Badges of trade
Written by Ray Coman
In most cases a person will know whether they are in business or not. However, there are instances where it is not so obvious. To provide examples, this can occur where:
- Buying and selling personal items online, for instance through Amazon or Ebay, starts to become more regular and frequent.
- A hobby which involved the occasional, casual sale, becomes a business endeavour. This could apply to an art collector who turns into an art dealer.
- Selling a property at a gain becomes a property development businesses.
Badges of trade
The approach used by HMRC to decide where there has been trading activity is to use the ‘badges of trade’. Assets are more likely not to be held for a trading purpose where:
- Subject matter indicates it is held as an investment (e.g. shares) or for its intrinsic value (e.g. a painting.)
- Acquired by gift or inheritance, or held by an administrator, or purchased as a fixed asset.
- Frequency of transactions is lower.
- Length period of ownership is higher.
- Work is not done to make the property more marketable nor steps taken to find purchasers
- The absence of a profit motive (e.g. not purchased from borrowed money)
The above list of badges are reflect court decisions in cases between HMRC and taxpayers. It is not necessary to show that all badges of trade are present.
The main implication of the above is to determine whether a sale is trading as trading activity or whether it is regarded as capital gain. The tax implications include:
- Trading profits are subject to income tax and national insurance for sole traders and partnerships and are subject to corporation tax for companies.
- A trader may be required to account for VAT.
- An item sold could be regarded as stock or work in progress. Therefore, costs of production (including overheads) can be deducted from the eventual profit.
- The way that a loss is eligible for tax relief differs. Trading losses can be set against other income of the individual taxpayer, carried back or carried forward. Capital losses are carried forward. They can only be carried back in the year of death.
- The availability of exemptions and reliefs for capital gains. This includes the annual exemption for capital gains tax.
There will be countless scenarios where the tax treatment of a transaction could be in doubt. The badges of trade are an attempt to help define such events. However, no one badge will be conclusive. Forward planning about business activity can help to avoid outcomes which result in more tax to pay.