In Gray v HMRC1, the First-tier Tribunal (FTT) has held that a taxpayer conducting promotional activities for his musician wife was not entitled to set losses from those activities against profits from his legal business.
Although those activities were sufficiently organised to constitute a trade, they were insufficiently planned or organised to be viewed as being conducted on a commercial basis or with a view to realising profits.
If a person accrues a trade loss for income tax purposes in a tax year, he can make a claim for the loss to be deducted from his net income for that tax year or the previous year. Furthermore, an individual who accrues a trade loss in any of the first four years of trading may make a claim for the loss to be deducted from net income for the three tax years preceding that in which the loss arises. The use of such losses in this way is known as “sideways relief”.
In order for sideways relief to be available the following two conditions must be satisfied:
- the loss must arise from a “trade” and
- the trade must be “commercial”, meaning that it is carried on throughout the relevant period on a commercial basis and with a view to realising profits (section 66(1) and (2), Income Tax Act 2007).
The taxpayer, a UK resident lawyer specialising in international tax law, was married to a well-regarded concert pianist. Before 2010, he had tried to help his wife with her career by sponsoring and underwriting her concerts and musical recordings. By the end of 2010, he had decided to enter into a separate business of promoting his wife and approached an agent with a view to the agent representing his wife. The agent declined the invitation and the taxpayer agreed to engage the agent as a paid consultant, paying the agent a monthly fee. The taxpayer was to provide marketing materials and spent a large amount of his free time on promotional activities, but he was of the view that the consultancy arrangement was needed due to the industry being something of a ‘closed shop’ and the agent had the necessary contacts within the industry.
The taxpayer agreed orally with his wife that he would retain any money generated until he had recouped his outlay, from which point they would divide the income from her activities equally. In giving evidence before the FTT, the taxpayer said that he had expected to at least break even after the first year and to make a profit in the second year. However, the volume and cost of the required marketing materials spiralled.
The taxpayer acknowledged that his motivation was not only profit he also wished to support his wife.
The taxpayer did not separate out the earnings and expenses from his legal practice and those from his promotional activities in his tax return. HMRC denied his claim for relief for the losses he had incurred from his promotional activities on the basis that those activities did not constitute a trade conducted on a commercial basis with a view to realising profits. Accordingly, sideways relief was not available.
The taxpayer appealed to the FTT.
The FTT dismissed the appeal, concluding that the promotional activities did not constitute a commercial trade and, therefore, the taxpayer was not entitled to sideways relief.
Was there a trade?
The FTT held that the taxpayer’s activities did constitute a trade.
The FTT considered the case to be marginal and took into account the taxpayer’s relationship with his wife (following Murtagh v HMRC2), as motivation is a relevant factor in determining whether there was a trade. However, the FTT considered that the activities were sufficiently organised to amount to a venture in the nature of a trade.
Was the trade commercial?
Although the taxpayer was carrying on a trade, the FTT concluded that the trade was not commercial. The FTT stressed that the issue of commerciality involved two separate questions. Firstly, was the trade carried on on a commercial basis, and, secondly, was the trade carried on with a view to realising profit.
It was not disputed that the first question involved an objective analysis. The FTT considered that, applying Rowbottom v HMRC3, although there was a subjective element to the second test, there was a need for objective evidence demonstrating an “appropriate basis” for the trader taking a particular view. The FTT concluded that the answer to the first question was, on balance, that the trade was not conducted on a commercial basis and that this was sufficient to determine the appeal.
As a result of several factors, including a lack of financial forecasts or budgeting information, the FTT concluded that the success, or otherwise, of the taxpayer’s venture depended entirely on the work and ability of the agent and the taxpayer’s wife, with no provision being made for the taxpayer’s efforts proving fruitless. Although there had been sufficient organisation for the promotional activities to constitute a trade, there was less organisation and planning than would be appropriate or expected for a commercial business in the nature of the taxpayer’s trade.
The FTT stressed that the question of whether there is a commercial trade is one of fact, and as a consequence previous decisions can only be of limited assistance in determining this issue. The decision illustrates the need for taxpayers wishing to benefit from sideways relief to be able to clearly demonstrate the commercial nature of their activities. The existence of a trade, on its own, might entitle the trader to carry forward losses from that trade and set them off against profits of the same trade in future periods, but the requirement of a commercial nature imposes an extra hurdle, and requires further analysis, if sideways relief is sought.
The decision is available to view here.