Trading Income

Question 1

Where is the legislation found on this subject?

Answer 1

Income Tax (Trading and Other Income) Act 2005 (ITTOIA 2005).

Question 2

What does s 5 ITTOIA 2005 state?

Answer 2

‘Income tax is charged on the profits of a trade, profession or vocation.’

Question 3

How did Scruton LJ define ‘profession’ and where?

Answer 3

CIR v Maxse (1919), a profession involved ‘the idea of an occupation requiring either purely intellectual skill, or if any manual skill…skill controlled by the intellectual skill of the operator.’

The line of demarcation may vary from time to time.

Question 4

Who and where considered the meaning of vocation?

Answer 4

Denman J in Partridge v Mallandaine (1886), vocation is ‘analogous to the word ‘calling’…it means the way in which a person passes his life.’

No limit to it being a lawful vocation.

Question 5

What activities are specified in the legislation which might not otherwise be considered trading?

Answer 5

s 9: faming and market gardening.

s 10: commercial occupation of land other than woodland.

s 12: profits of mines, quarries, railways etc.

Question 6

How is trade defined in the Income Tax Act 2007?

Answer 6

s 989: trade is defined to ‘includes any venture in the nature of trade’.

Question 7

What did CIR v Fraser (1942) say?

Answer 7

Normand LP said it is less difficult yo hold a single transaction as an ‘adventure in the nature of trade’, as opposed to full-blown trade. Therefore, s 989 expands the net to include ‘one-off’ trade-like transactions.

Question 8

What counts as a ‘venture’?

Answer 8

Clyde LP in Rutledge v CIR (1929) suggested that venture means an adventure or speculation.

Question 9

What counts as ‘in the nature of trade’ when it comes to ‘a venture in the nature of trade’?

Answer 9

Lord President Clyde in CIR v Livingston (1926) said it is ‘whether the operations involved in it are of the same kind…as those which are characteristic of ordinary trading in the line of business…’

Question 10

How have the courts usually defined trade?

Answer 10

They have held the trade usually involves the provision of goods or services to customers for reward.

Question 11

What did Lord Reid note in Ransom v Higgs (1974)?

Answer 11

Trade is ‘commonly used to denote operations of a commercial character by which the trader provides to customers for reward some kind of goods or services’.

Question 12

What did Lord Wilberforce have to say in Ransom v Higgs (1974)?

Answer 12

‘Trade, moreover, presupposes a customer…or, as it may be expressed, trade must be bilateral - you must trade with someone.’

Question 13

Is the meaning of the word trade a point of law or fact?

Answer 13

A point of law and therefore it is a legal point that certain indicators or characteristics are relevant in determining what is a trade.

Question 14

Where can you find the most canonical list of certain indicia of trade?

Answer 14

The report of the Royal Commission on Taxation of Profits (1955), which listed six ‘badges of trade’.

It is not law, but the cases provide (legal) authority for each of the badges being an indicia of trade.

Question 15

What is the first badge of trade?

Answer 15

1. The subject matter of realisation: property which does not yield to its owner an income merely by virtue of its ownership is more likely to have been acquired with the object of a deal than property that does.

Question 16

What is the second badge of trade?

Answer 16

2. The length of the period of ownership: property meant to be dealt in is realised within a short time after acquisition.

Question 17

What is the third badge of trade?

Answer 17

3. The frequency or number of similar transactions by the same person.

Question 18

What is the fourth badge of trade?

Answer 18

4. Supplementary work on or in connection with the property realised. If the property is worked up in any way during the ownership, there may be some evidence of dealing.

Question 19

What is the fifth badge of trade?

Answer 19

5. The circumstances that were responsible for the realisation: if sudden, probably not dealing.

Question 20

What is the sixth badge of trade?

Answer 20

6. Motive

Question 21

What did Normand LP comment in CIR v Fraser?

Answer 21

‘The purchaser of a large quantity of a commodity…greatly in excess of what could be used by himself….a commodity which yields no pride of possession…I can scarcely consider to be other than an adventurer in a transaction in the nature of a trade.’

Question 22

What happened in Rutledge v CIR?

Answer 22

Taxpayer purchased 1 million rolls of toilet paper and made a profit when selling it in London. Lord Sands noted than the quantity of the subject suggested it could not have been disposed of in any other way than as a trade transaction.

Question 23

What did Lord Templeman observe in Ensign Tankers (Leasing) Ltd v Stokes (1992)?

Answer 23

The subject matter of the transaction needs to be seen in the context of the other activities of the taxpayer and regard has to be had to the quantity of the subject matter as well as its nature.

Question 24

What did the case of Wisdom v Chamberlain (1968) tell us about length of ownership?

Answer 24

Norman Wisdom bought £200,000 worth of silver bullion to hedge against a potential devaluation of Sterling.

Harman LJ commented that: ‘it was nevertheless a transaction entered into on a short-term basis for the purpose of making a profit out of the purchase and sale of a commodity, and if that is not an adventure in the nature of trade I do not really know what is.’

Also attached importance to the fact the transaction was financed by borrowed money.

Question 25

What does Pickford v Quirke (1927) tell us about the frequency of the transactions?

Answer 25

It is possible that even if an isolated transaction is not an adventure in the nature of a trade, a series of such transactions may constitute trading. In this case, the taxpayer took part in four transactions which together, but not separately, were held to be trading.

Question 26

What did Leach v Pogson (1962) tell us about the frequency of the transactions?

Answer 26

Court can take into account subsequent transactions in determining whether the first transaction can be held to be a trade.

Question 27

What did the case of CIR v Livingston tell us about work done on property?

Answer 27

Concerned work done on the property to enhance its value. Taxpayers made extensive renovations to a cargo ship.

Lord Clyde LP held that the profit arose from the expenditure on the subject for the purpose of making it marketable at a profit. That seems to me of the very essence of trade.

Question 28

What did Martin v Lowry tell us about work done on property?

Answer 28

There was a trade by virtue of the particular efforts of the taxpayer to find purchasers for the aeroplane linen.

Question 29

What did the case of Cohan’s Executors v CIR (1924) tell us about the circumstances responsible for realisation?

Answer 29

Shipbroaker died but beforehand had entered into a shipbuilding contract. As the sale was affirmed by the executors, in carrying out their duty to realise the assets of the deceased’s estate, it was not taxable.

Question 30

What did the case of West v Phillips (1958) tell us about the circumstances responsible for realisation?

Answer 30

Taxpayer built number of homes planned to be let out as an investment. But combination of rent control and higher taxation meant they were no longer a profitable investment, and he therefore sold them. The High Court found that there was no trading, relying on the reasons for why he sold and the fact that the houses had always been investments.

Question 31

What did Wisdom v Chamberlain tell us about the motive of the taxpayer?

Answer 31

The case placed significance on the taxpayer’s motive her by describing his purchase as ‘a transaction entered into on a short-term basis for the purpose of making a profit…’

Question 32

Will a tax avoidance motive prevent something from being trading?

Answer 32

No: Ensign Tankers (Leasing) Ltd v Stokes.

Question 33

What about illegal conduct and trading? What case shows this?

Answer 33

The better view is that illegality does not of itself make a business not a ‘trade’ and therefore not taxable.

Lindsay v CIR (1932): illegality of smuggling whisky into US did not prevent the enterprise being taxable as a trade.

Question 34

How does J P Harrison Ltd v Griffiths (1962) tell us about illegal conduct and trading?

Answer 34

Lord Denning famously said that: ‘It is burglary, and that is all there is to say about it.’ The better view here is that there was never a trade because if the burglars had drawn up proper accounts there would be no profit because of a liability to return the stolen property. This statement should be regarded as obiter.

Question 35

What did Lord Morrison say in Lindsay v CIR about illegal conduct and trading?

Answer 35

‘It is, in my opinion, absurd to suppose that honest gains are charged to tax and dishonest gains escape.’

Also suggested that burglary is not a trade or business, but might be different if the burglar stole his rival’s order book and derived profit from this.

Question 36

What is the ‘cash basis’?

Answer 36

Reference to the actual amounts received and paid, but for most traders the law does not allow the cash basis to be used.

Question 37

What does the law require traders to calculate taxable profits by?

Answer 37

Reference to accounts prepared in accordance with GAAP (generally accepted accounting practice).

Question 38

What receipts are used when calculating the profits of trade?

Answer 38

Only receipts that are both derived from the trade and are not capital in nature.

Question 39

When are deductions allowed?

Answer 39

Allowed for items only that are (i) not capital; (ii) incurred wholly and exclusively for the purposes of trade; (iii) not otherwise prohibited by statue.

Question 40

What is the normal basis on which trading income is calculated?

Answer 40

The ‘earnings basis’. But under limited circumstances a trader may elect to be taxed on the cash basis’

Question 41

What does ITTOIA 2005 s 7(1) tell us?

Answer 41

That income tax on trading income is charged on the ‘full amount of the profits of the tax year’.

Question 42

What does ITTOIA 2005 s 25(1) tell us?

Answer 42

Under the earnings basis the ‘profits of a trade must be calculated in accordance with generally accepted accounting practice, subject to any adjustment required or authorised by law…’

Question 43

Where is GAAP defined in the legislation?

Answer 43

ITTOIA 2005 s 997.

Question 44

How does the earnings basis treat stock and work in progress (WIP)?

Answer 44

An amount is brought to account (i.e. a trading receipt recorded) at the end of each accounting period. Same amount is deducted from the opening balance of the next accounting balance.

Question 45

What does SSAP 9 and IAS 2 tell us?

Answer 45

Under GAAP trading stock is valued at the lower of cost and market value. This follows rule in CIR v Cock Russell & Co Ltd (1949).

Question 46

What about the earning basis for stock when various items have been purchased at different times at different prices?

Answer 46

First-in-first-out rule is most commonly used.

Question 47

What about the earnings basis and cessation of trade?

Answer 47

On cessation of a trade both stock (ITTOIA 2005, s 173-181) and WIP (s 182-186) are required to be brought to account at market value not cost.

Question 48

What does ITTOIA s 172B and s172D tell us?

Answer 48

172B: where a trader appropriates stock for himself for a non-trading purpose;
172D: where a trader disposes of stock otherwise than in the course of trade;

both the amount he pays or consideration received is disregarded and the open market value of the stock is used to account for tax purposes.

Question 49

What does Sharkey v Wernher tell us about acquisitions not made in the course of trade?

Answer 49

Lady Zia transferred horses from her stud farm to her racing stables (which was for recreational activity). Under 172B she had appropriated stock for a non-trading purpose and therefore would have to bring to account the market value of each horse when computing the profits of the stud farm.

Question 50

What does ITTOIA s172C say?

Answer 50

If an item owned by trader becomes trading stock: cost of stock is deemed to be its open market value at the time of the trading stock.

Question 51

What does ITTOIA s172E say?

Answer 51

Where a trader acquires an item of stock otherwise than in the course of trade, the cost of the stock is deemed to be its open market value at the time it became trading stock.

Question 52

Where is ‘trading stock’ defined?

Answer 52

ITTOIA 2005, s 172A.

Question 53

When do the rules in ITTOA 2005, s 172A-F not apply>

Answer 53

To vocations or professions.

Question 54

What does ITTOIA 2005, s 31E say?

Answer 54

The cash basis generally looks at the actual amounts received and paid each year, not the values recorded in the accounts.

Question 55

What changes were made in FA 2013 regarding the cash basis?

Answer 55

It has become more widely available, so that certain individuals carrying on a small business may elected to be taxed on the cash basis: ITTOIA 2005, s 25A.

Question 56

What does ITTOIA 2005, s96 tell us?

Answer 56

Only receipts that are not capital can brought to account in calculating the profits of trade.

Question 57

What does Viscount Haldane say in the case of John Smith and Son v Moore (1921) about the test of income/capital divide?

Answer 57

Test for determining whether an item is of capital or income nature is to look to the distinction of fixed capital (owner turns profit by keeping it in his possession) and circulating capital (makes a profit by parting with it and letting it change masters).

This test depends on the nature of the trade. If a company sells weighing scales to butchers those machines are stock-in-trade, but will be fixed capital to the butcher.

Question 58

What are the five propositions made by the authors in ‘Whiteman on Income Tax’ concerning income/capital divide.

Answer 58

(1) Payments for the sale of assets of a business are prima facie capital receipts.
(2) Payments made for the destruction of the recipient’s profit making apparatus are receipts of a capital nature.
(3) Payments in lieu of trading receipts are of a revenue character.
(4) Payments made in return for the imposition of substantial restriction on the trader’s activities are on capital account.
(5) Payments of a recurrent nature are more likely to be treated as a revenue receipt.

Question 59

What does the case of Orchard Wine and Spirit Company v Loynes (1952) tell us?

Answer 59

Taxpayer sold parts of a business in return for a commission on future sales, and the receipt of the commission was taxable as trading income. (Concerns proposition 1).

Question 60

What doe Van Den Berghs Ltd. v Clark tell us about proposition 2?

Answer 60

Joint venture agreement between two margarine companies. In 1927 the Dutch company made a payment of £450,000 for the termination of the agreement which was held by the House of Lords to be capital.

Lord Macmillan said these contracts were not ordinary commercial contracts, but the cancelled agreements related to the whole structure of the Appellant’s profit-making apparatus. They affected the whole conduct of their business. Hard to see how this can be regarded as income receipt.

Question 61

Is the threshold to qualify as ‘destruction of the recipient’s profit making apparatus’ high or low>

Answer 61

High: CIR v Fleming & Co (Machinery) Ltd (1951) - £5,320 compensation for the termination of an agency agreement where the taxpayer company was the sole agent for the sale of ICI’s explosives in Scotland, which amounted to between 30-45% of the taxpayer’s business in Scotland.

Found this did not cripple the whole structure of the recipient’s profit-making apparatus and therefore taxable.

Question 62

What does the case of London & Thames Haven Oil Wharves Ltd v Attwooll (1966) tell us about proposition 3?

Answer 62

A trader receives from another person compensation for the trader’s failure to receive a sum of money which, if it had been received, would have been credited to the amount of profits…the compensation is to be treated for income tax purposes the same way as that sum of money would have been (Diplock LJ)

In the case, jetty damaged by tanker, which the owner received the full cost or rep[aid and £21,000 for consequential loss. This £21,000 was held taxable as a trading receipt because it was received in lieu of a trading receipt.

Question 63

How do we draw the distinction between payments in lieu of trading receipts and proposition 2 (compensation for crippling the recipient’s profit-making apparatus)?

Answer 63

Short Bros Ltd v CIR (1927): Hindustan Steamship Company ordered 2 large ships from taxpayer, but then paid £100,000 because they no longer wanted the ships. It was held to be a trading receipt. Judges emphasised the taxpayers had not entered into a restrictive covenant. Not compensation for not carrying on their business but rather sum paid in the ordinary course.

Wiseburgh v Domville (1956): agency agreement wrongfully terminated and taxpayer received £4,000 for the work they did for the company was one of only 2 agency agreements they had and amounted to half their income. Held this sum was a trading receipt, but this might have been different if it was there only agency agreement at the time of repudiation.

Question 64

What did the case of The Glenboig Union Fireclay Co Ltd v CIR (1922) say about proposition 4?

Answer 64

Concerned the sterilisation of assets. Railway paid out £15,316 to the taxpayer to prevent further mining of the fireclays where the line of the Caledonian Railway went over. This was treated as a capital asset which was sterilised and not a trading receipt, even though the compensation was calculated by reference to anticipated profits.

Question 65

What did the case of Higgs v Olivier (1952) say about proposition 4?

Answer 65

Concerned payments for accepting trading restrictions. Sir Laurence in July 1945 was paid £15,000 for not appearing in or directing another film for 18 month. The Court of Appeal held that it was a capital payment for not carrying on a vocation, and so was not taxable as a trading receipt.

Question 66

What did the case of Jeffrey v Rolls-Royce (1962) tell us about proposition 5?

Answer 66

Concerned the supply of ‘know-how’ by Rolls Royce to manufacture ‘aero engines’ to various governments and companies. This was held taxable as a trading receipt due to its recurrent nature as opposed to Evans Medical Supplies (1957) which was distinguished as an isolated transaction and so not capital.

Question 67

Only receipts that are both…and not capital in nature are used to calculate the profits of the trade.

Answer 67

Derived from the trade

Question 68

What is the rule regarding voluntary payments and the fact that the payment must be derived from trade? Name a case for this?

Answer 68

A voluntary payment that supplements the purchase price or is intended to be used in the taxpayer’s business will generally be derived from the trade. IRC v Falkrirk Ice Rink (1975): voluntary payments made by curling club to supplement loss-making provision of facilities.

Question 69

When will voluntary payments not count as payment derived from the trade?

Answer 69

(i) Given as a general testimonial, or (ii) given on termination of business arrangements, to compensate for loss or express regret. Highlighted by Simpson v John Reynolds (1975) where payment to insurance broker on termination of relationship was not taxable.

Question 70

What is the rule regarding payment for not exercising a profession and payments derived from a trade?

Answer 70

Will not generally be taxable as trading income: Higgs v Olivier.

Browne-Wilkinson distinguished Higgs v Olivier from White v G&M Davies because the latter was concerned with carrying on a trade in a specified way (i.e. under a positive obligation to maintain 68 bovine units).

Question 71

What is the general rule of deductibility in computing trading profits?

Answer 71

ITTOIA 2005 s 33: it must be income, not capital;
s 34: must be incurred wholly and exclusively for the purposes of trade;
must not be a kind prohibited by statute.

Question 72

What does Vodafone Ceullular Ltd v Shaw (1997) tell us?

Answer 72

Whether a payment is income or capital is a matter of law.

Question 73

What did Atherton v British Insulated (1925) say?

Answer 73

Expenditure that generates an asset for the enduring benefit of the trade will be capital.

Question 74

Everything about income/capital

Answer 74

Everything about income/capital

Question 75

‘Exclusively’: What if an item of expenditure is made partly for business purposes and partly for non-business purposes?

Answer 75

It is not exclusively for a business purpose, even if the business purpose is predominant (Mallalieu v Drummond (1983)).

Question 76

‘Exclusively’: what if there is a private advantage achieved incidentally from the expenditure?

Answer 76

The object of the expenditure is distinct, the mere existence of private advantage does not preclude an exclusively business purpose.

Question 77

‘Exclusively’: Is it a subjective or objective test as to what the object of the payment is?

Answer 77

It is the subjective object in the mind of the taxpayer at the time of the payment to ascertain the purpose of the expenditure.

Question 78

What does the case of Prince v Mapp (1969) tell us about the prohibition on dual-purpose expenditure?

Answer 78

Guitar player cut his finger and paid £81 on an operation to restore sufficient dexterity in his finger. But the purpose was not only to make money exploiting his skill, but so he can also practice his hobby. Hence this expenditure was disallowable in computing profits.

Question 79

What happened in the case of Executive Network Ltd v O’Connor (1996)

Answer 79

IT company sponsored equestrian events. But the riding school was owned by the director’s wife and facilitate his children’s participation in such events. The Special Commissioners hence found that ‘personal benefit’ played a part in the decision to make sponsorship payments.

Note Lord Brightman in Mallalieu v Drummond who said that just because there was the effect of a private advantage to the taxpayer, this does not mean there was dual-purpose expenditure.

Question 80

What does ITTOIA 2005 s 34(2) provide?

Answer 80

If the expense is incurred for more than one purpose, a deduction won’t be prohibited if an identifiable part of portion of the expense was incurred wholly and exclusively for the purposes of trade.

Question 81

In Caillebotte v Quinn, what did Templeman J note?

Answer 81

‘It is possible to apportion the use and cost of a room on a time basis, and to allow the expense of the room during the hours in which it is used exclusively for business purposes.’

Question 82

What is the connection between apportionment and arm-length costing?

Answer 82

When apportionment takes place, it seems to work by disallowing any excess above the arms-length cost of the business/commercial cost of the expense, as was done in Copeman v William Flood & Sons Ltd

Question 83

What did the case of Strong and Company of Romsey Ltd v Woodfield (1906) say about the allowance of a deduction only for items of expenditure incurred ‘for the purposes of the trade’?

Answer 83

It is ‘not enough that the disbursement is amde in the course of, or arises out of, or is connected with, the trade or is made out of profits of the trade. It must be made for the purpose of earning the profits.’

Hence, this is something of a high-water mark case.

Question 84

What deductions are restricted or prohibited on deductibility of expenses in calculating the profits of a trade?

Answer 84

s 45-47: business entertainment and gifts

s 35: certain debts

s 36-37: unpaid remuneration to employees

s 55: bribes