The recent first tier tribunal decision Dr K M A Manzur v Commissioners for HMRC TC/2010/174 [2010] UKFTT 580 (TC) highlights the importance in applying the simple concept. It looked at whether a trade is being carried out.
In 1955 a report by the Royal Commission on the Taxation of Profits and Income reviewed case law and identified six badges of trade. This was the starting point and as you can imagine there has been some development in the area supplemented by case law. HM Revenue & Customs (HMRC) now lists nine badges of trade:
It is clear that having an intention to make a profit can indicate a trading activity, however by itself it is not enough. In case Salt v Chamberlain – Ch D 1979, 53 TC 143; [1979] STC 750, a research consultant made a loss on the Stock Exchange after trying to forecast the market. The loss was made after several years and over 200 transactions. This was not seen as trade and capital in nature. It was concluded that share trading by a private individual can never have the badges of trade pinned to them. These transactions are subject to capital gains tax.
In another case, Rutledge v CIR – CS 1929, 14 TC 490, the taxpayer was on a business trip to Germany a taxpayer purchased one million toilet rolls. On returning to the UK the sole consignment of toilet rolls were sold to one individual for a profit. The profit made on this large quantity single purchase and resale item was ‘an adventure in the nature of trade’. The case was decided on the fact that the purchase was not made for own use or investment purposes.
A single transaction can amount to a trading activity, it is more indicative if there are repeated and systematic transactions. This was clearly displayed in the case Pickford v Quirke – CA 1927, 13 TC 251. A syndicate purchased a cotton-spinning mill with the intension of using it in a trade, however, on purchase of the mill it was in a worse state than first anticipated. The syndicate then decided to strip the mill of its assets and sell it piecemeal, making a profit. This was repeated a number of times with a number of mills. Due to the repeated nature of the transactions it was held that the profits were trading profits and taxable as such.
This principle is more difficult to explain, it looks at the asset, problems arise when assets are bought either as:
An important case in this area was Marson v Morton – Ch D 1986, 59 TC 381; [1986] STC 463; [1986] 1 WLR 1343. This was where land was purchased with the intension to hold it as an investment. No income was generated by the land, however, it did have planning permission. The land was sold latter following an unsolicited offer. As the transaction was far removed from the taxpayer’s normal activity (potato merchant) and was similar to an investment, it was not a trading profit. The transaction was not an adventure in the nature of a trade.
Another case Wisdom v Chamberlain – CA 1968, 45 TC 92; [1969] 1 WLR 275; [1969] 1 All ER 332, looked at the principle ‘pride of possession’ assets that generate no income. A taxpayer purchased two large quantities of silver bullion to counter the effects of the devaluation of the pound. The purchase was made following advice and was partly financed by loan. As the purchase was done on a short term basis in order to realise profit. There was an adventure in the nature of trade and was therefore assessed as trading profit.
This is best demonstrated in the case CIR v Fraser [1942] 24TC498. In this case the taxpayer was a woodcutter who bought a consignment of whisky in bond. He subsequently sold the whisky through an agent at a profit. Within the decision the judge stated:
‘The purchaser of a large quantity of a quantity of a commodity like whisky, greatly in excess of what could be used by himself, his family and friends, a commodity which yields no pride of possession, which cannot be turned to account except by a process of realisation, I can scarcely consider to be other than an adventurer in a transaction in the nature of a trade… Most important of all, the actual dealings of the respondent with the whisky were exactly of the kind that take place in ordinary trade.’
It is important to take note of any changes or modifications made to an asset that may make it more marketable. In the case Cape Brandy Syndicate v CIR – CA 1921, 12 TC 358; [1921] 2 KB 403, members of a wine syndicate joined in a separate syndicate to purchase brandy from South Africa. Some was shipped to the East with the remainder being sent to London to be blended with French brandy, re-casked and sold at a profit. The taxpayer tried to argue that the transaction was of a capital nature from the sale of an investment. It was held that a trade or business was carried on and was assessable as a trading profit.
HMRC states in its guidance that it is always a pointer if a transaction follows that of a ‘undisputed trade’. The case CIR v Livingston and Others 11TC538, involved three unconnected individuals that together bought a cargo vessel. The vessel was converted into a steam-drifter and sold for a profit. The purchase was the first vessel the three individuals bought. An assessment was raised on the profit which was upheld as a trading profit. Within the decision the judge stated:
‘I think the test, which must be used to determine whether a venture such as we are now considering is, or is not, in the nature of “trade”, is whether the operations involved in it are of the same kind, and carried on in the same way, as those which are characteristic of ordinary trading in the line of business in which the venture was made.’
Determining the source of finance is important when deciding whether a trade is carried on. Finance taken out to purchase an asset, in the first instance may indicate that to repay the debt the asset would have to be sold.
This was demonstrated in the Wisdom v Chamberlain – CA 1968, 45 TC 92; [1969] 1 WLR 275; [1969] 1 All ER 332 mentioned above.
The length of time an asset is held is an important indicator of trade. The longer the period of ownership the greater the chance of it been seen as an investment rather than a trade. HMRC also look at the intention, if you can demonstrate an intention it could indicate the tax treatment. The two key cases on this are Wisdom v Chamberlain – CA 1968, 45 TC 92; [1969] 1 WLR 275; [1969] 1 All ER 332 and Marson v Morton – Ch D 1986, 59 TC 381; [1986] STC 463; [1986] 1 WLR 1343 both mentioned above.
Finally, it is important to look at how an asset is acquired. If it is inherited or gifted it is a good indication that a trade is not being carried, although this is not always the case. An asset acquire at a market could indicate that it has either been purchased for a trade or an investment.
The case Taylor v Good – CA 1974, 49 TC 277; [1974] STC 148; [1974] 1 WLR 556; [1974] 1 All ER 1137 concerned a taxpayer who purchased a house with the intention of using it as a family home. The taxpayer’s partner did not approve the house and refused to move in, which forced the taxpayer to sell the house immediately. The purchaser genuinely had the intention of not buying the property for a profit motive. As the sale was a short period of time after purchase it was still not deemed to be a trade. Within the decision the judge stated:
‘Even if the house was purchased with no thought of trading, I do not see why an intention to trade could not be formed later. What is bought or otherwise acquired (for example, under a will) with no thought of trading cannot thereby acquire an immunity so that, however filled with the desire and intention of trading the owner may later become, it can never be said that any transaction by him with the property constitutes trading. For the taxpayer a non-trading inception may be a valuable asset: but it is no palladium. The proposition that an initial intention not to trade may be displaced by a subsequent intention, in the course of the ownership of the property in question, is, I think, sufficiently established…’
This is only a summary of the badges of trade and leading tax cases. As in all cases, each situation must be judged on its own merit.