You may think that HMRC considering your business to be a hobby is a good thing. However, this does not mean that the income you receive will always be tax-free . You could also lose out on a number of valuable tax advantages. There are many facets to consider when asking the question. ‘is my business a hobby or a trade’?
For example, you cannot claim losses arising in your business against other income for tax purposes unless you are carrying out a trade on a commercial basis. Nor can you claim capital allowances on plant and machinery purchased for your business. In addition to this, claims for relief for inheritance tax and capital gains tax purposes will not be available unless a trade exists. As it is so important to determine whether or not you are carrying on a trade, you should be aware of some of the indicators .
As it is so important to determine whether your business is a hobby or a trade, you should be aware of some of the indicators . These ‘badges’ determine whether your business is a trade or if it is simply a hobby
Your intentions will be a factor in deciding whether or not a trade exists although this alone will not be conclusive. If you are intending to sell an asset at a profit, even if a profit is not actually realised, this may indicate that a trade exists. Similarly, if you intend to hold an asset as an investment, even if this is then sold, this could support a claim that a trade was not being carried on.
It can be difficult to provide evidence to support your motive but you should try to keep records of your intention. This is particularly important if this changes due to unforeseen circumstances.
Nature and quantity of the asset
How many items you purchase, and the nature of these items will also be taken into consideration when determining whether a trade is being carried on. Purchasing, and consequently selling, many of the same items may indicate a trade exists. This is particularly true if this is not an item you are likely to use personally.
An instance which actually happened in the 1900s involved an individual who purchased, and quickly sold one million toilet rolls. As it is unusual for an individual to require so many toilet rolls, the courts felt that the individual must have purchased the toilet rolls with the intention to sell. They were, therefore, carrying on a trade.
Improving the asset before sale
By making improvements to your asset before selling it, you may indicate that you are carrying on a trade. This is because it is felt that you are making the asset more attractive to potential buyers. As well as increasing its value so you may sell it at a profit. The changes to the asset do not need to be drastic. Simply repackaging the items into more attractive packaging could indicate you are carrying out a trade.
Number of transactions
If you repeatedly enter into the same or similar transactions, this will be an indication that you are carrying on a trade. These transactions do not necessarily have to occur within a short space of time. They could occur over a number of years.
For example, purchasing a home which you live in and then selling it at a profit is not likely to indicate that you are carrying out a trade. If, however, you purchase and sell three homes within the same number of years, this could indicate that you are involved in a property business with the aim of making profits on the sale of these properties.
Is my business a hobby or a trade? Looking at the whole picture
These ‘badges’, amongst others, will be looked at together in order to identify whether or not a trade exists. It is unlikely that just one of these points would produce a foregone conclusion.
In recent years, HMRC has been taking a hard approach on whether or not a trade exists. In particular, HMRC has been targeting individuals making profits by selling goods online or at car boots.
The proposed introduction of the micro entity allowance, a £1,000 allowance for individuals trading at home, suggests a reduction in pressure on these individuals. Until the micro entity allowance is introduced next year, and the final details confirmed, all traders will still be required to report their profit or loss to HMRC through their annual tax return. If you are unsure if your business is a hobby or a trade please contact us. We would be pleased to discuss this with you and assist with any reporting requirements which may be necessary