All of us buy and sell things from time to time, but is this trading income taxable ? In order to answer this question, we must first understand exactly what constitutes trading from a tax point of view. We usually change out cars regularly, or even buy and sell our home or get a second home or even a holiday home in a nice cosy resort by the beach. The examples can go on and on. However we don’t think of ourselves as traders when we do that. This is why it is important to distinguish between a trading and a non-trading situation because:
- Trading carried out by an individual is assessable to Income Tax as “Trading income”
- Non-trading activities may be subject to Capital Gains Tax, or may be outside the scope of all taxation
HMRC uses several tests known as “the badges of trade” to help decide whether it believes an activity should be classed as trading. The results of each of these tests will provide evidence in one direction or the other, and the final decision will be judged on the overall weight of evidence. These tests are give below with a brief explanation to help you understand and determine whether you are a trader or whether you are just involved in non-trading activities or whether this should not worry you at all.
The badges of trade
- Proft motive: where profit is clearly the driving force behind the trading activity, then this is a strong indicator that the activity may constitute trading.
- Subject matter of the activity: where the items bought and sold are of no personal use to the individual then this is further evidence of trading; this case is strengthened if the individual already works on a situation where such items are traded. Where, however, the items are used by the individual or can provide personal pleasure then this would be evidence that the activity is not trading.
- Length of ownership: where items are sold after acquisition then this is an indicator of trading. Where they are held for a long period it may provide evidence that it is not trading.
- Frequency of transactions: where there is a series of similar transactions, then this indicates trading. A single transaction is less likely to be considered as trading.
- Supplementary work: where the individual carries out work on the items (such as repairs) to make them more saleable, this is evidence of trading.
- Reasons for acquisition and sale: an intentional purchase and planned sale will provide evidence of trading. An item that was given to the individual or one that was sold quickly to raise money to pay personal debts is less likely to constitute trading.
- Source of finance: where money is borrowed on a short-term basis to fund the purchase, this may provide evidence of trading if the item needed to be sold to repay the loan.
Let’s see how this works when applied to a real-life situation: Jason works as a full-time chef in a busy restaurant in the centre of Edinburgh. But in his spare time he often works on one of the cars in his garage. He usually owns a couple of cars at the same time – one to drive around in and one that he is repairing. Jason attends a car auction about once every six weeks and buys a car that needs a little work, provided it is at a good price. After he has repaired the car, he usually keeps it for a few weeks to use, before advertising it on marketplace and selling it, so that he can obtain the best price. Jason regards this activity as his hobby and has not needed to borrow money to finance it.
In the case of Jason, the badges of trade will be used to establish whether his hobby actually constitutes trading from HMRC’s point of view. Most importantly, is this trading income taxable ?
- Proft motive: Jason seems to deliberately buy and sell at a profit: he buys cars only at auction, then he sets his own price through his adverts. This indicates trading.
- Subject matter of the activity: Jason gets personal use from the cars that he buys and this could indicate that he is not trading. The fact that he is not employed in the car trade helps this argument.
- Length of ownership: after Jason repairs the cars, he only keeps them for a few weeks. Such a short time of ownership indicates trading.
- Frequency of transactions: the buying and selling of cars seems to be an activity that Jason does regularly, with purchases made about every six weeks. This indicates trading.
- Supplementary work: repairing the cars counts as supplementary work and Jason deliberately buys cars that need work carrying out. This indicates trading.
- Reasons for acquisition and sale: Acquisition of cars appears to be planned with the ultimate goal in mind to sell them. This indicates trading.
- Source of finance: Jason does not borrow money to finance this activity. However, it could be argued that the regular sale of cars provides the finance, just like in a normal trading situation.
In conclusion, nearly all indicators of the badge of trade point to Jason trading. The only point that indicates the opposite is that Jason uses the cars before sale. The fact that he views his activity as a hobby is not relevant in the face of such evidence. It is likely that HMRC would wish to assess Jason’s income from this activity as trading income.
If you think you are in a situation that suggests you may be trading, now might be the ideal time to engage the services of an accountant to do all the work for you and provide you with all the tax advice you need.
Don’t hesitate to get in touch for any further inquiries at: firstname.lastname@example.org