Are you pursuing a trade or following a hobby?

Are you pursuing a hobby or carrying out a trade? In some circumstances, it can be hard to define, so we’ve explained the ‘badges of trade’ used by HMRC.

Many of us have hobbies dear to our hearts, whether playing guitar, building a giant model train system or knitting copious numbers of jumpers for our family.

In many cases, it’s pretty clear whether these activities are being carried out in the course of a trade or are nothing more than a personal hobby. However, disputes with HM Revenue & Customs (HMRC) do arise. Are the profitable activities you carry out as part of your niche interest no more than a hobby? Or are the loss-making activities considered a trade, with the losses used to reduce your overall tax bill?

Let’s look at how you prove if this is simply a hobby or a profit-making trade.

The nine ‘badges of trade’ and what they tell you

There’s not much meaningful guidance in the UK legal statute on what does and does not constitute a trade or hobby. So, how do you make the differentiation?

One approach has been to consider the badges of trade. These badges can show the presence or absence of certain aspects that indicate whether a trade exists.

These nine badges are:

• Profit-seeking motive: An intention to make a profit supports trading, but by itself is not conclusive.

• Number of transactions: Systematic and repeated transactions will support ‘trade’.

• The nature of any asset acquired: Is the asset of such a type or amount that it can only be turned to advantage by a sale? Or did it yield an income or give ‘pride of possession’, for example, a picture for personal enjoyment?

• Existence of similar transactions: Transactions similar to those of an existing trade may themselves be trading.

• Changes to the asset: Was the asset repaired, modified or improved to make it more easily saleable or at a greater profit?

• How the sale was carried out: Was the asset sold in a way typical of trading organisations? Alternatively, did it have to be sold to raise cash for an emergency?

• The source of finance: Was money borrowed to buy the asset? Could the funds only be repaid by selling the asset?

• The interval between purchase and sale: Assets that are the subject of trade will normally, but not always, be sold quickly. Therefore, an intention to resell an asset shortly after purchase will support trading. However, an asset which is to be held indefinitely, is much less likely to be a subject of trade.

• Method of acquisition: An asset acquired by inheritance or as a gift is less likely to be the subject of trade.

These badges are not an ‘all or nothing’ indicator. However, when considered in the round, they may lead to an overall impression of whether or not a trade is being carried out.

Even if it is agreed that a trade exists, HMRC may argue that it’s not being carried out commercially. If so, this would deny any sideways loss relief (offsetting the losses of one activity against the profits of another for tax purposes).

Talk to us about checking the status of your hobby or trade.

With the new trading allowance of £1,000 per annum, any activities that generate income below £1,000 won’t be required to be reported on your tax return. Because of this, there’s no danger of minor income from hobbies being targeted as trading activities.

The emerging problem is in areas such as crypto assets and day-trading shares. Depending on the specific circumstances, these can be considered trading, generating capital gains and losses, or being outside of taxation altogether.

Where you carry out any activities outside of your mainstream business, talk to us so that we can advise you of any potential tax traps and tax benefits that may arise.

Get in touch to talk through your non-business activities.