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Hobby Trading Losses

You might think you have a business, but HMRC can disagree with you.  If HMRC considers that you are never going to make a profit, they will also refuse any loss relief.

Losses and profits

You might think that HMRC is being unfair in refusing loss relief, but if your activity is a hobby you won’t have to pay tax on profits either.  This rule can be tricky as revealed in the case of P, when  HMRC dismissed his claim for loss relief.

Trade or personal loss?

HMRC challenged P’s claim at a tribunal because in its view it related to non-business transactions and so was a personal financial loss and not one arising from a trade. Non-trading losses can’t be set against taxable income and it’s not just HMRC being difficult.

Trading tests

HMRC and tax specialists refer to the so-called “badges of trade” to decide if a trade exists. These tests were set out in a court judgment decades ago, but remain valid today. One of the tests to establish if a trade exists is that there must be an intention to make profit from a business. In P’s case the tribunal extended this test a little further.

Incapable of making a profit

P started two “businesses”, neither of which made a profit because, in the tribunal’s view, he was inexperienced and couldn’t devote enough time to them. Neither venture was capable of making a profit without P reducing the hours he spent in his main job. In essence P didn’t have the business acumen or time to devote to making his business profitable.

Putting the boot on the other foot

The ruling in P’s case is useful, not just for guidance on when losses are deductible, but for countering HMRC if it claims money you make from a hobby is taxable. Its view has always been that if you advertise your hobby in a newspaper or online you’re probably trading. But the tribunal’s judgment, supported by HMRC, dispelled that idea. If you don’t have the time or intention to carry on a trade, profit you make from isolated sales isn’t liable to income tax.

Turn your hobby into a business

For advice on converting your hobby to a profitable business, including help with setting up a limited company or registering for VAT, please contact Alterledger.

Is my hobby a business?

Shopping chart on notebook isolated

The criteria used to assess if an activity is a hobby or a business are:

  • The size and commerciality of the activity.
  • The frequency of the activity and transactions
  • The application of business principles.
  • Whether there is a genuine profit motive.
  • The amount of time devoted to the activities.
  • The existence of arm’s-length customers (as opposed to just selling your wares to family and friends).

HMRC have some great examples to help you decided, for example

Gail is a full-time employee working for a stationery company. She pays her PAYE tax on this employment every month.

In her free time Gail makes cushions and uses most of them in her home. Occasionally she sells them to friends and work colleagues for an amount that just covers the cost of materials of £15. Sometimes she makes a loss. Any money she does make goes towards her holiday fund.

She decides to make extra cash by selling cushions on an Internet auction site and starts auctioning three or four to see how they go. They all sell for more than £50, a profit of at least £35 each.

She uses this money to buy more materials and within a month she is selling around ten cushions a week, always at a profit, and is considering setting up her own website.

Gail’s initial sales of cushions to friends are not classed as trading. It lacks commerciality and she does not set out to make a profit. The occasional sales are a by-product of her hobby. Once she begins to auction her cushions, she has moved into the realms of commerciality.

She is systematically selling her goods to make a profit. She will need to inform HMRC about her trade, and keep records of all her transactions. On the level of sales shown in the example the potential turnover of around £26,000 is well below the VAT annual threshold so Gail does not need to register for VAT.

You can find more examples at HMRC

Many traders start off in a small way and don’t realise that they need to register with HMRC, they assume their activity will be treated as a hobby, but things can grow quickly.

You should register as Self Employed as soon as your hobby becomes a commercial venture, even if you are losing money!

If you don’t register, HMRC will be looking for you and if you have an online business it won’t be hard for them to find you.

Ebay say they work ‘hard to ensure that businesses that trade on the platform are aware of their tax obligations’.

It added: ‘We do not hesitate to share information with government agencies should there be evidence of wrongdoing. We require all sellers trading as a business on eBay to register for a business account.’

steve@bicknells.net
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