Badges of Trade Essay Example

‘Trade’ concerns its trade nature on its own facts for each case. (HMRC BIM20201, n. d. ) “Over the past years, the Commissioners and the courts examined the facts and looked for the presence or absence of common features or characteristics of trade. ” (HMRC BIM20201, n. d. Detailed meaning of “trade” is listed in the Business Information Manual BIM24045 of HMRC and was enclosed in the appendix of this report. In the case of Ransom v Higgs (1974), Lord Wilberforce considered trading transactions are usually concerned the exchange of goods or services for reward. There must be some way to providing the business for addressing customers. (Lee, 2007) Six “badges of trade” had been defined in 1955 by the Royal Commission on the Taxation of Profits and Income to distinguish between trading and non-trading activities. Combs, Dixon and Rowes, 2010) Nowadays, it was expanded to nine. (HMRC BIM20205, n. d. ) When deciding a taxpayer whether carried on a trade or not, single test is not conclusive and it is suggested considering all criteria of “badges of trade” together as reference and attached each of them depending on the actual situation. (Melville, 2011) The criteria are:

• Subject matter of the transaction What is the nature of the asset? If the asset was purchased for personal enjoyment or held as source of income, the sale of the asset should not be treated as trade income but subject to capital gain instead.

Conversely, if the asset was acquired neither for providing personal enjoyment nor yield income, then the only benefit from this asset perhaps is selling and the profit arisen from the sale will be treated as

a trading profit. (Melville, 2011) In the case of Rutledge v CIR (1929), the taxpayer has made profit by buying and selling one million toilet rolls. By applying the concept of badges of trade, the subject matter of this activity was interpreted as trading. (Melville, 2011)

• Length of the period of ownership How long that the asset was being owned by the taxpayer?

Was the transaction owned in a long or short period? Assets acquired for personal use are normally kept in a long period as well as long-term investment. The stocks for trading purpose before it sold are usually kept in a short period. Therefore, the shorter period of the asset kept by the owner is more likely classified as trade and any profit generated from the selling of such asset will be treated as trading profit. (Melville, 2011) In the case of Wisdom v Chamberlain (1969), the taxpayer bought silver bullion as a ‘hedge’ and sold shortly three months later with profit generated.

The ownership period of the silver bullion is short and the selling activities support as trade in nature. (Melville, 2011)

Frequency of transactions How often that the transaction was carried out by the taxpayer? When the transactions were repeatedly and systematically performed, it was more likely the transactions be identified as trading. (Melville, 2011) In the case of Pickford v Quirke (1927), the taxpayer has made profit on buying and selling the cotton mill, transactions was carried out repeatedly and systematically, therefore there was held to be trading. (Melville, 2011) Supplementary work Was the asset sold in its own state? Was there any supplementary work made further to the assets? When supplementary work

was carried out on the asset in order to make it saleable, the work done was obviously translated as a trade. Any profit generated from the selling of such asset will be treated as trading profit. (Melville, 2011) In the case of Cape Brandy Syndicate v CIR (1921), a large quantity of brandy was bought by three individuals, they had blended them over 18-month period before sold them out. Their activities illustrate trading. (Lee, 2007) Reason for the sale Why did the asset be sold? Is it because of the need of emergency cash? If the selling activities are forced in order to raise emergency cash, the activities were not construed as trade. (Melville, 2011) An emergency cash raises from compulsory sale is also less likely defined as trade. (HMRC BIM20280, n. d. )

Motive What was the intention of the taxpayer at the time of acquiring? If the purchase had intended to earn profit, this was the evidence for trading. However, profit generated from some long-term sale investments are treated as capital gains. (Melville, 2011)

In Wisdom v Chamberlain (1969), the taxpayer generated profit from the purchase and sale of silver bullion which is abnormal to his normal activities. The silver bullion was held short-term and financed by a high interest loans. The obvious intention of the taxpayer when acquired the silver bullion is to generate profit. It was the main factor that convinced the Commissioner that the transaction was trading nature. (HMRC BIM20300, n. d. )

• Existence of similar trading transactions or interests If the transactions were similar to existing trade, they were identified as trade. (Melville, 2011)
• The source of finance

Was the asset that

purchased by taxpayer financed by loans? How was the loan repaid? If the asset was used a high interest loan to purchase, the sale of the asset in the short term is necessary in order to repay the loan and the interest. The profit generated from the purchase and sale was treated trade. (HRMC BIM20300, n. d. ) In the case of Wisdom v Chamberlain (1969), the taxpayer borrows money to purchase the silver bullion and then produced profit from the sale of bullion. It indicated that the sales proceed of the bullion was attempt to repay the loan and interest in a very short period of time.

The taxpayer was held to be trading. (HMRC BIM20300, n. d. )

• Method of acquisition If the source of the assets was by inheritance or gift, it was less likely considered trade. (HRMC BIM20315, n. d. ) In the case of Cohan’s Executors v IRC (1924), the sales from winding up the inheritance or estate of the deceased (or of the company) to the best advantage of the inheritance or estate is not trading. (HMRC BIM70570, n. d. )

Analysis of Harjit’s hobby

• Subject matter of the transaction The subject matter of transaction for Harjit’s case is in regard his purchase and sales activities of the rock memorabilia items.

Harjit’s collection of the rock memorabilia is not only for his personal enjoyment or giving himself ‘pride for possession’ but yield income. The mixture of personal enjoyment and yield income could be constitutes trade. Harjit generated a gross profit of ? 35,000 from the purchase and sale of the rock memorabilia. The amount was substantial and was more than his income

generated from employment. Therefore, it is more likely trade.

• Length of the period of ownership How long that Harjit owned the rock memorabilia items before he sold is one of the key elements to determine trading or non-trading.

The shorter period that he owned is more likely classified as trade. Since the length of the period of ownership is not mentioned in this case study, we assume Harjit own those rock memorabilia items in a short period and the activities of selling the rock memorabilia items are trade in nature.

• Frequency of transactions / Existence of similar trading transactions or interests If Harjit had carried out the selling activities of the rock memorabilia repeatedly many times, the transactions would be resulted in the nature of trade.
• Supplementary work Was Harjit sold the rock memorabilia items in its own state or after supplementary work done?

If Harjit sold the rock memorabilia items with any changes to improve them to become more marketable for greater profit generation, for instance, new packing with extra free components, this would be obviously constitutes trading.

• Reason for the sale / Method of acquisition This is not applicable for Harjit unless the rock memorabilia items that he sold were the deceased’s estate and he acted as an estate administrator for the sale. There is also no sale reason stated in this case study. However, if Harjit has used the income which generated from the sale of rock memorabilia items to cover his daily living expenses, it can constitute trade. Motive The motive of Harjit when he acquired the rock memorabilia was not described in the case study. However, he spent ? 5,000 for advertising,
  

travelling and other expenses to support the selling activities and generated a gross profit of ? 35,000. It is more likely treated as trade.

Calculations of income tax and national insurance payable

First of all, we assumed Harjit is a UK resident. All his income arises in the UK and overseas is taxable. His employment income is taxed per the rules in the Income Tax (Earnings and Pensions) Act 2003 and his income earned from trade is taxed per the Income Tax (Trading and Other Income) Act 2005. Therefore, if his hobby is conducting a trade, he will be assessed the trading income tax. i) Calculation of adjusted trading profit for the tax year 2010-2011 of Harjit’s rock memorabilia.

Assume he is aged below 64 and entitled the basic personal allowance, which is ? 6,475 in 2010-11. 3”Under the Pay As You Earn (PAYE) system, employers deduct both income tax and National Insurance contributions from their employees when paying them their wages and salaries. ” (Melville, 2011, P. 104) iii) Calculate the national insurance payable of Harjit for the tax year ended 5 April 2011. “National Insurance contributions (NICs) are payable by employees, by employers and by those who are self-employed.

Contributions are collected by the National Insurance Contributions Office (NICO) of HM Revenue and Customs and paid into a National Insurance Fund. Class 1 National Insurance contribution are payable in relation to employees aged 16

or over. Class 2 National Insurance contribution are payable by self-employed people who are over 16 and under pensionable age. ” (Melville, 2011, P. 225) Assuming that Harjit is subject to Class 1 NICs and he is not a contracted out employee. His monthly salary is ? 2,000 (? 4,000/12 months) and therefore his monthly Primary Class 1 NICs payable is equal to (? 2,000 - ? 476) x 11% = ? 167. 64. It gives a yearly national insurance payable of ? 2,011. 68.

Conclusions

As referring to each concept of “badges of trade”, Harjit’s hobby constitutes trade. His hobby is not only for his personal enjoyment but yield income, the mixture of nature arise trade. The profit that he earned from the sale of rock memorabilia items is significant.

It represents 55% of his total income. He has also published advertisements in newspapers and media for selling his rock memorabilia items and buying new items. That is, obviously, making trade and therefore his income made from the purchase and sale of rock memorabilia is taxed per the Income Tax (Trading and Other Income) Act 2005 and is assessed to the trading income tax. Appendix BIM24045 - Mutual trading: introduction: essential that the activity is a trade What is a trade? Whether the activities in question constitute a trade is a question of fact.

Guidance on the general subject of whether particular activities amount to a trade is at BIM20050 onwards. You should look to see if the activities involved have the outward characteristics of trade. The so-called ‘badges of trade’ (see BIM20200 onwards) can be helpful indicators in some cases. You can also usefully apply the test

from CIR v Livingston and Others that: …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.

Further, although it is not essential that there should be a profit for activities to amount to trade, there must be an element of commerciality. The subjective test, of whether there was the intention to make a profit, has played a central role in the development of case law; for example in Ransom v Higgs [1974] 50TC1 at page 88G: Trade involves, normally, the exchange of goods or of services for reward - not of all services ... but there must be something which the trade offers to provide by way of business.

Trade, moreover, presupposes a customer ... you must trade with someone. Mutual associations are established for a variety of reasons. Many mutual associations have no overt profit-seeking motive or may be required to apply their profits to particular ends. Such a state of affairs does not prevent them from carrying on a trade. The absence of a profit-seeking motive does not preclude the carrying on of a trade – see for example Brighton College v Marriott. Brighton College was a company, limited by guarantee.

The company was formed to carry on a public school. Under its Memorandum of Association the whole of the company’s income and property was applied solely towards the promotion of the objects of the college, including the remuneration of its officers and other persons for services rendered. The fees charged for attendance at the school exceeded the current

expenses. The surpluses were mainly applied in paying interest on, and in reducing, mortgage debts incurred in connection with extensions and improvements of the college.

The Court of Appeal decided that the surplus fees were profits or gains arising from the carrying on of a trade assessable to IT under Schedule D notwithstanding that: the surplus was applied in a particular way, or * the college’s professed intention was not to make a profit. The Master of the Rolls, Pollock, explained that what the college did with its surplus did not have a bearing on the taxability of that surplus: …it is clear that under Income Tax law the fact that profits when made are to be devoted solely to the advancement of the charity will not induce an exemption.

Profits when made are subject to the tax, and their destination does not secure immunity for them. Pollock M. R. , goes on at page 221 to quote with approval Cotton L. J. in Hermann Gusav Erichsen v W H Last [1881] 4TC422, at page 427: …when a person habitually does a thing which is capable of producing a profit for the purpose of producing a profit and enters into a contract habitually, he is carrying on a trade or business... The House of Lords unanimously agreed that the college was trading.

Lord Blanesburgh made the following points:

• The college did not lose its charitable status by charging fees.
• The charging of fees did not of itself make the college’s activities into a trade.
• Whether activities amount to a trade is always a question of fact.
• What the college did with any surplus was irrelevant.
• The important issue
  

was whether the activities were conducted on a commercial basis. That an entity professes to conduct its affairs on a ‘not for profit’ basis does not preclude a finding of trading.