Badges of Trade – when your hobby becomes a business!

Is it a trade or capital gain 

Typically, it will be obvious when you are running a business selling goods, or simply selling personal assets. However, as the tax treatments between running a business and simply selling personal item is drastically different, there are rules and principles to provide clarity in scenarios where the lines start to become blurred. 

Trading 

HMRC does not give a statutory definition of ‘trade’ and only refers to it as a ‘venture in the nature of trade.’ However, the courts have given further interpretation of the statutory definition of ‘trade’ and found the ‘badges of trade’ to be helpful indicators of determining whether an activity is trading or investment in nature. 

The decision as to whether a transaction gives rise to a trading profit or capital gain can be significant because: 

• For individuals – it helps consider the difference between the top rate of income tax, which applies to trading profits and the top-rate of capital gains tax, which applies to investment activities. You also receive a unique tax-free threshold for both types of tax.  
• For companies – even though capital gains and income are taxed at the same rate, having a trade affects the enactment of losses generated by a company. 

What are Badges of Trade? 

HMRC uses the ‘badges of trade’ tests to establish whether a person’s activity is trading or investment in nature - for taxation purposes this decides if you are taxing a profit or a gain.  

To establish whether you are carrying on a trade, you need to consider the following nine badges of trade that HMRC uses as part of their overall investigation: 

Profit-seeking motive

Even though an intention to make a profit supports trading - it’s not conclusive of a trade by itself.  

It may point to the conclusion that a trade is being carried out - if evidence shows that the sole purpose of acquiring an asset was to resell it at a profit - without any intention of holding it as an investment or personal use. 

The number of transactions

To support trade, your transactions will be: 

• Systematic and repeated – there are multiple transactions that are the same or similar. For example, it can be considered a badge of trade if you buy large quantities of materials to resell and attract some sort of discount (a price not available to the public). 

• Operations or activities are conducted in a similar manner to those trading in the same line of business. For example, if you purchase or use supporting business infrastructure or requirements to facilitate the transactions. 

The nature of the asset

The test determines if: 

• The asset type or amount can only be turned to advantage by a sale. 
• The asset yields an income or gives ‘pride of possession’ to the buyer. 

To demonstrate that your selling activity is NOT a trade, you may need to prove the goods are: 

• An investment that usually, but not necessarily, yields income. 
• For personal use or enjoyment, for example, paintings and classic cars. 
• A fixed asset of an admitted trade. 

Existence of similar trading transactions or interests 

If you are part of existing trade - from which there is a similarity to the transaction under consideration - it may be a pointer to that transaction having a trading character. For example, selling your vintage car is not a trade if you are an accountant - but may well be if you are a mechanic, car dealer or antique collector.  

Changes to the asset

This test looks at what you do to an asset pending to resell. It counts as a trading activity if you make - modifications, repairs, improvements or any adaptation to make it saleable or make more profit. 

The way the sale was carried out

It becomes a pointer towards trade if you carry out transactions the same way as an undisputed trader. For example, ordinarily, people who work professionally as chefs take stands at food markets and cooking fairs - if you do the same, you stop being a hobby chef and start engaging in trade. 

The source of finance

In this case, HMRC will investigate the method used to finance your purchase. If you needed a loan to buy your asset (say an oven for a baker) and you would not have acquired it without the loan - and cannot afford to repay the loan without generating income from it (selling cakes and buns). It shows an intention to engage in trade. 

Interval of time between purchase and sale

The length of time you hold an asset is an indicator of trading. In general, assets that are subject to trade are sold quickly. Therefore, an intention to resell an asset shortly after purchase will support trading.  

Method of acquisition

An asset you acquire by inheritance or as a gift is less likely to be the subject of trade. 

It is crucial to remember that 'badges' will not be present in every case - those that do - may point in different directions. The presence or absence of a particular badge is unlikely, by itself, to provide a conclusive answer to the question of whether there is a trade. That being the case, the weight attached to each badge will depend on the precise circumstances. 

Tax implications of conclusions made from Badges of Trade 

Once you determine whether a sale falls as trading activity or a capital gain, the tax implications include: 

Get badges of trade help

If you need assistance regarding the badges of trade or any tax-related issues, contact us for support.