In Akhtar Ali v HMRC [2016] UKFTT 8 (TC), the First-tier Tribunal (FTT), in allowing the taxpayer's appeal, has provided some helpful guidance on the factors to be taken into consideration when deciding whether activities comprise a trade which is commercial, for the purposes of section 66, Income Tax Act 2007 (ITA).

Background

Mr Ali, the taxpayer, was a pharmacist who ran a successful pharmaceutical business. Since the 1990s he had been buying and selling publicly listed shares, in addition to his pharmacy business. However, from 2005, he decided to become a 'day trader' and bought and sold shares on a commercial basis with a view to a profit. He employed locums at the pharmacy in order to free up his time to enable him to engage in share trading. He spent most of his time trading in an upstairs office in the same building as his pharmacy.

In the period 2006 to 2013, the taxpayer continued his share activities, despite making overall losses each year. Notwithstanding these losses, he believed his skills were improving and that he would begin to generate profits from his share trading activities. The taxpayer funded his share trading business from the profits generated from his pharmaceutical business. This enabled him to  sustain the losses incurred from his share trading in the relevant years in question.

For tax years up to 2004/05, the taxpayer's returns dealt with the profits or losses from his share activities under the capital gains tax rules. However, from 2005/06 onwards he treated his share activities as a separate trade, and losses were claimed in that and succeeding years.

The taxpayer considered that his share activities comprised the carrying on of a trade and that the trade was commercial under section 66, ITA. He argued that his share activities satisfied the 'badges of trade' due to the high frequency of his transactions in short periods and the amount of time and effort he expended in gaining knowledge and experience of trading. Accordingly, the losses stemming from the share activities could be set against the profits of the pharmacy business.

HMRC disallowed the losses generated by the share activities in the period 2006 to 2013, on the basis that the share activities were no more than speculative investment over a prolonged period and should not therefore be treated as trading. HMRC imposed 'inaccuracy' penalties at a rate of 10%, under section 8, Taxes Management Act 1970, on the basis that the taxpayer had been negligent and failed to take reasonable care to ensure his returns were correct.

The taxpayer appealed to the FTT.

The FTT's decision

The taxpayer's appeal was allowed.

The FTT's starting point was that the taxpayer's activities bore the classic hallmarks of 'trading'. Over an extended period of time, he bought assets, in the form of shares (his stock), with the intention of selling them on at a profit. This was further supported by applying the 'badges of trade' (as referred to in the report of the Royal Commission on the Taxation of Profits and Income (Cmd 9474)). In the view of the FTT, four of the badges: the length of period of ownership, the frequency or number of similar transactions by the same person, the circumstances that were responsible for the realisation, and motive, pointed firmly in favour of trading. Although the other two badges: subject matter of the realisation and the supplementary work on, or in connection with the property realised, pointed in the other direction, on balance, the FTT concluded that the taxpayer's share dealing activities constituted trading.

The FTT noted that the courts are wary of awarding 'trading' status to an individual speculating in shares, as the activity can look like trading, but yet not constitute a trade because it really consists of gambling transactions. In the present case, it was evident that the taxpayer was not gambling, as his activities were not impelled by addiction or habit. In reaching this conclusion, the FTT considered a number of factors, including the following:

Organisation

Although the activities were carried out on an 'informal' basis, the FTT considered that external physical equipment required for such activity is minimal, particularly in the age of the internet. A trader needs to "organise his efforts" (as discussed by Rowlatt J in Graham v Green [1925] 9 TC 309). The FTT concluded that the taxpayer did have a sufficient degree of internal organisation.

Lack of formal qualifications and the division of time between different activities

With regard to the taxpayer's share activities, the FTT observed that he was operating in a field that did not require any professional qualification, where relevant information was readily accessible. In the light of this, it considered that the taxpayer could (and did) amass sufficient knowledge and ability, through his experience and research, to develop a business plan. The FTT commented that it is not uncommon for self-made business entrepreneurs to be "self-taught" and confident of their abilities. 

Funding

The taxpayer was self-funded. The fact that he was able to fund his share activities himself was an indicator that the activity may be non-trading, however, in the FTT's view, activities which are constitute trading will be so, whether those activities are funded by third parties or self-funded.

In the light of the above, the FTT concluded that the taxpayer's activities did not constitute gambling transactions and that he was carrying on a trade in undertaking his share activities in the tax years in question.

The next question for the FTT to consider was whether the trade was commercial for the purposes of section 66 ITA. HMRC's position was that given the long time period over which losses had been sustained, the taxpayer's share activities were not carried out on a commercial basis. Applying the guidance provided by Walker J in Wannell v Rothwell [1996] 68 TC 719, the FTT concluded that whilst the taxpayer's business plan was unsophisticated, it was nonetheless commercial. Transactions took place at market prices and a business plan was implemented. The fact the taxpayer was self-taught and undertook considerable risk did not cause his trade to be uncommercial as these are indicia of the risk-taking entrepreneur, rather than uncommercial activity. In addition, the trade was carried on with a view to making profit. The fact the taxpayer was willing to persevere through year after year of incurring losses confirmed that he continued to believe his profit-making strategy would prove successful. In the light of this, the FTT concluded that both limbs of section 66(2) ITA were satisfied and his trade was commercial for the purposes of section 66 ITA for each of the tax years in question.

Comment

The courts tend to be wary of awarding trading status to individuals speculating in shares or gambling transactions. The decisive factor in this case appears to have been the FTT's finding that the taxpayer had a business plan (unsophisticated as it was) and had pursued it in a sufficiently organised manner to rebut the presumption that individuals engaging in share speculation are not trading. Had there been no business plan, or had such a plan not been followed, the taxpayer's appeal may not have succeeded.

For the full judgment click here.