In recent years, there has been a seemingly unending string of cases relating to whether certain activities constitute trading. Ewan Leslie James McMorris v HMRCis the latest case to consider the circumstances in which a taxpayer may deduct losses incurred from his other income under section 64, Income Tax Act 2007 (ITA).
Dr McMorris (the Appellant) was interested in horseracing and his knowledge of racing and racehorses dated back to his time as an undergraduate when he became a "professional gambler" on horses, achieving a reasonable level of profit. Following graduation, the Appellant ceased this activity.
Sometime thereafter, following discussions at work, the Appellant became aware of a colleague who, with her husband, owned a number of horses. There was one particular horse they owned called "Hermes" that they thought had promising prospects as a racehorse, but they did not have the funds to allow Hermes to be properly trained. The Appellant was approached and asked if he was interested in acquiring a share in the horse and funding half the necessary training costs. After considerable research into the pedigree of the horse concerned and after obtaining advice from the horse's prospective trainer, the Appellant agreed to contribute to purchase a half share in Hermes. The intention was to put Hermes into professional training, win some races so as to enhance the value of the horse and then sell him on at a profit. The racing was a necessary part of this process.
The Appellant acquired a half share in Hermes for £5,000 to £8,000 (he was unable to recall the precise amount). He also agreed to meet a half share of the training, livery and racing costs. In February 2010, the Appellant applied to the British Horseracing Association to be registered as the half owner of Hermes and, following this registration, he applied to be registered for VAT in respect of his activities in relation to the horse. Hermes ran his first race in October 2010 and finished in second place. That performance caused some interest in the racing world and the Appellant was informed that an unsolicited offer had been received from a prospective overseas buyer who was willing to pay £50,000 to purchase the horse. After discussing the offer with his co-owners and trainer it was decided not to accept the offer. A potential tie-up with the luxury brand Hermes was also discussed at this time.
Unfortunately, this was the high point of Hermes' fortunes and his performance deteriorated and eventually the horse was sold as a polo horse for £1,000.
In his tax return for the year to 5 April 2011, the Appellant claimed loss relief in the sum of £12,316, under section 64 ITA, in respect of self-employed activity described in the return as "Race Horse". The Appellant's claim was rejected by HMRC and he appealed to the First-tier Tribunal (Tax Chamber) (FTT).
Section 64 ITA provides:
"(1) A person may make a claim for trade loss relief against general income if the person-
(a) carries on a trade in a tax year, and
(b) makes a loss in the trade in the tax year ("the loss-making year")."
Section 66 ITA provides:
"(1) Trade loss relief against general income for a loss made in a trade in a tax year is not available unless the trade is commercial.
(2) The trade is commercial if it is carried on throughout the basis period for the tax year
(a) on a commercial basis, and
(b) with a view to the realisation of profits of the trade."
The Appellant submitted that the activity was a serious commercial venture and not merely a hobby. He argued that he had participated in the venture after detailed research into the pedigree of the horse and had employed the services of a well- known professional racehorse trainer. HMRC's position was that neither the evidence forwarded to HMRC during the course of its enquiry nor the evidence before the FTT demonstrated that the Appellant's activity was anything other than a "speculative venture" or hobby activity.
The first issue for determination was whether the Appellant's loss was incurred in the course of carrying on a trade. The FTT considered the well-known judgment of Sir Nicolas Browne-Wilkinson VC in Marson v Mortonin which he refers to the so called 'badges of trade'.
Whilst the Appellant hoped to make a profit and used his knowledge and skill to identify the opportunity, the FTT was of the view that this was not sufficient to transform what was a gambling hobby into a trade. It concluded therefore that the Appellant's activities did not amount to a trade (including a "venture in the nature of a trade") and that the appeal failed on this ground.
Although this disposed of the appeal, the FTT went on to consider the second issue which was whether the Appellant had, throughout the relevant period, carried on the trade on a "commercial basis" with a view to "the realisation of profits", for the purpose of satisfying section 66(2) ITA.
With regard to the "commercial basis" test contained in section 66(2)(a), the FTT commented that:
"the organisation of the activity was very informal and there was no evidence before us of any degree of systematic organisation or structure to the activity….the whole project was on the evidence before us, based on a series of informal and undocumented conversations. Whilst we accept that the appellant carried out research into a horse's pedigree, that is little different from a normal gambler studying "form" and is not sufficient to persuade us that he acted on a "commercial basis".
The FTT therefore concluded that the "commercial basis" test was not satisfied.
With regard to the "realisation of profits" test contained in section 66(2)(b), the FTT was willing to accept that the Appellant's subjective intention was to make a profit rather than a loss and that section 66(2)(b) was therefore satisfied.
This case demonstrates that HMRC continue to scrutinise loss relief claims and will seek to challenge such claims either on the basis that the taxpayer was not carrying on a trade, or if he was, that trade was not being conducted on a commercial basis with a view to the realisation of profits. It is important in such cases that the taxpayer concerned is able to provide sufficient evidence to HMRC, or ultimately the FTT, to demonstrate that he was not only carrying on a trade but that trade was also being conducted on a commercial basis with a view to a profit. Such cases are likely to be won or lost on the evidence provided by the taxpayer.
Interestingly, the FTT also said that it derived no assistance from the VAT cases to which it was referred and made the point that the underlying concepts of "trade" in the direct tax context and "business" in the VAT context, are different in material respects.