Enter Your E-mail

Julie Butler considers the importance of business commerciality for loss relief purposes, and highlights a recent tax case.

Is a Business Being Conducted on a Commercial Basis?

The question regarding evidence of commerciality and the allowability of Income Tax losses to offset against total income (ITA 2007 s 64) is constantly being raised by HMRC with regard to farming, land diversification and equine pursuits. The Tax Office arguments presented regarding ITA 2007 s 64 are reiterated in principle during attempts by HMRC to deny the claim for Business Property Relief (BPR) for Inheritance Tax (IHT) on the grounds of lack of evidence of a “business carried on for gain with a view to a profit”.

The case of a livestock farming partnership in Walsh v Taylor [2004] STC SCD 48 questioned the commercial trading basis throughout the relevant period of the partnership. Questions were raised as to whether the business was conducted in such a way that profits could be reasonably expected to be realised in that period and in a reasonable time thereafter, i.e., was the business of commercial design?

A recent case, John Agnew (TC 566), relates to a beautician’s business and raises two important points – who is actually trading and is the business structured in a way that it would ever be profitable? It can be argued that the Agnew case highlights the need for the trader to produce a business plan.  If the taxpayer has to show that a business would be profitable, then they have to show that from the outset of the business there was commercial intent – the business plan must show a potential profit and a profit that can be sustained.  HMRC will check the validity of the business plan during an enquiry. As a practical approach the plan should be convincing enough that a bank would lend money on the strength of the plan AND there is evidence to support the detail of the business proposal.

What are the Facts of the Agnew Case?

Mrs Agnew worked part-time, about ten hours a week, as a manicurist, pedicurist and beautician from her home. Her husband claimed that he owned the business and that she was employed by him, although in fact his wife effectively ran the business on her own. Mr Agnew claimed losses from the trade against his income. HMRC began an enquiry, questioning whether or not Mr Agnew was trading with a view to profit. Eventually, HMRC decided that the wages paid to Mrs Agnew were a transfer of income rather than expenses of the trade. HMRC issued assessments to recover the underpaid tax as a result of the disallowed loss relief claims.  The taxpayer appealed.

The First-tier Tribunal found that there was a trade, but that it was undertaken by Mrs Agnew, rather than Mr Agnew. Mrs Agnew carried out all the treatments, dealt with all the bookings, bought most supplies, and the insurance was in the name of Mrs Agnew. There was nothing to show that Mr Agnew was involved in the business.  The business was not being carried on on a commercial basis, as it was not structured in a way that it would ever be profitable.

Mr Agnew’s appeal was dismissed. This was subject to the fact that for 2003/04, the Tribunal concluded that Mr Agnew had told HMRC in October 2004 that the business would not be run on a commercial basis for 2003/04, so the insufficiency of the assessment should have been clear. Therefore the later raising of the 2003/04 assessment under TMA 1970 s 29 was not permitted. 

The Importance of Commercial Design

The Agnew case emphasises the importance of the business being of commercial design and structured to be able to make a profit in order to achieve Income Tax relief. There are points raised in this case that apply to many equine and farming operations which make large and/or persistent Income Tax losses. The questions have to be asked - who is undertaking the trade and is it structured for profit? There are many similarities in principle with non-commercial equine activities. Who is the trade actually undertaken by? Is the structure such, mindful of the overhead costs of an equine activity, as to make a profit? The emphasis in order to prove commerciality is on the original structure and therefore the need for a business plan to show that the proposed structure can produce a profit.

Practical Tax Planning Point

Wherever an Income Tax loss claim is made, the question of commerciality must be considered. If there is no business plan then it is essential that the whole question be reviewed and one be prepared. Ideally, there should be evidence that the taxpayer has responded to the problems shown by both the results and projections and taken positive action to rectify problem areas.