Are you trading?
It will not always be apparent when a hobby tips over into a trade and the point at which you need to declare your income to HMRC. There is no statutory definition of a trade beyond that a trade includes a ‘venture in the nature of a trade’. Consequently, in deciding whether a trade exists, HMRC look to the ‘badges of trade’. These are indicators of trading developed from case law.
The badges of trade
There are nine badges of trade.
- Profit-seeking motive: an intention to make a profit support trading but is not by itself conclusive.
- The number of transactions: systematic and repeated transactions will suggest a trade.
- The nature of the asset: is the asset of a type than can only be turned to advantage by sale, does it yield an income or does it provide ‘pride of possession’ (for example, a picture for personal enjoyment). An asset which is acquired for sale would suggest trading, whereas an asset acquired to yield an income would suggest an investment.
- Existence of similar trading transactions or interests: transactions that are similar to those of an existing trade may themselves be trading.
- Changes to the asset: has the asset been repaired, modified or improved to make it more easily saleable of saleable at a greater profit?
- The way in which the sale was carried out: was the asset sold in a way that was typical of a trading organisation, which would suggest the existence of a trade, or did it have to be sold to raise cash in an emergency?
- The source of finance: was money borrowed to buy the asset and could the funds only be repaid by selling the asset?
- The interval between the purchase and the sale: assets that are the subject of a trade will normally (but not always) be sold quickly. Consequently, the intention to sell an asset shortly after sale will suggest trading. However, where the intention is to hold the asset indefinitely, it is less likely to be the subject of a trade.
- Method of acquisition: an asset that is acquired by way of inheritance or as a gift is less likely to be the subject of a trade.
It is important to note that the above is not a checklist and it is not necessary for every badge to be present for there to be a trade. Further, no particular badge is conclusive evidence of a trade. Rather, it is a case of considering each badge and whether it is present or absent to form an overall impression of whether a trade exists.
If you are earning a small amount of money from your hobby, for example, making and selling occasional birthday cakes, it is unlikely that you will need to tell HMRC. The trading allowance means that if the income from your self-employment is less than £1,000 you do not need to report it to HMRC. However, it should be noted that each person is only allowed one trading allowance across all sources of self-employment. Consequently, a person who is already self-employed and earning more than £1,000 will need to pay tax on any income from a hobby business, even if the income from the hobby is less than £1,000 a year.
If your income from your business for the tax year is more than £1,000, you will need to register for self-employment by 5 October after the end of the tax year.
Partner note: HMRC’s Business Income Manual BIM20000ff.; ITTOIA 2005, Pt. 6A, Ch. 1.