Have you ever noticed how often tax reliefs and dispensations seem heavily weighted towards those business activities that are regarded as “trading “? The usual explanation for this is that governments of every persuasion have all been keen to use the tax system to favour business activity that promotes economic stimulation and job creation. Companies that are merely passive or predominantly investment vehicles shuffling assets around clearly don’t attract the same level of support as those which demonstrate the creation of a product or service on a regular basis. The tax services professionals at London based accountants, Baker Tilly, have recently issued a timely note on the subject and what could be at stake if your business falls into the “wrong “ camp.
Let’s look first at some of the drawbacks identified by the tax services experts if a business is not classified as “trading”. Well, for a start, one of the most generous tax reliefs available is the research and development credit but you can only ever obtain this if you are classified as a trading company. Similarly, leading providers of tax services will tell you that the new patent box relief that adjusts trading profits leaving an effective rate on relevant profits of only 10% is clearly dependent on having a “trade” in the first place.
When it comes to capital gains tax, there is a myriad of situations where trading status forms part of the equation in either the reduction in or exemption from CGT. The tax services professionals will also tell you that a recognised trading activity is essential to qualify for substantial shareholdings exemption, statutory demergers and the best tax advantaged share scheme available at the present time – the enterprise management incentive all require that essential trading classification. A specific warning is also issued by leading tax services regarding the possible loss of input VAT recovery where there is an absence of economic activity which carries a wider definition than that of a trade but is nevertheless closely related.
So having looked at a selection of tax breaks that could be lost if one’s trading status fails to be upheld, what clues do the tax services providers offer when it comes to seeing if one qualifies or not. Well, unfortunately, although the UK has one of the longest tax codes in the world, it is nigh on impossible to find a foolproof definition of what “trade” actually is. The sort of definition one might find in the UK’s tax legislation is something totally anaemic like “any venture in the nature of a trade”.
It seems that trainee providers of tax services have to learn early on that part of their work is clearly an art rather than a science and recognising a trade is something akin to identifying a Chateau Margaux in a blind tasting i.e. something that only comes with experience.
As is normally the case in British law, if you can’t find the answer, you can always rely on precedent and, in making judgements on whether or not a particular activity is a trade, the Courts will often turn to a collection of historical precedents known as the “badges of trade”. Tax services experts will tell you that this is basically a checklist that examines such aspects as profit motive, reason for sale, the period of time that elapsed between purchase and sale, and the frequency and number of similar transactions.
As we have already said, it seems to take a seasoned tax services professional to decide whether or not a specific commercial activity is a trade. He or she can usually recognise a trade that is valid for tax purposes on sight and this is why they are employed by businesses to make an initial assessment and then, if necessary, carefully plan ways to manage the position to firmly establish a company’s trading status thereby gaining access to the various reliefs that can be legitimately obtained.
It’s usually a lot cheaper to call in an experienced tax services professional early on than to wait and pay for protracted action through the courts.
If you would like advice on any element of tax, Baker Tilly’s team of tax services experts would be delighted to discuss your requirements with you.