HM Revenue & Customs (HMRC) are not slow to tax the profits of a trader; conversely, it can sometimes be reluctant to allow trading losses. HMRC may seek to restrict or deny loss relief claims in some cases.
The relief for trading losses against a person’s general income for the tax year of loss and/or the previous year (often referred to as ‘sideways loss relief’) (ITA 2007, s 64) is a very useful one. However, there are hurdles to overcome. A hurdle which is often overlooked or taken for granted is that there must be a ‘trade’ (see, for example, Murtagh v Revenue & Customs [2013] UKFTT 352 (TC)). This requirement applies, of course, not only for the purposes of sideways loss relief, but for any form of relief for trading losses.
What is ‘commercial’?
Even if it can be demonstrated that a trade is being carried on, there is a restriction in sideways loss relief unless the trade is ‘commercial’ (ITA 2007, s 66(1)). As well as the general sideways loss relief restriction in s 66, there is a separate relief restriction in respect of farming or market gardening (s 67).
There are two tests to be satisfied in respect of the ‘commercial’ requirement. Section 66(2) states:
“(2) The trade is commercial if it is carried on throughout the basis period for the tax year—
(a) on a commercial basis, and
(b) with a view to the realisation of profits of the trade.”
With regard to the first of these tests in (a), the term ‘commercial’ was explained in Wannell v Rothwell [1996] 68 TC 719. Mr Justice Robert Walker said:
“It was suggested that the best guide is to view ‘commercial’ as the antithesis of ‘uncommercial’, and I do find that a useful approach. A trade may be conducted in an uncommercial way either because the terms of the trade are uncommercial (for instance, the hobby market-gardening enterprise where the prices of fruit and vegetables do not realistically reflect the overheads and variable cost of the enterprise) or because the way in which the trade is conducted is uncommercial in other respects (for instance, the hobby art gallery or antique shop where the opening hours are unpredictable and depend simply on the owner’s convenience). The distinction is between a serious trader who, whatever his shortcomings in skill, experience or capital, is seriously interested in profit, and the amateur or dilettante.”
With regard to the second of the above tests (b), s 66(3) provides:
“(3) If at any time a trade is carried on so as to afford a reasonable expectation of profit, it is treated as carried on at that time with a view to the realisation of profits.”
Applying the commercial tests
What do the commercial tests mean in practice? Recent cases have sought to address them.
In Atkinson v Revenue & Customs [2013] UKFTT 191 (TC), the taxpayer, an experienced entrepreneur, bought a yacht and operated a chartering business as a sole trader. He took professional advice on a business plan prior to start up, and researched competitors’ pricing. The taxpayer claimed relief for trading losses against his general income for the tax years 2007-08, 2008-09 and 2009-10. HMRC considered that the taxpayer’s trade was not commercial (within s 66), and that he was not permitted to offset the losses against his general income (but he could carry them forward against future profits of the same trade).
The taxpayer set up a company (B Ltd), which handled corporate charters in 2007-08 and 2008-09, and separately operated as a sole trader to carry out charters to private individuals. However, in March 2009 the taxpayer ceased using B Ltd, and operated all charters as a sole proprietor in 2009-10. In the three tax years under appeal, the taxpayer trading as a sole proprietor did not make a profit. B Ltd made a profit in 2007-08, but a loss in 2008-09. The taxpayer and B Ltd combined suffered an overall loss in each of the years. The taxpayer argued that the poor performance of the chartering business was due to the recession and unpredictable summer weather conditions.
The tribunal considered whether the taxpayer’s trade was ‘commercial’ within ITA 2007, s 66, and pointed out that there are two separate elements to be satisfied to meet the test. First, the trade must be conducted on a commercial basis. Secondly, the trade must be carried on with a view to realising a trading profit. The second test is expanded upon (in s 66(3)) (see above). The tribunal concluded on the facts of the case that the taxpayer’s sole proprietorship did not meet the ‘commercial’ test in s 66(2) for 2007-08 or 2008-09. The tribunal found that arrangements which existed with B Ltd were such that the taxpayer was starved of business, and were used for the offsetting of expenditure. As the ‘commercial’ test was not met, the tribunal did not need to consider the second (‘view to the realisation of profits’) test.
However, the tribunal noted that circumstances had changed in 2009-10. The taxpayer had dispensed with B Ltd, and ran the business under the single umbrella of the sole proprietorship. In doing so, business expenditure reduced by one-third. The taxpayer also relocated the business to Plymouth, which was a better trading proposition. The tribunal found that these changes enabled the taxpayer to carry on the chartering business on a ‘commercial basis’. In addition, whilst the taxpayer made a loss in 2009-10, the taxpayer had initiated a cost reduction programme associated with the relocation and operating the business under a single umbrella. The tribunal’s view on the evidence was that the taxpayer had ‘a reasonable expectation of profit’ from the business in that year, and the tribunal was therefore satisfied that the taxpayer’s business was commercial within ITA 2007, s 66. The taxpayer’s appeal was therefore allowed in part: he was not entitled to offset trading losses against his general income for 2007-08 and 2008-09, but he was entitled to do so for 2009-10.
View to realising profits
In Kitching v Revenue & Customs [2013] UKFTT 384 (TC), the taxpayer owned and operated a part-time business since 1989. He claimed relief for losses from that business against his employment income for 2007-08, 2008-09 and 2009-10.
The tribunal noted that the business had made losses every year since 1989, and the taxpayer had claimed relief against his general income for each of the tax years up to and including the three tax years under appeal. The taxpayer had made a projection of future net profit, but the tribunal held that there was insufficient evidence to be satisfied that the taxpayer’s expectations of profit were reasonable.
The tribunal accepted that the taxpayer’s business was operated on a commercial basis. For example, the business had retail premises, recognised suppliers, and a business bank account with an overdraft facility. However, the tribunal also had to consider whether the trade was carried on with a view to the realisation of profits (as required by ITA 2007, s 66(2)(b)). This was considered to be a subjective test. The tribunal found that the taxpayer was willing to stand the business losses as he anticipated moving out of his full-time employment as an accountant. He believed that when he was able to devote himself full-time to the business it would make a profit. Unfortunately, the tribunal was unable to share that belief on the evidence. There was no business plan or detailed projections to support the taxpayer’s belief. The tribunal concluded the taxpayer must have known that if the business was carried on without his full-time involvement it could not make a profit. The second test (i.e. trading with a view to the realisation of profits) was not satisfied in the three tax years under appeal. The requirements of s 66(2)(b) were not met. The taxpayer’s appeal was dismissed.
Interestingly, the tribunal in Kitching disagreed with the tribunal’s analysis of s 66(2) and (3) in the Atkinson case above. The tribunal in Kitching commented:
“Section 66(3) appears to us to be a deeming provision, rather than a definition as the FTT construed it in Charles Atkinson. If there is a reasonable expectation of profit then the trade is treated, or is deemed to be carried on with a view to the realisation of profit. If it is not established that there is a reasonable expectation of profit, it is still open to the taxpayer to establish that he did carry on the trade with a subjective view to the realisation of profit.”
Further points
When enquiring into a claim for sideways loss relief (or indeed any form of trading loss relief), HMRC will first consider whether the activities carried on amount to trading, before going on to consider whether the above tests in s 66 apply. HMRC’s guidance indicates that the commercial test in s 66 was previously considered to be satisfied if the activities carried on amounted to a trade, but that (following the case Wannell v Rothwell mentioned earlier) “…we now accept in very unusual cases the activities may constitute a trade even though they are uncommercial.” HMRC will consider whether there are any non-commercial reasons for becoming involved in a particular business, and cites the example of a trader with a general interest in sailing who ventures into yacht chartering (BIM75705). ‘Hobby’ trades in which losses are made are vulnerable to challenge by HMRC, particularly if there is no realistic possibility of making a profit.
Losses made in the early years of a trade (or profession or vocation) are subject to separate loss relief provisions (ITA 2007, s 72), with a different commercial test. The trade must still be carried on throughout the basis period on a commercial basis. However, in addition it must be carried on in such a way that profits could reasonably be expected in the basis period, or within a reasonable time afterwards (s 74). In HMRC’s view, ‘reasonably’ and ‘reasonable’ is a different and tougher test than in the test in s 66(2) mentioned above. For example, HMRC considers that ‘a reasonable time’ in general is a fairly short period of a year or so (BIM75735).
Finally, it should be noted that even if the conditions for sideway loss relief are satisfied, there is an overall limit on certain tax reliefs with effect from 2013-14, including sideways loss relief under ITA 2007, s 64. This limit is the greater of £50,000 and 25% of the taxpayer’s adjusted net income (ITA 2007, s 24A).