Given that trades will often make losses in their early years, one of the most useful tax reliefs for traders as they start up is ‘sideways’ loss relief. If the trader has other income at the same time as carrying on the trade, relief can be claimed against the current or previous year’s income (under ITA 2007, s 64). Alternatively, in the first four years of trading, the loss can be claimed against the income of the three years before the year in which the loss was made (under ITA 2007, s 72).
Relief conditions
However, in order to obtain relief, it is necessary to show that the trade is being carried ‘on a commercial basis’ and with a view to making a profit. These restrictions are imposed by ITA 2007, s 66 in respect of the s 64 relief and (with slightly different wording about the likelihood of making a profit) by ITA 2007, s 74 in respect of the s 72 relief.
So what does the requirement to carry on the trade on a commercial basis mean, and how does it differ from the question of whether a trade is being carried on at all? Several recent tribunal cases have examined this, with Johnson v Revenue and Customs [2016] UKFTT 010 (TC) perhaps being the most illuminating.
Mr Johnson was a naval officer until March 2012. However, he had a long period of leave from the spring of 2010 until January 2011, when he decided he was going to leave the Navy. He hoped to get voluntary redundancy, so did not immediately resign. In September 2011, he was selected for redundancy. He spent six months on a combination of resettlement training and parental leave, so was only in the office for two weeks between then and leaving the service in March 2012.
The Johnsons lived in a house mostly heated by wood-burning stoves and fireplaces. Mr Johnson took away wood as fuel that his neighbours did not want, and went on his first chainsaw course in 2009. In 2010, he decided that this was how he wanted to make a living after leaving the navy, and in October 2010 had some business cards and other promotional items printed. The following month he registered as self-employed with HMRC.
Over the period from then until March 2012, Mr Johnson took a number of courses, both as part of his resettlement training and to improve his chainsaw expertise. He also did a number of jobs for clients at weekends and during annual leave. He did not get paid cash, he took the wood away as payment. He had some expenses, including building log stores and acquiring further tree surgery equipment. His first paid job was in May 2012.
He claimed s 62 loss relief in both 2010/11 and 2011/12. HMRC enquired into the returns and refused the relief on the grounds that he was not carrying on the trade commercially. Mr Johnson took his case to the tribunal in person.
Was it a trade?
Looking at whether there was a trade, the judge considered the well-known ‘badges of a trade’ and concluded that repeated work of cutting and clearing away wood, paid for by the wood itself, was a trade; although Mr Johnson’s calculation of his profit and loss both included disallowable capital expenditure on the construction of the log stores and failed to bring in the value of the wood as income.
The trade started when he had got past the stage of considering what to do and had put himself in a position to deal with his customers by buying the tools he needed and by acquiring and distributing business cards. He therefore started the trade in November 2010.
Was the trade commercial?
However, this was not enough to make the trade commercial. The tribunal felt that in 2010/11 he had a hobby that had become more serious, but that there was no clear prospect at that time of either:
a) the value of the wood he took in the short term being worth more than the expenditure he would incur; or
b) the value of the wood and the cash receipts in the long term being worth more than the expenditure he would incur over that longer period.
In 2011/12, Mr Johnson bought a Land Rover for his business, which indicated that he thought it was going to be profitable. However, the tribunal needed to consider whether it was objectively likely to be profitable. He did not want to work full time, which did not stop it being commercial but did limit the likely income. On the other hand, he was going about his business in an organised way, still getting work in exchange for the wood, and looking for paid work. This was operating on a commercial basis, the tribunal said: ‘because it was reasonable to expect Mr Johnson to make profits in later years and overall to expect the aggregate income over a period of say three to five years from the beginning of 2011/12 to exceed the expenses.’
He therefore got sideways loss relief for the 2011/12 losses, albeit after the calculation was amended. To summarise the tribunal’s view on commerciality, it seems to be that a trade is being carried on commercially when, either in the short or the medium term, income can realistically be expected to exceed expenditure.
Not commercial
This case can usefully be contrasted with that of Anthony & Anor (Re T J Charters) v Revenue and Customs [2016] UKFTT 009. Here, the taxpayers had bought a boat called Lady Louise in May 2008 for just over half a million pounds. Their claim was that they intended to make an income from it by chartering. However, there was a delay in getting the boat registered after purchase as they went on holiday just after delivery, with the result that they missed the 2008 summer chartering season.
They had prepared a business plan showing that income from chartering should be approximately £50,000 and expenses around £40,000. However, neither the number of days for which the boat was chartered nor the price ever matched the business plan, and the expenses were significantly higher, particularly because they included between £15,000 and £30,000 a year for motoring expenses that had not been shown on the business plan. The accounting losses for three years totalled almost £100,000. The taxpayers claimed these against other income, but HMRC refused them.
One of the key issues discussed by the tribunal was whether the trade was carried on commercially. The taxpayers’ argument was that it would have been successful had it not been for the financial crash brought on by the collapse of Lehman Brothers, which significantly reduced the demand for corporate charters, coupled with poor weather in 2009. HMRC essayed a strange macro-economic argument against this, that quantitative easing had actually made rich people richer, which the tribunal judge had no trouble in rejecting. HMRC were on firmer ground in arguing that the business plan was unrealistic from the outset, and that the taxpayers had shown no serious attempt at planning or any significant marketing of the boat.
The judge agreed. He said that a commercial trade did not have to be one that would support the proprietors, but that the introduction of significant motoring expenses, not included in the business plan, did show that it was not being carried on commercially. It was useful to approach the definition of commercial as being the opposite of uncommercial, and the financial crash was too vague an explanation of a very substantial difference between the anticipated and actual takings. The level of planning undertaken for what was a half-million-pound investment showed a lack of serious research. He therefore disallowed the losses.
Practical Tip:
So, to be commercial a business must be objectively likely to make some profit, and it should be approached in a serious and business-like manner. The level of planning required for a business needing little capital outlay is probably less than that for one where the investment is substantial, and where a rigorously researched business plan would be expected.
