Article by Arthur Sellwood, a former Inspector of Taxes, published in the April 2001 issue of "Tax Adviser".
Sales of assets – or trading? The question whether speculative transactions or sales of assets which are isolated or infrequent are chargeable to tax has been under consideration since the early days of income tax. Cases are still heard not infrequently before the commissioners and sometimes before the courts. Originally the question to be decided rested on the old argument, which permeates so many aspects of taxation, concerning the
distinction between capital and revenue transactions. If a sale could be shown to be on revenue account the profit realised on it was taxable. If it was simply the disposal of an investment or any other form of capital transaction it was not taxable.
Is there a taxable source?
It has frequently been stated in the courts that if a particular form of income is to be taxed it must be shown to come from a source which was within the schedules. In some of the early cases it seems to have been assumed that the source was a trade or adventure in the nature of a trade chargeable under Sch. D, Case I. However, in a case concerning the purchase and sale of a small number of properties – Pearn v Miller (11 TC 610) – the Revenue raised assessments which they defended under Case I or Case VI. The court held that such profits were not within Case VI and remitted the case to the commissioners to consider whether the transactions constituted a trade within Case I. There was a somewhat similar result in Leeming v Jones (15TC 333) when the commissioners decided on remission to them that the transaction was not a concern in the nature of trade and the House of Lords ruled that there was no liability to assessment. A dictum in the Court of Appeal to the effect that an isolated transaction was either an adventure in the nature of trade or simply a case of sale and resale of a property was approved by the House of Lords. The introduction of CGT changed the position considerably. However, although a taxpayer can no longer escape entirely from liability by showing that the sale of an asset was a capital receipt, there may still be some distinct advantages in being assessed to capital gains tax rather than income tax. It is also true that, in general, assessment to income tax is still the Revenue’s preferred option.
What is a trade or an adventure in the nature of a trade?
It has been shown above that, for a transaction of the kind under consideration to be assessed to income tax, it must be shown to be a trade or a concern or adventure in the nature of a trade. The Acts have, however, lacked a definition of these terms and dictionary definitions are not sufficiently wide to cover all trading ventures. The selling of goods or services to an independent customer is normally seen as an important element in a trade but many other activities need to be taken into account. In cases which have been before the courts the existence of a trade has had to be established by pointing to some features of the transactions under discussion which are characteristic of a trading activity. The Report of the Royal Commission of 1955 on the Taxation of Profits and Income identified six badges or insignia of trade. The appearance of one or more of these badges (which are derived from case law) in a transaction will indicate that that transaction may well be a trading activity. The badges have frequently been mentioned by the judiciary in tax cases and by writers on taxation matters and there has been a tendency to increase the number of such badges and to update them. In the case of Marson v Morton (59 TC 381), Sir Nicholas Browne-Wilkinson listed ten such pointers for trade. It is not proposed here to suggest that there is any exact number of relevant badges but a list of them is given below.
The profit motive
Where an asset has been held for many years as an investment before sale as in Hudson’s Bay Co Ltd v Stevens (5 TC 424), or has been inherited, the subsequent sale of the asset may well not be a trading activity. Similarly, where an asset is clearly purchased as an investment but has to be sold because of changed circumstances, as in Simmons (as liquidator of Lionel Simmons Properties Ltd) v IR Commrs (53 TC 481), there may be no trade characteristics.
But where a profit motive has been apparent from the outset or where it has subsequently developed, it will be a badge of trade. Instances of this are the purchase and sale of silver bullion in Wisdom v Chamberlain (45 TC 92), of cotton-spinning plant in Edwards v Bairstow and Harrison (36 TC 207) and of whisky in IR Commrs v Fraser (24 TC 498). It is also to be noticed that s. 224(3) of Taxation of Capital Gains Tax Act 1992 denies private residence relief if the house is acquired wholly or partly for the purposes of realising a gain.
The subject matter of the transaction
Traditionally, stocks and shares and real property have been purchased as long-term income-producing investments and they may still be purchased for this purpose although the modern trend is to buying with the making of a fast buck in mind. Other assets such as antiques and paintings may be collector’s items or be acquired as a hobby or otherwise for the purchaser’s personal use or satisfaction. If, however, the asset is not likely to be acquired for such purposes or the acquisition is of a quantity far beyond such possible use, it will obviously have only been acquired with resale in mind, as with the toilet-paper in Rutledge v IR Commrs (14 TC 490) and the war-surplus linen in Martin v Lowry (11 TC 397).
The method of finance
Financing of a purchase by borrowed money – particularly where there are no other resources with which to repay the loan and the asset is not required for the purchaser’s immediate use or enjoyment is suggestive of a trade. In Wisdom v Chamberlain, quoted above, the loan required to purchase silver bullion could only be repaid out of a subsequent sale. In Johnston v Heath (46 TC 463) a purchaser of land needed to sell a part of it in advance in order to raise the money for its purchase.
Connections with an existing trade
If a sale of an asset is made by a person or persons who are at that time, or had been in the past, engaged in selling such assets in the ordinary course of business or if the assets were of a type closely related to that now sold, it is likely that the present
transaction is also a trading activity. This is especially the case with builders and property-dealers, as, for instance, in Shadforth v H Fairweather and Co. Ltd (43 TC 291). But it can also apply in other trades as in the case of wine merchants dealing in South African brandy in Cape Brandy Syndicate v C.I.R. (12 TC 358).
Frequency or repetition of sales
An isolated transaction may be enough to constitute a trade but repetition of transactions, especially at frequent intervals is even more likely to do so. In Pickford v Quirke (13 TC 251) a taxpayer was a member of four different syndicates which were engaged in successive liquidations of cotton-mill companies and the resale of their businesses. He was held to be carrying on a trade.
Business organisation
In order to resell the surplus linen, the taxpayer in the case of Martin v Lowry, quo0.
Modification or repair
Where the purchaser of an asset repairs it or puts it in working order or otherwise modifies it to make it more readily saleable, the purchase and sale transactions are likely to be seen as trading activities. In C.I.R. v Livingston and others (11 TC 538) three otherwise unconnected persons purchased a cargo vessel and converted it into a steam-drifter before reselling it. One of the judges in the Court of Session said that the procedure adopted seemed to be the very essence of trade.
Sales of real property
The principles set out apply to sales of all types of assets. But with many classes of assets such isolated sales or dealings are comparatively rare. A person who wishes to buy and sell such assets is more likely to set up a regular business of doing so and this will be readily recognisable as a trade. But there are some assets, such as real property, which lend themselves to occasional deals. A great many of the court cases relating to the matters under consideration have been concerned with purchases and sales of property. It should be remembered, too, that real property has always been regarded as a suitable sphere for investment which has naturally led to the argument that a sale of such property is simply a change of investment and not a trading activity at all, or, at least, that any profit on the sale is capital rather than revenue. In Kirkham v Williams ([1991] STC 342) a demolition contractor purchased a site and used it for office space and storage. He later obtained planning permission to build a large dwelling house on the site. He then sold the entire site and carried on his business elsewhere. The Revenue raised a Sch. D Case I assessment on the profit and this assessment was upheld by the Commissioners and by the judge in the Chancery Division. This decision was, however, overturned by a majority verdict in the Court of Appeal, where it was accepted that the site was acquired and sold as a capital asset. Again in Marson v Morton, already quoted, the High Court upheld a decision by the Commissioners that a gain on the purchase and resale of land by shareholders in a potato-merchanting company was a capital and not an income profit. There have been other successes achieved by taxpayers with regard to property so that it cannot be said that selling property is always to be regarded as a trade. But the Revenue, too, has had many successes in this area. They also have ways and means of countering avoidance schemes in ICTA 1998, s. 776 ff.
Sales of stocks and shares
Stocks and shares are assets which are very frequently bought and sold outside the sphere of a regular business. They are also assets which are commonly regarded as an investment, although nowadays many sales are simply made to realise a quick profit. It might, therefore, be thought that this would be one of the main areas in which disputes involving the distinction between trading and capital profits would arise. Rather surprisingly this is not so. In the past, the Revenue seem to have fought shy of trying to assess occasional gains on stocks and shares as a trading profit. Before the second world war, it was less common for those who did not make a full-time
business of it to indulge in buying and selling shares and those who did so probably made losses more often than they made profits. It is commonly believed that the Revenue did not suggest taxing occasional dealing as a trade because they were afraid of opening the door to loss claims. Indeed, it has been taxpayers rather than the Revenue who have suggested that selling shares was a trading activity because they have wished to claim relief for losses.
Two companies have been successful in making such claims. In Lewis Emmanuel and Son Ltd v White (42 TC 369), the High Court reversed a decision of the Special Commissioners and held that the company dealing in fruit and vegetables was also carrying on a trade of dealing in securities and was entitled to relief for its losses. In Cooper v L and J Clark Ltd (54 TC 670) a company manufacturing footwear also claimed successfully to be dealing in gilt edged stocks. An individual was less successful with such a claim. In Salt v Chamberlain (53 TC 143), the court upheld a decision by the commissioners that the taxpayer’s transactions did not constitute a trade.
There is no doubt, however, that dealing in shares with a view to realising a profit has become much more widespread and the Revenue may be tempted to treat it as a taxable trade. In December 1996 the Privy Council reinstated a New Zealand High Court decision that had been overturned by the Court of Appeal. This was in the case of Rangatira v IR Commrs. Before 1983 the company’s profits on occasional sales of shares had been treated as capital gains. But then it made 41 sales in seven years and admitted that in three cases the shares had been bought with resale in view. The decision rejected the Revenue’s claims that all the transactions were taxable as income but accepted that in the case of shares bought for resale the profit was taxable.
Technical Department
020 7235 9381
April 2001 by Arthur Sellwood
