Tax bomd on badges of tradeBADGES OF TRADE  –  WHAT SORT OF ASSET IS IT?

The type of asset you’re dealing in can have a bearing on whether or not HMRC consider the transactions to be trading. Now this may come as a surprise, because it would be easy to assume that either you’re trading or you’re not. But, as I’ve tried to illustrate in my earlier blogs, in order to establish whether or not an activity is ‘trading’, HMRC will usually need to take every factor into account.

The nature of the asset can be of great, even decisive, importance. Some assets are generally realised by way of trade (for example chemicals) and for transactions in such assets the existence of a trade is rarely in doubt. The ‘grey’ area concerns assets that are generally bought:

  • as an investment that usually, but not necessarily, yields income, for example shares, or
  • for personal use or enjoyment, for example, paintings and classic cars, or
  • as a fixed asset of an admitted trade, for example, plant and machinery.

The point is that the very nature of these assets provides an initial presumption that they are not acquired for the purposes of trade. Although it’s true that most people who buy shares do so with the ultimate intention of selling at a profit (if they can!) the fact that shares have an investment value prevents this activity from being classed as trading (in the absence of other evidence).

Certain types of asset, which do not produce income, are frequently acquired for the pleasure which ownership brings to the owner, for example, antiques, paintings or other works of art. This is sometimes called ‘pride of possession’.  The owner may well make the purchase hoping for an accretion in value and even realise a surplus in due course. However, that hope and expectation does not make the transaction a trading matter unless there are other significant indications of a trading intention.
On the other hand, some commodities or other assets are of such a nature that in addition to yielding no income they produce no aesthetic enjoyment, no ‘pride of possession’, and are of a sort that is normally dealt in by way of trade. You may recall from one or my earlier blogs the 1942 case of Mr Fraser, who bought a quantity of whisky far greater than he could reasonably use for home consumption. It was held that there was no ‘pride of possession’ element and the conclusion was drawn that he could only have purchased the whisky with the objective of selling it. In the 1968 case of Wisdom v Chamberlain profits were made from the purchase and sale of silver bullion by an individual whose normal occupation had nothing to do with that type of activity. In addition to producing no income, being held short-term and financed by loans at a high rate of interest, the fact that the bullion, while it lay in the vaults, was otherwise useless, was a factor that influenced the courts to decide that the transactions were of a trading nature.

Another factor to be taken into account relates to what happens to the assets after you have acquired them. If you proceed to modify the asset by way of processing or manufacture, or some kind of adaptation to make it more readily marketable, then these actions are typical of trading activities. Let me give you an example from a very early case (1926):

Having got together sufficient capital, three individuals bought, as a joint venture, a second-hand boat, converted it into a marketable drifter and then successfully sold it. The judge held that these operations, from beginning to end, were the same as those which characterise the trade of converting and refitting second-hand articles for sale. The profit came, not from the increase in capital value of an isolated purchase for resale, but from the interim expenditure for the purpose of making it marketable. That was held to be the essence of trade.

Of course each case will turn on its own facts. However, if your hobby is buying property, or boats or other assets, doing them up and then selling – you may find that HMRC treats you as trading!

It’s also been held that the breaking down of assets into smaller lots for resale may point to a trading motive.

However, on a brighter note, expenditure on an asset after purchase and before sale is not always strong evidence of a trading motive. It depends on the nature and scale of the expenditure. For example, insurance against loss, normal maintenance to prevent deterioration, or the cost of repairing some fault, which prevents the asset carrying out its normal function, may have little or no relevance when considering a question of trading, because this is the sort of expenditure that any owner would incur.

What if you don’t need to modify the asset at all before resale? It would be nice if this was a pointer against trading – but I’m afraid the absence of modification is classed as neutral (that is, it doesn’t affect the issue either way!)