#2409 - Business Tax Problem Question - Tax Law

To calculate A’s tax liability, we must determine what tax statutes apply to him: applying the “control” over the person test present in Ready Mixed Concrete v. MPNI and other indicators such as “who bears the risk of loss in a business” present in Addison v. London Philharmonic, [NOT REALLY NECESSARY HERE, HE’S CLEARLY TRADING, RUNNING A RESTAURNT] John, as he is described as the “sole proprietor” is self-employed for the purposes of his tax assessment. This matters because the tests for deductions and income assessment will be governed by ITTOIA 2005.

As a necessary preliminary, it is necessary to establish that John is engaged in a trade, profession or vocation. This is necessary for calculating whether J has income tax liability as ITTOIA 2005, Part 2, s.5 stipulates that “income tax is charged on the profits of a trade, profession or vocation”. [THIS IS FINE, BUT NO NEED TO FURTHER DISCUSS]

The definition of “trade” is not precise: in the Tax Acts and the Taxes Management Act 1970 s118(1), 'trade' includes every trade, manufacture, adventure or concern in the nature of trade. This is definition contains the word it attempts to define: however, it is clear that while it is not essential that there should be a regular business of buying and selling (Barry v Cordy (Inspector of Taxes) [1946]), if there is, a trade will be presumed, (as per Lord Wilberforce in Ransom v Higgs: “trade normally involves the exchange of goods or services for a reward”). In disputed cases, determining whether an activity is a trade is done on the basis of the “badges of trade”¹: these provide guidance as to whether the activity is a trade, though no one test is decisive: they are: (1) the subject matter; (2) the length of the period of ownership; (3) the frequency of similar transactions by the same person; (4) supplementary work on the property realised; (5) the circumstances giving rise to the realisation; (6) motive. [THE BADGES ARE NOT RELEVANT IN RELATION TO HIS RESTAURANT, ONLY FOR THE LAND]

Applying this to J’s activities, the operation of a restaurant will be considered trade: not only is having paying customers, and thus trading, the very purpose of a restaurant (confirming the motive of J’s activity as sole proprietor of the restaurant), there is much evidence in the text of customers regularly engaging his services, “Cynthia, a regular customer” and “restaurant’s long-standing contract to provide catering”. The personal income J receives and the profits from the restaurant are taxable.

J is not solely engaged in running the restaurant: he also purchased land. We must determine whether this is trade, and the profits are taxable.

There is nothing to stop a company engaging, and therefore being taxable for, 2 different trades, as held in Scales (Inspector of Taxes) v George Thompson & Co Ltd . Here, the potential trades are property buying and running a restaurant. However, this presupposes J’s property buying is a trade:.

We must use the “badges of trade” to determine whether the property sale is trade.

1. Property that neither yields an income nor gives personal enjoyment is more likely to form the subject matter of trade. Applying this test to J’s situation does not give a clear result: obviously, the empty plots of land did not generate an income, and it is highly unlikely they gave J personal enjoyment, which makes it look like the sale of them was potentially trading, however, the fact that J intended to extend his restaurant, rather than selling it for a profit, and it was pure happenstance that he sold them on make the subject matter of the realisation look more like an investment than trading.

2. A quick sale is likely to indicate trading rather than investment. J only held the property for 7 months (maximum) which would indicate a quick sale; however the special reason for the sale (his inability to secure funds for the extension) rebuts this presumption of trade.

3. Repeated transactions in the same subject matter point to a trade. J has “dealt in land in the past” which would indicate that he is trading in land. However, it is unhelpful to consider the badges of trade separately, when J’s motivation (6) might indicate this is not trade. If J’s motivation for dealing in land in the past was to realise a profit i.e. buying and selling houses (playing the property market), this motivation is different from buying the plots now, where his motivation was to extend his restaurant on to them. As such, the fact that he has deal in land in the past may point to trade then and not now, by looking at his motivation for both sequences of activity.

4. An investment will normally be held passively by the person concerned either while he receives the income or until he can realise a capital gain from selling it. J procured planning permission for one of the plots, which may indicate but did nothing to the other: it was held in Taylor v Godd that the mere enhancement of value, as y obtain planning permission is not sufficient to create a trade: as such this test does not indicate J’s purchase of the plots was trade. [A GOOD POINT]

5. The circumstances of the sale of the plots is not made explicit in the text, however it does not seem that there was any emergency calling for such a sale to be made. [POSSIBLY HIS PLANS FOLLOWING THROUGH FOR LACK OF FINANCING] However, this does not prevent a conclusion that the sale was not trade, as all the tests must be looked at together. Motive (6) has already been addressed with frequency (3) above.

Applying these “badges of trade”, the sale of the land is unlikely to be trading, therefore the profit for one plot, yet overall loss when combining the 2, is not taxable, or in the case of the loss, deductable. [AS YOU NOTE BELOW THE SECOND PLOT IS LESS CLEAR. IN FACT HE MAY NOT BE TRADING IN IT AT ALL. MORE GENERALLY, YOU MADE VERY GOOD USE OF THE FACTS IN YOUR ARGUMENT AND THE BADGES BUT IT IS IMPORTANT TO DISCUSS MORE OF THE CASES IN A BADGES ISSUE, AND DRAW ANALOGIES TO THE FACTS AT ISSUE HERE – CASES OF PARTICULARL RELEVANCE WOULD BE MARSON V MORTON AND KIRKHAM V WILLIAMS]

We must compute his taxable profits from his trade.

The profits of a trade must be calculated in accordance with generally accepted accounting practice, subject to any adjustment required or authorised by law in calculating profits for income tax purposes (S.25(1) ITTOIA). We must determine what the net profit for J is, in order to determine his tax liability: net profit must therefore be calculated so as to add all trading receipts and income receipts together before deducting allowance expenses. [GOOD, PERSONALLY I’D START WITH THIS AND LEAVE THE BADGES TO THE END BECAUSE FROM A TIME MANAGEMENT POINT OF VIEW YOU CAN SAY A LOT ON BADGES IF YOU HAVE TIME, REALLY SHOW OFF YOUR KNOWLEDGE OF THE CASES, AND IF YOU DON’T HAVE TIME YOU CAN CUT TO THE CHASE WITH JUST THE KEY CASES. BUT IT’S NOT A BIG DEAL]

There are 4 payments J receives that might be trading receipts: 1) the payment for Cynthia’s party 2) the additional cheque for 250 from Cynthia 3) the cancellation fee from the local college 4) The payment for Christmas party held at the restaurant in 2009, booked one year in advance, deposit was paid on booking and then set against the final bill

To be a trading receipt, the sum must fulfil 2 requirements:

1) the sum must be derived from trade and not made voluntarily “in recognition of some personal quality” of the recipient, as held in Murray v Goodhews, where payments were made to acknowledge a good relationship and maintain a good name. [GOOD]

2) the sum must be income not capital, (s.96(1) ITTOIA) The traditional test for this is distinguishing between the fixed capital of a business and its circulating capital: the analogy used by Lee to explain the complex terminology is the fruit tree – the tree is the capital producing the fruit which is income.

1) Payment for wedding party: this payment is “in return for services” as the service provided was the organisation of the Christmas party. Payment for this therefore is a trading receipt. [GOOD]

2) the additional cheque: this was made ‘with gratitude’, however, just because it was voluntary does not preclude it from being a trading receipt, as shown by IRC v Falkirk Ice Rink, where the donation from a curling group to save the ice rink from closure was held to be taxable [AND POSSIBLY HERE A SIMILAR TOP-UP TYPE PAYEENT AS IN FALKIRK GIVEN THE ‘ADVANTAGEOUS PRICE’]. Therefore we must determine whether it was for personal qualities or service: arguably, the letter thanking John for his efforts which went ‘beyond the call of duty’ indicates the 250 payment was made on the basis of a personal quality: if the first cheque was a reward for services, this second cheque might be considered for personal qualities since the behaviour which gave rise to an extra payment was not within the bounds of what was required of John. However, if this was the case, a pleasant waitress² who received a tip on that basis might claim she was entitled to this tax-free as she was going beyond what her job required her to do i.e. clear plates. However, J was paid for being exceptionally good at providing his services, not for personal qualities irrelevant to his success as a restaurant owner. As such, it is likely (and fair) that such a payment should be considered a trading receipt and therefore add to his tax liability.

3) The cancellation fee: whether this is a trading receipt depends on the significance of the cancelled contract to the business, as held in Van den Berghs Ltd v Clark, where the cancelled...