BackToBasics
Eight signs a hobby has become a trade
HMRC’s badges of trade are sure signs of trading
Words Nick Craggs, First Intuition
When is a trade a trade? By which I mean when is someone working for a living and when are they not working? It sounds like a simple question – surely you know when you are working? However, in reality it is not so obvious that you are conducting a trade. You may think you are not trading, but HMRC could believe you are!
HMRC appreciates that everyone’s circumstances are different and that business practices change over time. Having a firm set of rules cannot account for every possible scenario. Therefore, HMRC has eight tests to confirm trading or otherwise. These tests are known as badges of trade. If the individual in question meets a substantial number of the tests, then a decision is taken on the balance of evidence. Being based on the weight of evidence, there could still be a grey area.
There is no particular order to the badges of trade as they all need to be considered.
Key point
The main takeaway from this is that these tests do not individually conclusively dictate that you are trading, they only add weight either way to the overall decision. This decision regarding whether someone is trading or not is based on the overall balance of evidence. However, there have still been cases of people and HMRC going to court to resolve these issues.
Badge 1: Seeking profit
The first one I am going to talk about is the profit-seeking motive. If the sole reason for buying the asset was because you felt that you could sell it on later for a larger amount and make a profit, then this is indicative of a trade. Whereas if someone buys an asset because they want it and then later they decide they do not want it and sell it on for a larger amount, that would not be indicative of being in trade.
Badge 2: Transactions
The next badge of trade is the number of transactions. If you were to buy a grandfather clock and then sold it because you did not like it, then this would not be indicative of a trade. Whereas in the period of six months, if you bought twelve grandfather clocks, HMRC would probably take the view that it is more likely that you are in fact an antique dealer and therefore considered a trade.
Badge 3: Asset(s)
For the next badge of trade, we look at the nature of the asset. Is this the sort of asset that someone might buy for their own use? If so then it is likely that this is not to be deemed as a trade. Whereas, if it is an individual buying parts for coal-mining machinery, unless they have an obscure interest in coal-mining machinery, this is more likely to be seen as a trade.
Badge 4: Similar transactions
Following on from the last badge of trade is the existence of similar transactions. If the person named above who has sold parts of the coal-mining machinery has also sold parts for diggers this again might indicate that they are carrying out a trade.
Badge 5: Altering asset(s)
So far, we have talked about people buying an asset and then selling it on. However, if someone buys an asset and then changes it in some way before selling it on, this again may make HMRC decide that you are carrying out a trade. A good example of this is someone who buys cake ingredients, bakes a cake and then sells the cake. This is more likely to be deemed a trade as opposed to someone buying an expensive bottle of whisky and then selling it on. This does not mean that if you do not change the item in any way that it will not be deemed a trade, but it is less likely. All the other badges of trade as a whole will need to be considered.
Badge 6: The method
The next badge, although there is no order, is how the sale was carried out. There are many ways in which you can sell an item; however, for example, creating a website to sell your goods is going to be very indicative of carrying out a trade. HMRC will look at the ways that people in the same trade, who are definitely carrying out a trade, sell their goods, and if you are using the same method, again, you might be deemed to be carrying out a trade. If you sell a rare bottle of wine through a specialist wine auction house that other wine dealers use, you are more likely to be deemed to be carrying out a trade than if you sold your wine through Facebook Marketplace, which no self-respecting wine dealer would be seen using!
HMRC might also look at the source of money used to buy the asset that you sold as if you had to borrow money to buy the asset and may take the view that you originally planned to pay the loan back when you sell the asset. Whereas if you bought something with savings it may make HMRC less likely to think you are carrying out a trade.
Badge 7: Time
Another test is the amount of time between the purchase of an asset and the time you sell it. If you buy something and then many years later decide you do not want it and sell it, this is not going to be indicative of a trade. Whereas, if you buy an asset and then sell it a week later is that because you changed your mind very quickly or, as HMRC might view it, you wanted a return on your investment as soon as possible?
Badge 8: Acquisition
Then, lastly, the method of acquisition will help HMRC decide if you are trading or not. Unintentional acquisition, such as inheritance of being gifted of an asset, will indicate you are not trading. Whereas if you make a conscious decision to purchase an asset this will add weight to the outcome that HMRC think you are trading.
