ATXP6 UK
Syllabus A1. Income tax A1a. Income from self-employment

A1a. Badges of trade

Syllabus A1a)

B3 Income from self-employment

Badges of trade

These are used to help differentiate whether a person is trading or whether they are selling their capital assets.

  • The need to differentiate between these 2 types of transactions arises because an individual who is trading will be assessed to income tax and national insurance contributions based on self employment.

  • However, an individual who is making sales of their capital assets will be assessed to capital gains tax.

Badges

  1. Subject matter 

    – anything can be trading stock but some items are more likely to be so than others. 

    For example, a sale of a substantial number of toilet rolls is considered trading.

  2. Length of period of ownership

    – normally, trading stock is held for a short period of time.

    For example an item that is held for less than 12 months will be considered trading stock, but an item that is held for more than 12 months is likely to be considered a capital asset.

  3. Frequency of similar operations

    – the more often a deal takes place, the greater the assumption that it is a disposal of trading stock.

    For example if cars are bought and sold throughout the year, this will be considered to be the trading of cars; however if there is a one time sale of one car, then that is likely to be considered to be the sale of a capital asset.

  4. Subsequent work 

    – change of character of an asset to make it more saleable is likely to be indicative of trading. 

    For example, buying bulk marble for flooring and breaking it down into smaller saleable units to use for individual floors, will be considered trading. Also, advertising and making the item more marketable may be indicative of trading.

  5. Circumstances

    – sudden emergency, for example the urgent need of cash can negate the presumption of trading.

    For example selling a vintage car from a collection of vintage cars because of the urgent need of cash will be considered to be the sale of capital assets.

    This is because the motive is not to trade cars, it is to obtain cash quickly.

  6. Motive

    – intention of making a profit is necessary for trading.

    For example, selling cars at a loss just to get immediate cash will not be considered trading, but waiting to sell cars at a price that will earn a profit will indicate trading.

Illustration:

On 1 May, Tony was made redundant from his job as a marketing executive. 

Tony decided to purchase a house for £180,000.

Tony lived in the house as his main residence while living there he refurbished it at a cost of £27,700, the renovations were completed on 10 August.

After completing the refurbishment, he was offered a new job and he immediately put the house up for sale; and it was sold for £275,000 on 31 August.

Tony had no other income or capital gains.

  • Will this be considered to be trading income or a capital gain?

Solution:

Badge Reason Trading income or Capital Gain?
Subject matter A house can be considered to be both a trading and capital asset. Trading + Capital
Length of period of ownership Less than one year Trading
Frequency of similar operations None before Capital
Subsequent work  Yes the house was refurbished Trading
Circumstance New job resulted in sale Capital
Motive He earned a profit, however this was not his motive, he sold due to the new job. Capital

As there are 4 badges pointing towards this being a capital gain and only 3 pointing towards this being trading income, the profit made on sale will be considered to be a capital gain.