent in your approach to transactions that may be trading transactions, irrespective of whether they lead to a profit or a loss. However, you should examine critically claims that a trade exists where that claim may have been made to get relief:

– that is only available to traders, such as loss relief or retirement relief, or – for the costs of a hobby, or – for investment losses, or – for capital expenses, which are in translated to be revenue deductions using an

artificial trading company.

• You should, as usual, consider all the facts. Consider whether a profit – is an isolated event.– A taxpayer who wants tax relief for losses, which are not, in truth, trading

losses may point to a profit in a particular year to support the trading assertion.

– This factor would normally carry little weight if that profit were an isolated event in an overall picture of continuing losses. The profit may be no more than a mere 'flash in the pan', or may even be a contrived event.

• So when did trade start and become taxable?

HMRC Manuals Business Income Manual: BIM 20080

• “Almost any asset or activity can be the subject of trading and the question whether a trade exists is primarily a question of fact. It follows that before you can take an informed view you must obtain all the facts relating to the transaction(s) in question.”

• An investigative approach is taken. When looking critically at a transaction or transactions you should normally:

– interview the person at an early stage to discover:– the history of the transaction and all the background detail which may affect its

treatment for tax purposes; – the person's intentions at the moment of acquisition (if the transaction is one

of purchase and resale) remembering that the person may have to give evidence regarding that intention before the Commissioners/Tribunal;

– obtain copies of all the related correspondence, and other relevant documents such as purchase and sales literature, brochures etc, estimates and invoices for work done on the asset, and the legal documents;

– obtain information, including documents, from other tax offices which may bear on the issue - for example, what the vendor and the purchaser on resale said about the transaction;

– review critically the assertions made in the light of the evidence available.

• You should not take a firm view of the nature of the transaction until after you have completed the above review.

HMRC ManualsBusiness Income Manual: BIM 20080[Continued]

• These suggestions do not impose any limitation on imaginative investigation.

• The scope of the preliminary work must depend– on the nature and complexity of the transaction,– the circumstances of the case– other sources of relevant information– ”In framing your enquiries take account of the 'badges of trade‘” – and any other factors

which may be relevant.

• BIM 75740 “Contrived Losses”• Where there is any suspicion that such losses have been created or that

the person claiming the loss is for practical purposes not suffering or is not liable to suffer the financial effect of that loss, then the case should be referred to Anti-Avoidance Group (Investigation), preferably before detailed enquiries are made.

• Does not intended to apply to cases where losses arising are simply ‘uncommercial’ in the sense that the business could not sustain such losses and be said to be running on a commercial basis.

Let’s revisit the examples

• Musicians • Writers• Painters• Actors• Online retailers

Musicians…an example…The scenario….

Paul • Buys a guitar• Writes some songs• Meets with some mates to jam, continues to book venue• Mates form a band & plays a gig at a friend’s wedding• Which is then available online via Youtube• Sets up a facebook page• Booked 3 months later for a gig at a local pub• Hires a recording studio• Recording available to download on the net slow uptake at first• After 8 paying gigs at roughly 2 a month he takes unpaid

leave from his job to “go on tour” with his mates• After a successful “tour” of various pubs, clubs and venues one

of the band leaves his job to act as the band’s manager..

• So have you changed your opinion?

Writers…an example…The scenario….

Joanne• Leaves University with a degree in English• Starts job in local newspaper• Does part time course in professional writing • Starts to write a weekly blog• Drafts the outline/ synopsis of a screenplay• Engages an agent – discusses future projects• Writes the first chapter of a novel and the outline of the

remainder of the book• BBC likes screenplay but want amendment of the

synopsis• Random House start to discuss terms for the novel• Advance received from Random House• Leaves job

• So have you changed your opinion?

Painters…an example…The scenario….

Mark • Enjoys drawing and painting and spends 2 weeks each

summer on holiday where he paints various scenes• Also has occasional weekends away painting harbours

and countryside scenes• Paintings are hung in his house and given away to friends

and relatives• Joins local art group and shows some of his best

work in an exhibition in the local village hall. • Offered £200 for one of his paintings• Made redundant• A month later a local gallery owner offers to exhibit some

of the paintings for a commission• Sells 5 new paintings for £2,500 via the gallery• “Holidays” cost £3,500 per annum

• So have you changed your opinion?

Actors…an example…The scenario….

John:• Appears in friend’s Youtube sketches• Joins Amateur Dramatic group• Auditions for X factor but fails to gain a place

(although appears on TV …)• Succeeds in becoming an extra in East enders

in a crowd scene (earning £150 for the day)• One year later is asked to accompany friend

to a televised awards ceremony starts to appear in gossip columns

• Decides to become an actor & engages agent• Lands minor role in Eastenders• Auditions for Big Brother succeeds• Stars in pantomime as Widow Twankey

• So have you changed your opinion?

Online retailers…an example… An Example

Margaret,• collects toby jugs, buys a few from various shops, as well as receiving

a couple as gifts from family and friends• Starts to attends car boot fairs & antiques fairs throughout the

summer buying various pieces to add to the collection• Having registered for an EBay personal account, Sells duplicates and

“cheaper” toby jugs via Ebay• Has collection valued and its worth £10,000• Notices that there is a lot of very nice “carnival glass ware”

which is fairly reasonable at car boot sales but selling for far greater sums from Ebay

• Starts to buy carnival glass from car boot sales and immediately puts them on ebay for sale

• Has a burglary and collection of glassware and toby jugs is stolen

• Changed your opinion?

The scenario….

Capital Gains Tax & hobbies/pastimes

• Depends on the assets used for the hobby or pastime. A lot of them will be exempt assets– Motor cars are not a chargeable item– Often items used will be chattels (see later slide for the

chattels rules)– Animals such as horses & dogs used for the hobby are not

chargeable items either– A lot of items used in a hobby or pastime are

consumables

However any land and property used may be taxed any relief depends on the nature of the asset

• Entrepreneur’s relief may be available on the assets used in a hobby or pastime if they are “trading assets”

Capital Gains Tax & hobbies/pastimes

• a gain accruing on a disposal of an asset which is tangible movable property shall not be a chargeable gain if the amount or value of the consideration for the disposal does not exceed £6,000

• If value exceeds £6,000 then the 5/3rds rule applies

• Losses – proceeds treated as if £6,000

• Rates unchanged since 1992

• Rules for “sets”

Chattels Rules: s262 TCGA 1992

Tax Penalties

• Failure to notify….– Since April 2010 the penalties due have been determined

by the potential lost revenue – Is a there a reasonable excuse for failing to notify that a

hobby has become taxable/ profitable?– Can the late notification be deliberate?– Unlikely to be deliberate and concealed but also…– Unlikely to be a suspended penalty imposed…

• Remember this includes not just Income Tax but also the National Insurance (both Class II & IV)..

Late Notification of Trading Business

Practical Steps to take

• Review business income … does it match their lifestyle?• Review personal bank statements whenever possible• Ask them about their hobbies & interests• Check whether they write blogs, have internet accounts,

advertise on Facebook….etc

Remember that HMRC are able to ask Facebook, Ebay & Amazon for their client lists of personal and business customer accounts to identify online retailers. A wide-ranging enquiry could be undertaken on the same basis as those for the offshore banks area without additional legislation…

Know Your Client!

Inheritance Tax for assets used in hobbies & pastimes

• Assets used in a hobby or pastime which are used in a “trading businesses” are potentially eligible for business property relief

• Must have been used in the business for 2 years preceding the chargeable event for IHT

• Must not have any binding conditions for sale at the time of the chargeable event

• Successions – continuing to be used in the trading business?

For Further Information Contact me at:

Andrew McKenzie-SmartSmart Solutions88 Pollards Oak RoadHurst Green Oxted Surrey RH8 0JW

Tel: 01883 715848Mob: 07952 217249

Email : mac@smartsolutions-online.co.ukWebsite: www.smartsolutions-online.co.uk

Disclaimer

• The illustrations and information presented is produced for your general information. It is based upon our understanding of current legislation and correct at the time that the seminar was prepared and presented. You should contact us before taking any specific action based on the information shown on these slides or any handouts provided as part of the seminar. No responsibility can be accepted for any use made of the illustrations or information presented herewith.

• Whilst every effort is made to ensure the accuracy of information

contained herein, we cannot accept liability for any reliance placed on these seminar materials and strongly advise that you seek further specific advice relevant to your individual circumstances.