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For tax purposes, the distinction between qualifying as an investor or a trader largely comes down to the frequency and goals of your trades. Investors generally buy and sell securities/assetsto earn income from dividends, interest and capital appreciation. And they typically hold on to securities/assets for a bit longer period like a six months or year.
On the other hand, traders are in the business of regularly and continually buying and selling securities/assets for their own accounts. They trade frequently in pursuit of profits based on daily market movements and expect trading to provide their livelihood.
In general, the tax rules favor traders over investors — and the HMRC has made investor status even less tax advantageous.
Let’s understand the context a bit in detailed
Investing
Investing is the traditional buy and hold approach in which an individual purchases an item outright with the purpose of holding it for an extended length of time and then selling it for a profit.Investing is a method of getting a return on cash that is not available through other sources. While you may leave your funds in a bank and earn interest, you could also choose to invest and take a risk with your capital. While investments might result in losses, they can also result in significant gains.
Trading – definition
On the other hand, Trading is not defined in statutory provision with a definite answer and Trade’ is defined as including ‘any venture in the nature of trade ass the term "trade" is not fully defined in the legislation, the interpretation of what it means has been left largely to the courts. Therefore, to determine whether someone is trading, the courts have formulated several tests. These tests are referred to as "badges of trade".
In most cases, it will be evident whether or not there is a trade. However, in a few cases of an isolated transaction, HMRC uses the ‘badges of trade to determine whether or not a trading activity exists.
However, ‘Badges of trade’ are also not found in the statute, having been developed by the courts. in 1955 a Royal Commission report on the taxation of profits and income used previous judicial decisions to identify six ‘badges of trade’; this number has increased to nine following rulings in subsequent tax cases over the period.
Badges of trade
It is not mandatory for a transaction to have all of the "badges" in order to be considered trading; the presence of just one badge can suffice. Given the circumstances, some badges clearly carry more weight than others. As per HMRC’s business income manual, there is a list of nine badges of trade which are as follows –
- Profit-seeking motive - An intention to make a profit suggests trading, but it is not conclusive by itself. Like did the owner originally intend to trade, or were the transactions for investment purposes only?
- Frequency and number of similar transactions - The othertrade badge is “Frequency and number of similar transactions”. Like systematic and repeated transactions, i.e. buying and selling frequently, indicate a trade.
- Nature of the asset - The third badge is related to the asset under consideration. The manner an asset was acquired is an indicator of whether it was acquired for resale or that it was acquired for private use or as an investment likebuying vintage cars and selling them after a lengthy period of ownership or what was the character of the land, was it suitable for long-term investment or for immediate development
- Changes to the asset - We are unlikely to be trading if we buy something, do nothing with it, and then sell it. However, If assets are repaired, modified or improved to make them more easily saleable or saleable at a greater profit this suggests a trade. Like someone buying property to refurbish then sell
- Connection with the existing trade - Transactions that are similar to those of an existing trade imply trading, On the other hand, if it is far removed from the taxpayer’s normal business activity, it may not amount to a trade transaction, itwill most likely be a trader
- Source of finance - How was the purchase funded and under what terms if purchased via a loan? Like If money was borrowed to buy the assets sold with the intention to repay the loan from sale proceeds, this indicates a trade unless ownership of the assets was an investment or for personal enjoyment.
- Length of ownership - Trading assets will normally, but not always, be sold quickly after acquisition. Therefore, an intention to resell an asset shortly after purchase will indicate trading. However, an asset which is to be held indefinitely is much less likely to be a subject of trade Likea purchaser buying to let out on a long-term basis is an investor
- Reason for the acquisition/sale - Finally, we will consider how the asset was obtained –like an asset that is acquired by inheritance, or as a gift, is unlikely to be the subject of trade.
- The way the transaction is carried out - If the sales have been conducted via an organized activity, such as carrying out extensive advertising, the opening of an office, employment of sales staff, etc., it would tend to indicate the presence of a profit-making undertaking.
Taxes for trading and investment
The main implication of the above is to determine whether the seller is a trader undertaking a trading activity or whether their activities are regarded as an investment for capital gain purposes. The tax implications include:
- Trading profit Trading profits are subject to income tax and national insurance for sole traders and partnerships and are subject to corporation tax for companies. A trader may be required to account for VAT.
Investment Profit: If the profit from the sale of chargeable assets like shares/ property exceeds the annual exemption for capital gains tax, you must pay capital gains tax (CGT) on the excess profit. If you fall in the category of higher or additional rate taxpayer, you need to pay CGT at a maximum rate of 28 per cent on sale of residential properties and 20per cent on gains from other chargeable assets.
In case you are in the basic rate taxpayer category, you must pay 18 per cent on sale of residential properties and 10 per cent on gains from other chargeable assets.The annual exemption limit for 2022/23 is £12,300.
However once an exception in there, in the case of rental business (e.g. buy to let) it is investment activity but it will be subject to income tax for Individual and partnerships and are subject to corporation tax for companiesbut no national insurance VAT compliance is required.
Note: Trading losses can be set off against other income of the individual taxpayer or any other corporation income in the case of the company and can be carried back or carried forward. Whereas capital losses are carried forward only and can be set off against the capital profit of the future.
Anti-avoidance provisions in land transactions
Anti-avoidance provisions are specifically applicable to the trading transaction involving land.HMRC often looks closely at the purchase and sale of land and buildings, simplydue to the size of the profits involved. It is in the area of land transactions that most cases involving the badges of trade have been taken to the Courts.
One of the important questions to ask is whether the taxpayer is “investing in the land”or “dealing in the land” – “dealing” is trading.When dealing with a land transaction, the first thing to consider is whether or not the badges of trade apply. If the transaction qualifies for the trade badges, it will be treated as trading income. If the trade badges do not apply, the transaction will be treated as a capital transaction and most times; it is subjected to capital gains tax. However, the transaction, however, may be taxed as miscellaneous income. This will only occur if a taxpayer has taken measures to convert a trading transaction into a capital transaction on purpose.
This is not the conclusive/ definite answer because professional advise needs to be taken care of before proceeding with this kind of transaction as it can put a huge tax bill burden on a taxpayers head.
Which is the more beneficial designation – trading or investment?
Whether it is more beneficial for a transaction to be taxed as trading or investment will depend upon a number of factors, not least whether the taxpayer is an individual or a company, the taxpayer’s own position (e.g. losses, CGT annual exemption, tax rate, etc), and the overall values involved.
Generally, wherever possible, if a property transaction/sharesare deemed to be an investment transaction then it may be worth considering holding the assets personally rather than through a company, (e.g. comparing the CGT rate with the overall tax cost if the gain is taxed within the company, and the post-tax gain is subsequently extracted from the company, such by salary or dividend). Remember that an individual is allowed an annual allowance, whereas a company is not.
However, if the transaction is trading in nature, the reverse is often true, because the charge to income tax (and NIC) may be much higher than the corporation tax rate.
There will be countless scenarios where the tax treatment of a transaction could be in doubt. The badges of trade are an attempt to help define such events. However, no one badge will be conclusive. Forward planning about the business activity can help to avoid outcomes which result in more tax to pay.
In case you have any queriesor want specialist advice on "Trading or Investing – Why does it matter?”, kindly call us on 03330886686, or you can also e-mail us at enquiry@dnsaccountants.co.uk.
“This article was correct at the date of publication. It is intended for general purposes only and does not constitute legal or professional advice. Independent professional advice should be sought before proceeding with any transaction”.
Any questions? Schedule a call with one of our experts.
Siddharth Agarwal
I am a Chartered Tax Advisor (OMB) and ACCA. I have 9+ years of experience in owner-managed business taxation issues, company reorganisations, property taxation, and succession planning.
I also work with private clients on bespoke tax planning strategies for trusts, residence status, and non-residents.
I aim to fulfil my professional duties towards my clients and keep them satisfied, my utmost priority. I believe in establishing and maintaining businesses and personal relationships as the key to mutual growth.
Siddharth Agarwal
I am a Chartered Tax Advisor (OMB) and ACCA. I have 9+ years of experience in owner-managed business taxation issues, company reorganisations, property taxation, and succession planning.
I also work with private clients on bespoke tax planning strategies for trusts, residence status, and non-residents.
I aim to fulfil my professional duties towards my clients and keep them satisfied, my utmost priority. I believe in establishing and maintaining businesses and personal relationships as the key to mutual growth.
