Trade
“Trade” is defined for income tax as any venture in the nature of trade.
Over the years the courts have taken this to include a trade, manufacture, adventure or concern in the nature of trade. The term is “commonly used to denote operations of a commercial character by which the trader provides to customers for reward some kind of goods or services".
Many different activities are described as trading. The “badges of trade” are accepted by the courts as a reasonable way of establishing whether a transaction was trading or capital in nature.
The badges of trade:
- The subject matter of the realisation.
- The length of the period of ownership.
- The frequency or number of similar transactions by the same person.
- Supplementary work on or in connection with the property realised.
- The circumstances that was responsible for the realisation.
- Motive.
A trading company is a company engaged in a trade, and a trading group is a group of companies whose activities are wholly or mainly trading ones, as opposed to investment activities. For groups and capital gains, the % of the shareholdings in the subsidiaries is important. Capital gains tax groups require 51% holdings.
Business
Business has a much wider definition than trade. Whilst a trade is a business, not all businesses are trades. Businesses may take many shapes or forms, and to quote Lord Diplock in the case of Town Investments Ltd v Department of the Environment [1978] AC 359, “the word “business” is an etymological chameleon; it suits its meaning to the context in which it is found”.
Investment businesses are not treated as trades for tax purposes:
A company that is in the business of holding and passively managing investments is taxed as an "investment business". The key feature is that for tax the allowable expenses will be limited to those required for investment management. This type of company may be taxed at main tax rates if it is a close investment company.
A business of holding land and property for rental is a "property rental business".
A furnished holiday letting business (FHL) is treated as if it is a trade for the years until until 5 April 2010. From 2010/11 FHL will still qualify as a trade if the sum of the business activities are such that there is more to the business then just regular letting activites.
Why is it important to distinguish between a trade and a business?
Capital gains tax
CGT Roll Over and Gift Relief and Entrepreneurs' Relief only apply on the disposal of business assets used in qualifying trades, an interest in a trading partnership or the shares of a trading company or group.
Inheritance tax
IHT Business Property Relief can be claimed an interest in a business and on shareholdings of unquoted shares, but it is denied to investment partnerships and companies and those whose business consists “wholly or mainly” of one of the following:
Dealing in:
- Shares or securities
- Land or buildings
- Making or holding investments
"Wholly or mainly" is not defined in the legislation; you need to consider the scale of investment activities on a case by case basis.
It is generally accepted that this test is not met where investment activities exceed 50% of turnover, but you have to weigh up the return on the various assets employed in the business, including human time. It may be that 99% of human activities and 99% of assets account for less than 50% of trading turnover, in which case the business would probably count as a trade, or it may not.
Tax tip: there is no mechanical test for BPR use the 50% rule with great care, and review cases year on year.
