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Mark McLaughlin looks at trading activities and their implications.

Introduction

The 2012 London Olympics will provide an excellent opportunity for enterprising individuals to apply their entrepreneurial skills to making some money (see Olympic Windfall below). The Olympics will no doubt be the catalyst for many individuals with aspirations of appearing on The Apprentice to engage in activities which they hope would win Lord Sugar’s approval.

Olympic Windfall

Arthur lives near one of the 2012 Olympic Games venues. He owns a small plot of land next to his house. Arthur has the idea of offering a car valeting service for the duration of the Olympics, whereby customers can drop off their car to attend the event, and have the car valeted in their absence. If the operation is successful (as Arthur predicts) he will probably extend his valeting service to future events at the venue after the Olympics. Arthur’s profits will be taxable as trading income.
 
The question of what constitutes a trading activity for tax purposes is far from new, however. A lack of legislative guidance has resulted in extensive case law on the subject over the years. Two recent tribunal cases on the subject are highlighted later in this article.

Identifying a Trade

‘Trade’ is defined as including ‘any venture in the nature of trade’ (ITA 2007 s 989). And that’s it. There is no further statutory guidance for Income Tax purposes. The previous definition of trade (in TA 1988 s 832) was that ‘Trade includes every trade, manufacture, adventure or concern in the nature of trade’.
 
The term ‘adventure in the nature of trade’ dates back at least to the Income Tax Act 1853. The term ‘adventure’ was changed to ‘venture’ during the Tax Law Rewrite Project as a modernisation measure, but was intended to have exactly the same meaning.
 
Many readers will be familiar with the ‘badges of trade’. These were identified by the Royal Commission for the Taxation of Profits and Income in 1955, using previous case law about what constitutes a trade.
 
Subsequently, in Marson v Morton [1986] STC 463, a total of nine badges were identified. As mentioned, there is also a large body of case law on what amounts to trading. A lack of space prevents discussion of the badges and cases. However, detailed commentary can be found in Simon’s Taxes (at division B1.403).
 
In addition, there is an HMRC summary of the badges of trade in the Business Income Manual at BIM20205, together with HMRC’s interpretation of those badges and relevant case law in subsequent paragraphs.
 
In the recent case of Azam (TC928), the First-tier Tribunal commented that the badges of trade ‘… must be approached with caution’, and highlighted two important authorities dealing with the application of the badges of trade.
 
In Marson v Morton, it was pointed out that the badges ‘are in no sense a comprehensive list of all relevant matters, nor is any one of them so far as I can see decisive in all cases. The most they can do is provide common sense guidance to the conclusion which is appropriate’.
 
In Salt v Chamberlain [1979] STC 750, Oliver J said:

‘I doubt whether the question whether in any given case a person is or is not carrying on a trade is capable of solution by the application of a logical progression of propositions culled from decided cases. The question is, I think, one of overall impression.’

Thus the badges of trade should not be used as a definitive checklist.
 
Not surprisingly, in the majority of previous cases on whether the taxpayer’s profits were derived from trading activities, the taxpayer sought to argue that there was no trade or adventure in the nature of a trade.
 
It might be thought that these harsh economic times would result in more taxpayers than before arguing that they are trading, in order to claim Income Tax relief for their losses.
 
However, loss relief claims made by individuals and companies on the basis of trading are nothing new; see for example Salt v Chamberlain, and Lewis Emanuel & Son Ltd v White 42 TC 369. HMRC guidance advocates a consistent approach, whether the transactions are profit or loss making (BIM20090).

Dealing in Shares and Securities

In Manzur (TC830) the taxpayer, a retired surgeon, invested in stocks and shares. His transactions resulted in losses, for which claims were made to offset them against general income. HMRC refused the claims, and the taxpayer appealed.
 
The tribunal held that the activities undertaken by the taxpayer amounted to investment rather than trading activities, and dismissed his appeal.
 
In reaching that decision, the tribunal recognised that there is no definitive checklist for determining whether an individual is trading or not. Their overall impression was that the transactions were more in the nature of managing an investment portfolio.
 
The tribunal noted (from the Lewis Emanuel case) that an individual speculating on price movement in shares without intending to hold the shares even as a short-term investment was analogous to gambling, and fell short of trading.
 
The tribunal considered that the characteristics of share trading by established business were such that ‘it is easier to classify the dealings of a company as trading than those of an individual’, and added ‘share dealing by an individual is more likely to give rise to a Capital Gains Tax charge’.
 
The tribunal’s decision in Manzur accords with HMRC’s stated approach, which is that transactions in shares and securities (or futures, options or other derivative contracts) are not generally trading transactions (BIM65701).
 
HMRC consider that an established share trader will typically have customers, move high volumes of shares very quickly, limit exposure to market movements and have strict rules on risk.
 
However, it should be remembered that HMRC guidance does not carry the force of law, and that First-tier Tribunal decisions such as Manzur do not create a binding precedent.

Dealing in Land

In Azam, the taxpayer’s returns also included claims to offset trading losses against general income. HMRC enquired into the returns, and concluded that the taxpayer’s activities amounted to UK property rental, not trading as a property dealer or developer.
 
The taxpayer had bought properties (11 in total) since 2002, but sold none of them. She claimed that the properties were purchased with the intention of reselling them at a profit within a short period, but that due to a downturn in the property market she was unable to sell any, except at a loss. The properties were therefore rented out on short-term leases until market conditions improved.
 
The tribunal found that the burden of proof was on the taxpayer to displace the figures in HMRC’s closure notice. It applied the badges of trade to the evidence, and accepted as a matter of law that trading stock does not become an investment because adverse market conditions prevent it from being sold for want of purchasers.
 
However, the tribunal was not satisfied overall that the taxpayer was engaged in a property trade, and dismissed her appeal.
 
An asset such as a property is capable of being an investment or trading stock. The correct treatment is a question of fact, which may ultimately be for the tribunal or courts to decide.
 
The taxpayer in Azam contended that there had always been an intention to trade. Unfortunately, there was an apparent lack of evidence to support that argument, which resulted in the tribunal making certain findings on a balance of probabilities.
 
Whereas company owners may be able to produce minutes of meetings to support an intention to trade (or not), the burden of proof is arguably more difficult for individuals.
 
However, HMRC describe the approach they will take in practice when considering whether a land transaction constitutes trading at BIM60015, which is repeated for other transactions at BIM20080.
 
This includes HMRC holding a meeting with the taxpayer to establish his intentions at the moment of acquisition.

Prove It

Whether someone is trying to establish that his activities are trading or investment, keeping supporting evidence is very important. In Edwards v Bairstow and Another 36 TC 207, the taxpayers entered into a transaction to buy and sell spinning plant.
 
The General Commissioners determined that the transaction was not an adventure in the nature of a trade.
 
On appeal, the High Court and Court of Appeal held that the determination was purely a question of fact, and it was not open for the courts to interfere with it, unless the commissioners had ‘acted without any evidence, or on a view of the facts which could not reasonably be entertained’.
 
Unfortunately for the taxpayers, the House of Lords allowed HMRC’s appeal, as the commissioners’ decision had originally been on the ground that the transaction was an ‘isolated case’. The House of Lords recognised that this was not a conclusive factor by itself. On the evidence, the taxpayers’ operations constituted an adventure in the nature of trade.
 
Nevertheless, the case may encourage taxpayers to take the time and trouble to compile evidence to support their case (whether trading or not).
 
If the evidence points in one direction this reduces the possibility of the tribunal deciding the other way, but even if it does, there should be scope to appeal to the courts. HMRC acknowledge this point in their guidance (at BIM20070 [6]).

Trade or Venture?

Even if an activity is insufficient to amount to a trade, it can still be treated as such for tax purposes if it is a venture in the nature of trade. But what is the difference between them? In broad terms, a ‘trade’ is normally established as a continuous operation with a degree of organisation or an infrastructure.
 
A ‘venture in the nature of a trade’ may lack those attributes but still display some characteristics of a trade. See Music festival below.

Music Festival

Ted creates temporary facilities on some farmland to stage a music festival over a weekend during the summer, the audience being charged for admission. The festival is a success. Ted’s operation is essentially the same as a concert hall, albeit that the ephemeral nature of the enterprise would disqualify it as a trade. It is therefore regarded as a ‘venture’ for tax purposes.

HMRC’s view (see BIM20065) is that a venture ‘brings in transactions that might in some respects be less than full trading operations, but are sufficiently close to a trade to be included in its meaning for tax purposes’.
 
Hobbies could be caught, although HMRC would probably argue that a hobby is not sufficiently commercial to amount to either if there is a history of losses.
 
HMRC’s recently announced intention to target those who buy and sell goods on ‘e-marketplaces’ may trigger alarm bells, if occasional sales have escalated into something more.
 
It is worth noting that certain activities are specifically treated as trades by statute, such as farming and market gardening (ITTOIA 2005 s 9(1)).
 
By contrast, the occupation of woodlands in the UK on a commercial basis with a view to realising profit is not a trade for Income Tax purposes (ITTOIA 2005 s 11).

Conclusion

Whether an activity constitutes a trade or a venture in the nature of trade is likely to be fact-specific, and circumstances will differ.
 
The message from case law (and HMRC guidance) is that the badges of trade should only be used as a general guide to the relevant principles.
 
The recommended approach can perhaps be summed up in Marson v Morton, where Sir Nicolas Browne-Wilkinson V-C said:
 
‘I believe that in order to reach a proper factual assessment in each case it is necessary to stand back, having looked at those matters, and look at the whole picture and ask the question … was this an adventure in the nature of trade?’
 
This holistic approach is perhaps reminiscent of the ‘elephant test’ – difficult to describe, but you know one when you see one.

The above article was first published in Taxation 30 June 2011.