Enter Your E-mail

Mark McLaughlin CTA (Fellow) ATT TEP looks at a recent case on the distinction between trading and investment and tax implications.

Introduction

The distinction between property trading and property investing is an important one. For example, individuals trading in properties may be eligible to claim Entrepreneurs' Relief on a disposal of the business. In addition, if the trade incurs losses, the individual may be able to offset those losses against general income. On the other hand, a property investor (e.g., a 'buy to let' business owner) will normally be subject to Capital Gains Tax on the disposal of an investment property, and the scope to offset losses is generally more restricted (although Furnished Holiday Lettings businesses are treated differently if certain conditions are satisfied).

Trading or Investment?

In most cases, it will be relatively straightforward to distinguish a property trader from a property investor (but bear in mind that there are difficult anti-avoidance rules regarding transactions in land, which can bite in certain circumstances). However, in other cases the answer to the question whether an individual is trading or investing in property will depend on the facts and documentation available.

In Azam v CRC [2011] UKFTT 50 (TC), the taxpayer's 2007 and 2008 tax returns included claims to offset trading losses against general income. HM Revenue and Customs (HMRC) enquired into the returns, and concluded that the taxpayer's activities amounted to UK property rental, and not trading as a property dealer or developer. The losses therefore could not be claimed against general income. The taxpayer appealed.

The taxpayer had bought properties since 2002. She claimed that the properties were purchased with the intention of reselling them at a profit within a short period. However, due to a downturn in the property market, she was unable to sell any properties except at a loss. The properties were therefore rented out on short term leases.

The taxpayer said that she intended to sell the properties quickly at a profit, and that her activities therefore constituted trading in real estate. HMRC pointed out that the taxpayer had initially returned the income from her activities as property until 2006-07, and argued that nothing had subsequently changed. The burden of proof was on the taxpayer to displace the figures in HMRC's closure notice, on a balance of probabilities.

Burden of Proof

The tribunal looked at the 'badges of trade' as identified in Marson v Morton [1986] STC 463, and considered their applicability in this case. The tribunal also 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. Having considered the taxpayer's arguments and the evidence overall, the tribunal was not satisfied that the taxpayer was engaged in a property trade. The burden of proof was on the taxpayer (on a balance of probabilities), and having failed to discharge that burden, the taxpayer's appeal was dismissed.

The taxpayer had contended that there had always been an intention to trade. Unfortunately, there was an apparent lack of evidence to support this argument. Of course, hindsight is a wonderful thing, and it might seem fanciful to suggest that taxpayers should record and document their intentions, such as in the form of a business plan. However, documentary evidence would certainly be useful in cases where the nature of the activity includes characteristics of both trading and investment.

[ There are interesting parallels re: intention / purpose between this case and the Herts Photographic Bureau case which Mark considers in another of his articles - What is a Close Investment Holding Company? - Ed. ] 

Badges of Trade

The 'badges of trade' were considered in another recent case, Manzur v Revenue & Customs [2010] UKFTT 580 (TC). In that case, the taxpayer was a retired surgeon who invested in stocks and shares. He unsuccessfully claimed a trading loss in respect of his transactions in stocks and shares. The tribunal in that case held that the taxpayer's activities were investment in nature, as they lacked the necessary characteristics of share trading.

In a better economic climate, most taxpayers would probably favour their activities being classified as investment in nature, so that profits or gains would be liable to CGT, as opposed to Income Tax at rates of up to 50%. The Azam and Manzur cases may prove to be helpful as and when the economy recovers, although in practice every case is judged on its particular facts.  

The above article is reproduced from Practice Update (March/April 2011), a tax Newsletter produced by Mark McLaughlin Associates Limited. To download current and past copies, visit: Practice Update.