Taxation Framework in The Trade System

Corporation tax is calculated on both a high and low rate of tax currently the high rate is 25% this is applicable to non-trading profits such as investment and rental income. The low is currently 12.5% for trading income. Because of the differences between income and capital gains tax along with both high and low rate of Corporation tax, determining whether a trade is being carried out is essential. To establish whether a trade is being conducted is crucial as it will determine the tax liability for the liable person and tax take for the government.

To ascertain if a trade is being conducted there are 6 badges of trade that can be assessed to decide whether an activity constitutes a trade, also a large body of law exists on this subject which can be used as precedence, in the absence of a trade been carried out the profit from that activity will not be liable to income tax but would fall under the remit of capital gains tax with the current rate of 33% been applicable. “Given the fact that trading income is liable to income tax at marginal rates of 60%(including PRSI, USC, and additional 5% USC if claiming certain property reliefs) while capital gains tax is payable at 33% the distinction is very important” (Irish Tax Institute, 2017/2018)

Taxation has been in existence for quite some time, from “private” which dates from 1177 in Ireland which was levied on ships importing wine where a levy of one-ninth of said wine was retained for the Kings use, there was after all many formal engagements that needed refreshment and libation, in ancient Rome for example records were kept of each citizens property and a wealth tax known as a “tribute” was levied on each citizen in respect of properties owned, this echoes a similar if very unwelcome tax currently levied on Irish households the LPT local property tax were the Romans forward thinking or our government regressive an argument for another day.

Our taxation framework has evolved and progressed in complexity and base in the intervening years. Prior to 1975 companies were subject to income tax and corporation profit tax on income and capital gains tax on their gains. 1976 saw the introduction a single tax on companies introduced which included both income and chargeable gains. These new provisions were provided for in the Corporation Tax act of 1976 which made the necessary amendments to the legislation.

This framework is based on common law and previous case law which gives precedent, cases heard in the Irish court system and the decisions of those cases from binding presidents which must be followed in all subsequent cases. Our current tax regime for 2017/2018 is as follows Income Tax – up to 40% plus PRSI and USC on an individual’s trading income. Capital Gains Tax – 33% on gains from disposal of other assets. Capital Gains for Companies – also 33%. Corporation tax 25% on investment income in a company. Corporation tax 12.5% on trading income in a company. “Companies normally include capital gains in their profits for Corporation Tax (CT) purposes.

However, when a company makes a capital gain from selling or transferring development land, it must pay CGT rather than CT on the gain.” “In order to ascertain whether or not, in any situation, a trade is being carried on is determined by an examination of the facts of the particular case and by interpreting those facts in the context of the badges of trade and of case law in so far as it applies”. The Six Badges of Trade. “Tax is charged under schedule D case I and II on the full amount of the profits or gains of traders and professionals respectively. Section 3 TCA97 defines the act as follows “trade includes every trade, manufacture adventure or concern in the nature of trade”.

A Royal Commission was set up in 1954 to establish the factors to be considered that would indicate whether a trade has been carried out or not. These factors became known as the “Badges of Trade”. These badges of trade are stated in the report of the Royal Commission as follows:

1. The Subject matter The nature of the asset, commodities and manufactured products are rarely bought as investments, if we take the example of a market trader that buys produce from a wholesale supplier to sell on at a profit such as buying 300 pears with the intention sell them later in the day is not investing in pears but trading in them. Antiques, classic cars, gold coins and rare wines would be classed as investments and not considered a trade.
2. Length of period of ownership A quick purchase and sale of an item or goods after acquiring them is a good indicator that a trade is taking place. For example, as above the market trader will not want to hold his produce for a long period as it would spoil becoming worthless. Items bought as investments are usually helpful for a period of a few years for it to appreciate. It would be very easy to justify an item you had in your possession for a considerable period that you bought for personal use and enjoyment that you dispose of would not be treated as trading profit for example a classic car that you have owned for 15 years that you dispose of would not constitute a trade is a ben conducted.
3. Frequency or number of transactions by the same person. If a transaction is conducted as a one-off or very infrequently it would not be classified as a trade, for example, changing your car every 4 years where you sell your current vehicle and purchase a new one this cycle would be repeated every 4 years. In the instance of the market trader, he would buy a large volume of produce from the wholesaler on a frequent basis weekly or bi-weekly and sell those for a profit over many transactions this would constitute a trade.
4. Supplementary work on the product. In normal circumstances, if you buy something and sell it on without doing anything to it, it would be unlikely you were trading, the market trader although does not change the product physically he arranges it on his stall where it will be visible to all potential purchasers. If you purchased a car and you replaced a defective engine got it to spray painted fitted new tires etc to make it more attractive to purchase it could be possibly construed that you were considered to be trading.
5. Circumstances responsible for the realization. The sale of an asset to raise cash in the circumstances of an emergency such as a hospital bill or to assist with your child’s college fees or other unplanned expense would not be considered a trading venture but an emergency sale of an investment. Likewise, if you received an inheritance of property that you did not want or need and subsequently sold the property via a classified advert, this would not be classed as a trade as you did not purposely go out and buy said property with the intention of selling it on for profit if that was indeed the case the badge of trading would apply. Realising an inheritance for cash is not the commencement of trade.
6. Motive. Motive as to the reason the transaction has taken place will identify if a trade or otherwise is taking place. The market trader who purchases goods from the wholesaler with the intent of selling them on in a short space of time to realise a profit in order to make a living would clearly be engaged in trade, however if he purchased an antique with the intention of keeping it for personal enjoyment it would be seen as an investment.

The above badges have been debated extensively and as such have the subject or court hearings, over the past number of years many cases have been heard and the resulting decisions have set precedent and are binding, most cases will refer to previous case law in determining if the trade is being conducted or not. It is important to not to rely on the badges of trade exclusively as there are many complexities and instances in today’s business environment the bigger picture and a degree of practicality should also be considered. No single test is decisive in establishing a trade. In the case of Marson V Morton (1986) 59 TC 381, the judge reviewed the badges of trade and broadened them by identifying the following questions.

• Has the taxpayer undertaken similar transactions?
• Is the transaction related to the taxpayer’s trade?
• How is it financed?
• Was the item normally the subject of trading?
• Was the transaction type of the trade in an item of that nature?
• Was work carried out on the item for the purpose of resale?
• Was it sold as bought or broken down into lots?
• Was enjoyment, the pride of possession or income derived from it?
• What was the taxpayer’s intention when the item was purchased?

The above is in no sense a comprehensive list of all relevant matters nor is any one of them decisive in all cases. They provide guidance to reach an appropriate conclusion. The following case law provides precedence and guidance for what does and does not constitute a trade. The Marson v Morton case which tested the difference between capital and trading profits the case involved the purchase of a plot of land which had planning permission, the intention was to keep the land as an investment, there was no income generated by the land, after some time through an unsolicited offer the land was sold, the transaction was far removed from the taxpayer’s normal activity he been a potato farmer, the purchase was deemed to be an investment so the sale was not a trading profit, the transaction was deemed not to be an adventure in trade.

In Erichsen V Last 4 TC, Lord Justice cotton defined trading as follows “where a person habitually does and contracts to do a thing capable of producing a profit, and for the purpose of producing a profit, he carries on a trade or business” The case concerned The Great Northern Telegraph Company of Copenhagen who was not resident in the United Kingdom Eischen was the company’s representative in England.

The company had 3 cables running across the North Sea to Scotland and had a number of staff there also. Messages were collected by agreement with the Postmaster General who deducted their agreed commission who then gave the messages to the company’s operators who in turn sent the messages across the North Sea to their destination. The company made a claim it was not trading in the United Kingdom as their cables were not wholly located in the United Kingdom or the company itself. The Judgment in the court of appeal made clear the matter was wholly one of fact. The decision was “The profit comes from the contract, the contract is here and there is trading in England and it is nonetheless trading in England even though the goods come from abroad or the service is provided through electric cables which are partly abroad.

All of the profits from the contract made in the UK are chargeable profits in the UK’. (GOV.UK, 2018) The case of Martin V Lowry 11 TC 422 an agricultural merchant who never had any involvement with the linen trade purchased surplus stock of airplane linen from the UK government, he had never traded inlined or conducted similar frequent transactions as per the badges of trade. He did however after failing to sell the linen in one lot conduct an advertising campaign, hired staff and rented offices to sell the linen to the public, it was held that the profit arising from the sale arose through trade.

Judges referred repeatedly to the mantle of trading, it was argued that supplementary work on the product such as the elaborate selling efforts employing staff and offices as well as adverting constituted trade activities. The well-known case of Rutledge V the Commissioners for Inland Revenue (Profit-seeking Motive) where a businessman on a trip in Germany he purchased one million toilet rolls, he subsequently sold the toilet rolls to one individual in a single transaction on returning to the UK for a substantial profit.

The profit made on this large single quantity and resale was deemed to be an adventure in the nature of trade, it was based on the fact that the purchase was not made as an investment or at such a large quantity would justify personal use. Wisdom V Chamberlain 45 TC 93, involved the purchase of silver bullion to hedge against devaluation. The court's decision was based that it was a transaction entered into on a short-term basis for the purpose of making a profit. It constituted an adventure in the nature of trade. “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 a natural in trade I do not really know what is. The whole object of the transaction was to make a profit”.