Tax return, profit, am I trading, taxable profit

Leading on from my recent blog on the badges of trade, I want to look at the way in which HMRC interprets some of these badges and I’m starting with one of the most obvious – is your intention to make a profit?

Now you may be thinking that if you don’t make a profit, then there won’t be anything to tax and so HMRC won’t be interested.  However, if you are trading, then you have an obligation to either register as self-employed or, if you are incorporated, register your company as trading, and submit the appropriate tax return. There are time limits in which to do so, and failure to comply may render you liable to a penalty.

So, let’s look at some examples of where profit is not your motive – and where you might be at risk of being classified as trading. You might be someone who draws and paints and maybe you exhibit your work – what if someone offers to buy? Or maybe you’re a writer and someone wants to publish some of your work.  Alternatively, what if you run a leisure activity such as a choir or a sports team and someone wants to hire it? (I should say here that many of the latter types of activity will be capable of being charities or clubs in which case different rules apply).

You may choose to describe what you’re doing as a ‘hobby’ or even a ‘hobby business’ – but HMRC will decide from all the evidence whether you’re trading or not. If you are faced with a claim by HMRC that you are trading, and you don’t think you are, my advice would be to state at the earliest opportunity that it was not your intention to do so. However a mere statement of your intention will rarely be enough, because whether or not you are carrying on a trade, or seeking a profit, can be inferred from the circumstances.

In theory, even if you don’t get any monetary consideration for your endeavours, if you receive a benefit it could be argued that you are trading. Although a profit-seeking intention is a badge of trade, it is not conclusive by itself because the profit could be a profit on a capital investment. On the other hand whether or not there is an intention to trade is not dependent on whether or not you are aiming for a profit (a non-profit-making business is still trading!)

Usually if you acquire an asset with the objective of re-selling at a profit, without any intention of holding it as an investment, this will point to the conclusion that a trade is going on. However not all assets are created equal! Most people who buy shares do so with the ultimate intention of selling at a profit. However, because of the inherent investment nature of shares, in the absence of other badges of trade, you will be making and realising capital investments and not trading (and will therefore of course be liable to Capital Gains Tax!). And, of course, people make losses on shares – HMRC don’t want to ‘tax’ a business which makes losses. They may end up giving rebates if the trader has other business income against which they can set-off the losses. They’ve got this one well and truly covered!

Whether or not your motive is profit may sometimes be obvious – but not always. Let’s go back to the example of the amateur artist who paints for pleasure. Maybe people get to know his (or her) work and a few paintings are sold. Then the artist finds that by exhibiting his work he is pretty well assured of finding buyers. Somewhere along that line is a point where, although he still gets great pleasure from the act of painting, he is also motivated by the possibility of sales – even if he only recovers the cost of production. The trick is to know when that point is reached, because that’s the point at which the profit-seeking motive kicks in.

And finally, don’t assume that just because you make a loss, you are not trading. If you seek to set-off the losses against other profits, you are likely to have great difficulty in persuading HMRC of the trading loss unless you were trading in the first place!

So much for one of the main pointers. But it’s only one, and not conclusive!  Look out for coming blogs on the others!