AITI Chartered Tax Adviser

What is a “trade”?

The first income tax legislation in 1799 taxed income in descending order of importance: Income from land, income from personal property, income from professions and income from trades. The gradation reflected the gradation in society. The land-owning classes – people with independent income, and who therefore did not have to work – were at the top. Educated professionals, such as doctors, clergy, governors, attended to the land-owing classes and could meet and converse with them in the drawing room. Traders, such as shopkeepers, although useful, were at a lower level, and members of decent society would keep their contact with traders to a minimum. A tradesman was a person who sold his manual skills, for example, a bricklayer or plasterer. Traders were not allowed to enter a grand house from the front door – they were required to use the tradesman’s entrance. Lower again were workers and servants. These were subject to a master-servant relationship. This class system can be seen at work in the novels of Jane Austen, the Brontë sisters, and Charles Dickens.
Although the world, and business structures, have evolved significantly since 1799, the income tax system still uses the concept of “trade” to tax business profits. This has led to the concept being stretched to breaking point. Trading, at its simplest, means buying something and selling it at a profit. For example, a fruit stall holder in a market may buy 200 apples in the morning from the fruit market at 5c each and sell them during the day at 25c each. The difference – 200 x 20c = €40, is his trading profit.
The world economy grew in the 1800s and 1900s with the advent of railways, electricity, telegraph, telephone, radio, air travel and television. Trading ventures became more complex, and legislation was introduced to allow the formation of limited liability companies to take on larger trading ventures. Cases began to appear before the courts, claiming that certain activities were not “trading” – for example, how could a company that owned a cable across the Atlantic seabed, with no premises in the UK, be said to be “trading” in the UK? The court held that it was trading in the UK, as it collected money from persons in the UK it allowed to use its cable.
Because a trade also includes “an adventure in the nature of trade”, profits from once-off transactions can be taxed as income.
The carrying on of a trade may be contrasted with the sale of a capital asset, i.e., the realisation of an investment which is generally not taxable. Although the realisation of an investment is usually a once-off transaction, such transactions have been held by the courts on many occasions to constitute an adventure in the nature of trade.

The badges of trade
Because of the confusion that has grown up over what constituted a trade, and the difficulty in distinguishing whether a profit is derived from the realisation of an investment or from a trading venture, a Royal Commission was set up in 1954 to report on what were the essential features of trading. The Commission reported that a trade could be identified by six characteristics, and these have since come to be known as the “badges of trade”:

(a) The subject matter of the realisation, i.e., the nature of the asset. Commodities and manufactured products are not normally the subject of investment. Antiques, gold coins, fine wines, and shares are normally held as investments. The fruit trader who buys 200 apples in the morning to sell them later that day is not “investing” in the apples. He is trading in apples.
(b) The length of the period of ownership. A quick purchase and sale is an indicator of trading. Property bought as an investment is usually held for several years. The fruit trader does not hold on to his apples for very long, because they will rot.
(c) The frequency or number of transactions by the same person. For example, the fruit trader does not buy and sell one apple. He needs to buy and sell a large number to make a profit.
(d) Supplementary work on the property. The fruit trader does not leave his apples under the stall table where no one can see them. He arranges his apples in a tempting display.
(e) The circumstances responsible for the realisation. The sale of an asset to raise cash for emergency reasons (for example, hospital costs) may indicate that the transaction was not envisaged as a trading venture, but an emergency sale of an investment.
(f) Motive. The fruit trader’s motive is clearly to resell the apples at a profit, i.e., to make a living to support himself and his family. If the fruit trader bought an original painting, with the intention to hold on to it and pass it on to his children, his motive is investment.

Transactions in land
Land may be traded, i.e., bought and sold at a profit, or held as an investment. Once-off transactions in land may be categorised under either heading depending on the particular facts of the case. The key question is: Were you investing the money, or were you doing a deal?