Tax “Badges of Trade”
The Income Tax (Trading and Other Income) Act 2005 states that the trading profit of a person who is resident in the UK are chargeable to income tax whether the trade is carried on. The trading profits of a non UK resident are chargeable to income tax only if the trade is carried on wholly or partly in the UK. When deciding if someone is trading or not it’s important to make two distinctions:
(a) The distinction between employment and self-employment
(b) For a taxpayer who sells goods or other assets, the distinction is between trading activities and non-trading activities.
Section 989 of the Income tax states that a “Trade” includes “any venture in the nature of trade”. This circular definition is f little real help and therefore it has been left largely to the courts to decide whether or not a given activity constitutes trading.
The way to distinguish is through the “badges of trade”, they are as follows:
(a) Subject matter of transaction
If a taxpayer sells assets of a type which might normally be acquitted for personal enjoyment or held as a source of income, this may suggest that any profit arising on their sale should be treated as a capital gain rather than a trading profit. But if the assets concerned do not provide personal enjoyment and do not yield income, it would seem that the only way in which they could be turned to advantage is by selling them. In these circumstances, any profit arising on their sale might be treated as a trading profit. In Mary v Lowry 1926 the tax payer bought and sold a huge quantity of ware surplus lien. In Rutledge v CIR 1929 the taxpayer bought and sold one million toilet rolls. In both cases, it was held that the subject matter of the transaction was such that activity could be construed as trading.
(b) Length of the period of ownership
Trading stocks are normally retained for only a short period before being sold, whereas assets acquired for personal use or as a source of income are generally retained for longer. Therefore, if assets are bought and sold within a short space, of time it is more likely that any profit made will be treated as trading profit.
(c) Frequency of transactions
The more often a taxpayer repeats a certain type of transaction, the more likely it is that the activity will be construed as trading. In Pickford v Quirke 1927, the taxpayer bought a cotton mill and sold off its assets at a profit. This was the fourth time he had carried out this type of transaction. Ir was held to trading.
(d) Supplementary work
A taxpayer who buys an asset, performs work on the asset so to make it more saleable and then sells the asset is more likely to be regarded as trading than someone who simply buys and sells an asset without performing any supplementary work. In Cape Brandy Syndicate v CIR 192, a group of individuals bought a large quantity of brandy which they first blended and sold. Held it was trading.
(e) Reason for the sale
The circumstances which have prompted the sale of an asset might be taken into account when deciding whether trading has occurred. A sale necessitated by a sudden urgent need for cash is less likely to be regarded as trading activity than a sale made in the normal course of events.
The presence of a profit motive in the mind of the taxpayer when acquiring an asset provides strong evidence of trading. In Wisdom v Chamberlain 1969, the taxpayer acquired silver bullion with the intention of selling it as a profit and eventually did so. Held to be trading. However, this test is not always conclusive. After all, many investments are bought at least partially with a view to their long term sale at a profit and yet such profits are generally treated as capital gains. This point emphasises the need to consider the evidence provided by all of the badges of trade (not just one) when trying to decide whether or not trading has occurred. Since trading requires the presence of a profit motive when the asset is acquired, the sale of an asset originally acquired by inheritance or by gift or in any way other than purchase is very unlikely to be considered as trading.