Badges of trade
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.
The basis of the conceptHow do you establish whether a person is carrying on a trade?
In 1955 a report by the Royal Commission on the Taxation of Profits
and Income reviewed case law and indentified 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:
- profit seeking motive
- the number of transactions
- the nature of the asset
- existence of similar trading transactions or interests
- changes to the asset
- the way the sale was carried out
- the source of finance
- interval of time between purchase and sale
- method of acquisition.
Profit seeking motiveIt 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 Chamber – 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.
The number of transactionsA 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.
The nature of the assetThis principle is more difficult to explain, it looks at the asset, problems arise when assets are bought either as:
- an investments that has the ability to generate income
- personal assets
- some assets used by a trade such as plant and machinery.
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.
Existence of similar trading transactions or interestsThis 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.’
Changes to the assetIt 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.
The way the sale was carried outHMRC 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.’
The source of financeDetermining 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.
Interval of time between purchase and saleThe
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.
Method of acquisitionFinally, 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.
Links to the cases included the first tier tribunal decision on Dr K M A Manzur v Commissioners for HMRC can be found
here.
source : http://uk.accaglobal.com/uk/members/technical/advice_support/tax/income_tax/2011/badgesoftrade
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