There seems to be an increasing scrutiny lately by HMRC into working tax credits claimed by self employed people. The general mode of enquiry seems to be questioning if the income is so small as to allow claiming for working tax credit, is it actually a trade?
Or a hobby, which will not allow you to claim working tax credits.
There is little in terms of legislation that defines what a trade is. In the absence of clear definition we can place some reliance on the “badges of trade” as set out by case low and the Royal Commission for the Taxation of Profits and Income in 1955.
- 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 between purchase and sale; and
- Method of acquisition.
Lets look at each on in turn.
Profit seeking motive
An intention to make a profit supports trading, but by itself is not conclusive. The item being bought and sold can be of importance. For example items which are often bought for investment such as shares, property and gold are more likely to be considered investment then trade. That said each case will be looked at its merit and in combination with the other badges of trade.
The number of transactions
Systematic and repeated transactions will support trade. A single isolated transaction can amount to the carrying on of a trade for tax purposes, but it is generally not easy to show that this is the case. While there is no guidance to as to a specific number of trades/sales in case law, generally a repeated number of transactions which are carried out in way that is usual for this type of trade will be in favour of a trade being carried out.
The nature of the asset
Is the asset of such a type or amount that it can only be turned to advantage by a sale? Or did it yield an income or give ‘pride of possession’, for example, a picture for personal enjoyment?
The nature of the asset used in the business can be of great even decisive importance. Assets which value can usually be only realised in the course of trade will provide considerable weight behind the trades claim.
Existence of similar trading transactions or interests
Transactions that are similar to those of an existing trade may themselves be trading. The existing trade here pertains to existing trade by the same trader.
Changes to the asset
Was the asset repaired, modified or improved to make it more easily saleable or saleable at a greater profit? If the asset was modified it is more likely that the activity is considered a trade vs the case where the same item was bought and resold without modification.
The was the sale was carried out
Was the asset sold in a way that was typical of trading organisations? Alternatively, did it have to be sold to raise cash for an emergency? For example an asset sold at a profit using channels used by similar trades is more likely to be considered trade then the same asset sold at a fire-sale to get emergency cash.
The source of finance
Was money borrowed to buy the asset? Could the funds only be repaid by selling the asset? If answer to both is yes this would be supportive of trade.
Interval between purchase and sale
Assets that are the subject of trade will normally, but not always, be sold quickly. Therefore, an intention to resell an asset shortly after purchase will support trading. However, an asset, which is to be held indefinitely, is much less likely to be a subject of trade.
Method of acquisition
An asset that is acquired by inheritance, or as a gift, is less likely to be the subject of trade.
HMRC’s BIM20050 has extensive commentary on the meaning of “trade”. While it does not have the weight of law behind it, it can be used as a useful guidance.
Not all “badges” of trade will be present in every case and in some some badges will point one way and some the other. If you are concerned if your business is considered trade or a hobby please reach to us for a free review of your circumstances. We can only commit to provide free reviews for the first 10 clients that reach out to use before 1st of June 16.
P.S We would generally recommend that you have a written business plan – while itself not a badge of trade, it can put a significant weight behind the claim you are running a trade rather than a hobby. It should also focus your business and make it more successful.