A person receives irregular sums of money from her wealthy friend who lives outside the UK. The friend makes the payments because she was provided with accommodation and support when she had no money. However, as time has passed, payments from the wealthy friend are also made in reimbursement of acquiring various luxury items. The question arises whether there is now an activity in the nature of a trade and what, if any, amount is paid for “a service” or alternatively are payments gifts and is there an expectation of reward (gratuity) for what might be regarded the help of a friend?
Activity in the nature of a trade
A trading activity is one that involves the provision of goods or services to customers on a commercial basis. It can be a one-off venture, occasional or continuous. The activity is carried on with a view to profit.
Legislation does not fully define the term ‘trade’ nor a ‘venture in the nature of trade’. It has therefore been for the courts to interpret and a number of tests have been developed including badges of trade.
For a trade to exist, a person entering into a transaction would have a profit seeking motive. This motive may be easier to establish if reliance is placed on the activity to generate income from which to live. However, where transactions are carried out in an informal manner it may be difficult to establish any correlation or rationale between the activity and a profit, indicating that a trade does not exist. Furthermore, when the manner in which the parties to the transactions relate is not that of a business relationship indicates a trade does not exist.
Lord Clyde stated in CIR v Livingston and Others (11TC538) that:
“I think the test, which must be used to determine whether a venture such as we are now considering is, or is not, “in the nature of trade”, is whether the operations involved in it are of the same kind, and carried on in the same way, as those which are characteristic of ordinary trading in the line of business in which the venture was made.”
Gratuity or gift
The dictionary definition of a gratuity is “a tip to a waiter, taxi driver etc.” or “a sum of money paid to an employee at the end of a period of employment.” The definition of a gift is “a thing given willingly to someone without payment”. Where you have the provision of a service and there is a gift, understanding the tax implications is difficult.
In Calvert (HM Inspector of Taxes) v Wainwright (27TC475), it was established that tips paid to an employed taxi driver were given in the ordinary way as remuneration for services rendered and were assessable to Income Tax. The employer employed the employee at a defined wage and made no reference to tips.
HMRC cited the case of Benyon v Thorpe (14TC1) where a managing director had resigned because of ill-health although retained a seat on the board until 1925. No duties were performed and no remuneration received between 1922 and 1925. The company customarily gave retiring employees voluntary pensions or allowances. In 1923 Thorpe was awarded a retirement a pension of £5,000 a year, although it was rescinded in 1925 and a final payment of £5,000 was agreed “not as or because he is a director but as a personal gift”. It was held that the allowances were gifts of a personal nature only. It was found that the pension was in no way a pension under tax legislation but a series of gifts.
The distinguishing principle appeared to be that if the voluntary payment or gift can be attached to an office, employment or vocation it can become taxable in the hands of the recipient. Gratuities are given because a person is carrying on a particular employment and, even though they have no right to ask for them, they receive them as profits in their employment. They are taxable.
A gift is not a profit at all and is not provided because the person is carrying on a employment or providing a particular service as engaged to do so.
The more recent first tier tribunal decision in Mr Colin Collins v HMRC (TC02088), considered whether a payment was gratuitous or in respect of past duties performed. The case was an appeal by Mr Collins considering several points at issue being whether:
- a gratuitous receipt by the appellant constituted emoluments of their employment
- HMRC had satisfied their burden in showing negligence on the part of the appellant making his return (thereby being able to assess outside the six year period)
The relevant broad facts of the case are that Mrs De-Haan, a shareholder and director of a travel company, had undergone a difficult divorce from her husband, in which her husband had ousted her from the company that he was also a shareholder of (after a period where she controlled the business due to her husband’s ill health). Mrs De-Haan had few confidants within the company although Mr Collins was one. After a period of dispute, Mrs De-Haan received sale proceeds forming both an upfront payment and an earn out arrangement. Mrs De-Haan made payments to Mr Collins and a few other select individuals on or after the anniversary of the sale and receipt of several earn out payments. Mr Collins had ceased to be an employee for a period although taken up a new employment with the company.
A letter accompanied the cheque given to Mr Collins stating “To celebrate the art of caring and sharing. In this context, I would like to recognise in a special way the people whose special contributions helped make RCI such a great company.” And “Thank you for your years of service, dedication and commitment and for your contributions in building RCI into the biggest and best exchange company.” In addition Mrs De-Haan’s witness statement reads “The payment in 1998 to Mr Collins was in recognition of his contribution and dedication to the company and our friendship that existed for many years”. HMRC had contended that the payment was an emolument and that it was paid as an incentive to encourage Mr Collins, thereby potentially affecting the earn out entitlement that could be achieved.
The Tribunal found “without hesitation that the Appellant’s receipt on 17 April 1998 was a pure gift and cannot be said on any basis to have constituted emoluments of his past, or indeed of any, employment.”
The same principles apply to receipts by companies. In Simpson (Inspector of Taxes) v John Reynolds & Co (Insurances) Ltd –  STC 271, a company had for many years acted as adviser to a company of which a large shareholding was acquired by ICI Ltd in 1965. ICI Ltd required the company to place all of its insurance with another insurance company. The adviser was informed that its services would no longer be required. A while later in the same year, the company informed the adviser that they would pay £1,000 per annum for a period of five years commencing in March 1966. The letter stated that the payment was in recognition of past services as insurance brokers and was calculated in reference to previous commissions. On appeal the commissioners held that the payment was not chargeable to tax. On 21 March 1972 the decision was upheld because it was a purely voluntary payment made in recognition of past services; it was not trading income in the hands of the taxpayer company. The Crown appealed contending that the payment had the character of a trading receipt because:
- it had arisen on the termination of a trading relationship
- it was calculated by reference to past premiums
- payments were in instalments over a period of five years
- the payment was shown in the accounts as a trading receipt
- it was paid as a consolation for the termination of the profits of a trading connection
It was held that the payment could not be properly described as annual profits or gains arising or accruing from the trade because:
- the payment was a wholly unexpected and unsolicited gift
- it had been made after the business connection had ceased
- it was in recognition of past services rendered over a long period
- it had been made as consolation for the fact that those remunerative services were no longer to be performed
Although, in Commissioners of Inland Revenue v Falkirk Ice Rink Ltd – 51 TC 42, a donation by a member’s club to cover the cost of providing the quality of the ice surface required was found to be a supplement to the trading income. The business, which operated as an ice rink on commercial basis, leased rooms to the member’s club at arms length. The members were entitled to admit the ice rink at preferential rates. Charges did not cover the cost of providing the quality of ice surface required. The club feared that, in the absence of a donation, the facilities for curling would be withdrawn.
It was held that the payment was made:
- in order that it might be used by the business
- to a trading company artificially to supplement its trading revenue from curling
- to preserve the ability to provide curling facilities in the future
The payment was of a business nature and was accordingly a trading receipt of the Respondent for tax purposes.
The principles of establishing whether there is a trade are well founded. However, where relations are informal, evidence to support the motives may be sparser. The key to deciding whether a trade is in existence hinge on determining the motive of the parties involved.
Payments that are genuine gifts are not taxed as income for an employee, ex-employee, self employed person or company. However, the test to establish that a payment is a gift requires establishing and demonstrating a motive. If the only relationship that existed was that of man and servant it may be more problematic to establish that a payment is a gift.
Where comparable transactions can be considered it may be easier to demonstrate a payment is either commercial, gratuitous or an outright gift.
The principles set out herein could affect the treatment of tax planning arrangements such as remuneration structures where self-employed persons or businesses have established trusts to benefit suppliers etc.