Starting in business or running one? Is your new or existing business a trade, a business or an investment activity? The differences between a trade, business and investment is very important for tax purposes. This guide runs through key issues for tax purposes.
The nature of the business activity carried on by a sole trader, business and investment impacts on tax in terms of:
What expenses are tax-deductible?
Entitlement to loss relief.
What reliefs are available on the disposal of the business?
The tax position for the owner in terms of Capital Gains Tax (CGT) and Inheritance Tax (IHT).
VAT registration.
What is a ‘trade’?
‘Trade’ is defined for 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 include:
Profit motive.
Frequency and number of transactions.
Modification of the asset.
Nature of the asset.
Existence of similar trade.
Source of finance.
Length of ownership.
The way the sale is carried out.
The reason for the acquisition and the sale
A Trading Company
A trading company is a company engaged in a trade. 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 percentages of the shareholdings in the subsidiaries are important. Capital Gains Tax (CGT) groups require effective 51% holdings.
A holding company which is not trading but which sits on top of trading companies will itself be treated as part of the trading group.
The definition of a trading company for Business Asset Disposal Relief (BADR) for CGT is:
A company carrying on trading activities whose activities do not include to a substantial extent (i.e. in practice, more than 20%) activities other than trading activities. Note that activities are viewed in terms of what the company is actually doing rather than based on time spent by the employees.
Business
Business is defined more broadly 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”.
An investment activity/business
An investment activity or business tends not to have the same advantages for tax as a trading one.
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.
National Insurance Contributions (NICs)
Trading profits & Class 4 NICs:
Class 4 NICs are only payable on trading profits.
They apply profits from hotels, guest houses and B&Bs etc.
Trading, investment and Class 2 NICs:
Class 2 National Insurance Contributions (NICs) are payable where an individual:
Is a ‘self-employed earner’.
Has ‘relevant profits’ at least equal to the small profits threshold (£6,725 for 2022-23).
To be a ‘self-employed earner’, an individual must be gainfully employed.
In the case of an investment business, to be an earner, management activities must extend beyond those generally associated with being an investor or landlord.
‘Relevant profits’ are defined in relation to income from trades, professions and vocations.
Rental or investment income will not usually constitute relevant profits.
Why is it important to distinguish between a trade and a business?
Income and Corporation Tax
Certain reliefs are only available if a person carries on either a business or a trade. Confuse the terms and there may be no tax relief.
Losses
Where there are investment activities, no carry back of losses is permitted. There are special rules depending on the type of activity undertaken:
Sole trades and partnerships
Property letting
Furnished Holiday Letting
Capital losses may in general only matched against capital gains although there are some exceptions in respect of share losses, which can be offset against income.
Tax Differences Between a Trade, a Business or an Investment
Starting in business or running one? Is your new or existing business a trade, a business or an investment activity? The differences between a trade, business and investment is very important for tax purposes. This guide runs through key issues for tax purposes.
The nature of the business activity carried on by a sole trader, business and investment impacts on tax in terms of:
What is a ‘trade’?
‘Trade’ is defined for 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 include:
A Trading Company
A trading company is a company engaged in a trade. 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 percentages of the shareholdings in the subsidiaries are important. Capital Gains Tax (CGT) groups require effective 51% holdings.
A holding company which is not trading but which sits on top of trading companies will itself be treated as part of the trading group.
The definition of a trading company for Business Asset Disposal Relief (BADR) for CGT is:
Business
Business is defined more broadly 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”.
An investment activity/business
An investment activity or business tends not to have the same advantages for tax as a trading one.
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.
National Insurance Contributions (NICs)
Trading profits & Class 4 NICs:
Class 4 NICs are only payable on trading profits.
They apply profits from hotels, guest houses and B&Bs etc.
Trading, investment and Class 2 NICs:
Class 2 National Insurance Contributions (NICs) are payable where an individual:
Why is it important to distinguish between a trade and a business?
Income and Corporation Tax
Certain reliefs are only available if a person carries on either a business or a trade. Confuse the terms and there may be no tax relief.
Losses
Where there are investment activities, no carry back of losses is permitted. There are special rules depending on the type of activity undertaken:
Capital losses may in general only matched against capital gains although there are some exceptions in respect of share losses, which can be offset against income.
Have a question? Speak to the Robinsons Team
credit: rossmartin.co.uk
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