Olympic Torches, Taxation and more

I have recently set up a separate blog at taxationpodcastmusings.wordpress.com and intended to record some slightly lighter-hearted points there – I recently added one concerning Olympic Torches and their taxability – but on reflection this raises one of those perennial subjects in taxation – whether an activity is or is not a trade.

Firstly lets remind ourselves about the Torch Story…

8,000 people are taking part in the flame relay, some are celebrities, some connected with olympic sponsors but many ordinary people chosen though schemes like that established by Lloyds Bank.

After their part of the relay the person selected can keep the torch and tracksuit on making a payment of £215 which is roughly half, so we are told, the actual cost of the torches themselves.  Now some will keep the torch as a souvenir but many have already found their way onto the online auction sites.

HMRC decided to get in the act by issuing a press notice pointing out that the torch is a chattel – tangible moveable property – the significance of this being that if sold for more than £6,000 a capital gains tax liability might arise.  They also pointed out that online traders and others might have an income tax liability even if sold for less than the chattel exemption.

An argument which HMRC do not explore is that if the torch could be said to be machinery then it would be deemed to be a wasting asset and so would be exempt, unless used in a business, regardless of what it was sold for.  The torch does convert gas into a flame thereby providing illumination which should satisfy at least some definitions of what a machine is.

At the moment there doesn’t seem to be much chance of a CGT liability as the market price on eBay seems to be about £3,000 although some vendors are holding out for more!

A number of people have raised a question though – is it possible that a person who buys their own torch because they immediately plan to sell it on is trading and so would be chargeable to income tax on the profit?  Trading as a concept in tax law includes not only the obvious act of regularly buying and selling goods but also can be a one-off transaction, or ‘an adventure in the nature of trade’.  Lawyers look at what are called the ‘badges of trade’ in trying to decide whether such a liability is likely to exist – these are concepts derived from many taxation cases that have been considered in the past – one problem is that they often refer to circumstances that arose many years ago.

One case that is often advanced by HMRC in arguing that an ‘adventure in the nature of trade’ has been conducted in the Rutledge case.  This case, heard in the 1930’s, concerned a man who supposedly bought and then resold 1 million toilet rolls, the courts concluding that this was an adventure in the nature of trade as the subject matter of the transaction was such that a purchase and resale of household goods, unless surplus to personal requirements, could only be explained as an ‘adventure in the nature of trade’.  There is a suggestion that the toilet rolls never existed, that they were a convenient fiction to conceal the real, and illegal, nature of the goods that were being traded in!

A Royal Commission looked at the nature of trading some 40 years ago but even their conclusions – the so called badges of trade, have been expanded and altered over the years.  One problem was applying them to new types of transactions – for example – property development, in the UK before the second world war this was normally a process of expansion as cities grew and developers bought farming land and constructed suburban housing estates – usually clearly trading.

With the advent of the second world war large parts of our inner cities were destroyed and needed post-war rebuilding, but when this process had been largely completed developers didn’t go back to expanding the suburbs, planning laws and the green belt movement ruled this out.  Instead they looked to acquire city centre sites, assembling a larger site from many smaller ones and REdeveloped – often changing the use of the land from residential to commercial and making substantial fortunes in the process.  Harry Hyams who developed the Centre Point Tower in Central London specialised in keeping property empty on the grounds that that building value was a function of rental yield and future rental values would be make the building worth more empty than immediately selling the building on – was this trading?

In the 1970’s and 1980’s the courts considered this problem in the cases of Taylor v Good and Marson v Morton.

Taylor v Good in 1974 concerned a greengrocer who purchased a large landed estate at auction in 1959 before post-war building controls were removed – he had grown up in the house as his parents were servants on the estate – he then, claiming that he wanted to occupy the property as his residence, applied for and obtained planning permission to convert the estate into 93 individual dwelling units.  Before carrying out this programme he sold the property to an established developer for a very substantial sum as the restrictions had then been lifted.   The courts applied the traditional badges and concluded that his motive had been to live in the property until he received an offer he couldn’t refuse – if he formed an intention to trade it was when the offer was received and this would cause the special rule on appropriation to be invoked.  If you acquire an asset for a non-trading purpose and then decide to bring it into a trade it is ‘appropriated’ at it’s current market value not the original cost, this would be a deemed disposal for CGT purposes and probably the greatest part of the increase in value would have been taxed as a gain.

The courts were looking at a type of transaction that was quite new and the existing badges could be made to fit, but only with a struggle.  Marson v Morton in 1986 concerned four brothers who bought a plot of land on the advice of a property developer – they were told “it would be a good thing” and sold it three months later. After repaying the overdraft they used to finance they acquisition they had doubled their money in this short period of time.  One of them admitted that they purchased the land as a ‘speculation’ although another claimed that they intended to keep it as an investment – even though it would not produce any income and could only generate a profit by sale and it was financed by short-term borrowing.

The court in this case decided to restate the ‘badges of trade’ to make them relevant to property transactions of this type and added factors such as the method of financing, and previous expertise in a particular type of transaction.  Notwithstanding this the commissioners found as a fact that the land was bought as an investment and the High Court found that they could not disturb this finding, the speculation was not an adventure in the way of trade.

A runner in the torch relay, particularly if a sponsored one, did not acquire the torch as an adventure in the nature of trade and if they formed an opinion that they did wish to sell it even this would probably not be an adventure in the nature of trade.  Even if it were the torch would be appropriated at current market value, presumably close to what it was eventually sold for.  Of course if a trader purchased a torch from a participant and then sold it on that would almost certainly be a trading transaction, but they would pay a lot more than £215 to acquire the torch – one would hope!

But this question, whether a trade is being carried on or not, can be relevant in other areas – consider a case earlier this year concerning a tax-avoidance scheme based upon film exploitation – Eclipse Film Partners LLP no 35 v HMRC.  The idea behind the scheme was that a syndicate of investors would borrow a substantial sum of money by way of loan and that these funds were to be used to acquire, for a very short period, the rights to distribute two films made by the Disney Corporation.  The rights would then be sold back again although if the films were very, very successful further profits might accrue.  The two films were called Enchanted and Underdog.

On 3 April 2007 the rights to the films were acquired for sums close to £790 million and then leased back again to Disney for £784 million.  The members had injected £50 million into the scheme but the bulk of the finance was provided by those diamond bankers – Barclays – on loan terms which would be repaid out of the proceeds, no member would be liable to pay any part of the loan back. As part of the agreement a substantial sum of interest was “prepaid” with the intention that the film partnership members should obtain interest relief to offset against their income for 2006/07 – in effect the £50 million they injected was to be turned into a tax deduction worth substantially more – but this could only work if the partnership was trading in the year in which the interest was paid in advance.  The Tribunal held that this was not an ‘adventure in the nature of trade’, merely a speculative investment and as a result the participants did not benefit from the interest relief they thought they could claim.  It was a business, but a ‘non-trade’ business.

So whether a trade is being carried on can be seen to be a quite complex issue – we don’t have time to examine each of the many badges of trade individually, but sometimes whether a trade is being carried on can lead to arguments not dissimilar to those of the middle ages when theologians would discuss the number of angels that could dance on the head of a pin!

A taxpayer might buy an asset, whether it is an Olympic Torch, a plot of land, a million toilet rolls or a commercial film and imagine on sale they have made a capital gain, in which case their CGT liability would be a maximum of 28% – it would be a nasty shock if HMRC successfully contend that it was an adventure in the nature of trade and they have an income tax and NIC liability at a rate which could be 52% or even higher!