It will generally be clear whether a person is carrying on a trade, although there will always be grey areas of uncertainty. There is little help to be found in the tax legislation, which merely defines ‘trade’ as ‘any venture in the nature of trade’ (ITA 2007, s 989; CTA 2010, s 1119). It is therefore necessary to look elsewhere for guidance.
An extensive body of case law has developed over the years on what constitutes a trading activity. In addition, the Royal Commission for the Taxation of Profits and Income identified certain ‘badges of trade’ in 1955. Subsequently, in Marson v Morton [1986] STC 463, a total of nine badges were cited. These are summarised in HMRC guidance as follows (BIM20205):
1. Profit seeking motive
2. The number of transactions
3. The nature of the asset
4. Existence of similar trading transactions or interests
5. Changes to the asset
6. The way the sale was carried out
7. The source of finance
8. Interval of time between purchase and sale
9. Method of acquisition
However, in Eclipse Film Partners No. 35 LLP v Revenue and Customs [2012] UKFTT 270 (TC), the tribunal identified another possible factor to consider when determining if a trade is being carried on. In that case, the tribunal had to decide if Eclipse Film Partners No. 35 LLP (Eclipse 35) was trading. The underlying issue was whether the individual members of Eclipse 35 would be entitled to tax relief for interest paid on borrowings to contribute capital to the partnership, on the basis that the capital was used wholly for the purposes of a trade carried on by the partnership (under what is now ITA 2007, s 398).
The Eclipse 35 case is relatively complex and long (73 pages), and the background to the transactions entered into by the partnership were specific to the particular case. However, on the general issue of whether Eclipse 35 was carrying on a trade, the tribunal considered the meaning of ‘trade’ and concluded that a degree of speculation needed to be present. The tribunal held:
“We consider that an element of speculation is a characteristic of the concept of trade – if a taxpayer is trading, what he does must, normally at any rate, be speculative in the sense that he takes a risk that the transaction(s) may not be as profitable as expected (or may indeed give rise to a loss).”
Applying that criteria to Eclipse 35, the tribunal concluded that the transactions entered into by Eclipse 35 did not have the speculative aspect which it would expect to see in trading transactions. The partnership’s activities amounted to a business involving the exploitation of films which did not amount to a trade, i.e. it was considered to amount to a ‘non-trade business’ within ITTOIA 2005, s 609.
More badges?
Whilst decisions of the first-tier tribunal are understood not to create a binding precedent, some commentators have suggested that ‘speculation’ represents a further badge of trade. Peter Vaines commented: “This is an interesting development because speculation is not one of the badges of trade and although it may be a very relevant factor, it is a surprise to find that this is so important that it overrides all other badges of trade” (Squire Sanders UK Tax Bulletin, May 2012).
The tribunal in Eclipse 35 also considered whether the partnership, on the facts of the case, had any “discernible customer”. This is based on comments made in another case, Ransom v Higgs [1974] STC 539. Lord Wilberforce commented “trade…presupposes a customer (to this too there may be exceptions, but this is the norm) or, as it may be expressed trade must be bilateral – you must trade with someone”. The tribunal concluded that Eclipse 35 had no ‘customer’ and did not offer to provide any goods or services by way of business.
The requirement for a customer may be considered to be another possible badge of trade, although in practice this requirement will be satisfied in most cases. However, the need for an element of speculation is a new and potentially more relevant development. It will be interesting to see whether this characteristic will be adopted as an additional badge of trade in future cases concerning whether a person is carrying on a trade.
The above article is reproduced from ‘Practice Update’ (July / August 2012), a tax Newsletter produced by Mark McLaughlin Associates Ltd. To download current and past editions of Practice Update, see the Newsletters section.