In brief
- Trading classification in Irish tax remains complex, particularly for financial services.
- The Badges of Trade offer guidance, but taxpayer intention and first principles are more critical.
- Recent cases and Revenue updates underline the importance of robust documentation and governance.
Background & Badges of Trade
In this article, Ronan Costello and Aidan Walsh discuss the importance of taxpayers relying on first principles with respect to assessing their trading status. This is of particular relevance now as most Revenue opinions become obsolete.
What constitutes trading in an Irish tax context is notoriously difficult. This is particularly so in financial services. In our view, a lot of the difficulty is caused by a reliance on the Badges of Trade.
The purpose of this article is to explore the Badges of Trade, case law and Revenue Guidance to provide a framework for assessing trading for tax purposes that is more subjective and with a smaller grey area between trading and non-trading.
As is well known, the Badges flow from a 1955 report by the UK Royal Commission on the Taxation of Profits and Income (“the 1955 Report”) which reviewed case law at the time and identified six Badges of Trade. What is less well known is that in the 1955 Report, there is a note of reservation from three of its members as follows:
We do not share the expectation that the “relevant considerations” [i.e., the badges] would serve to reduce the present legal uncertainty….In fact, in all doubtful cases some of the tests suggested are bound to give results contradictory to the others; and there is no indication how such contradictions are to be resolved. …..In our view, the enumeration of these “relevant considerations” serves not only to emphasise the uncertainty of the present legal border-line that separates taxable from [at the time] tax-exempt profits [i.e., capital gains], but to reveal how wide that border-line or border area is, relative to the area which it encloses.
Of particular relevance to us is that this reservation was illustrated by a financial services-type example:
Thus, the profits of a man who speculated in a commodity on a produce exchange – by buying and selling tea, for example – would pass the first test (since the subject matter of the realisation is normally the subject of trading rather than investment) but completely fail in the fourth (since “nothing at all is done” to bring the commodity into a more marketable condition).
We think this view has held true and correctly reflects the doubt that can arise from applying the Badges, particularly with respect to modern commercial transactions in a world that is increasingly “financialised”.
UK case law on trading extensively references the Badges of Trade which has led to significant difficulty for UK courts in consistently applying them. In a recent (February 2024) UK first-tier tribunal case Mark Stolkin, Margeaux Stolkin and Faye Clements v HMRC [2024] TC09086 the HMRC submitted that the Badges of Trade were of “limited utility in the present case”. In that same case Baldwin J stated that while the Badges are a useful starting point, one must “stand back.. and look at the whole picture”.
Further, the authors are only aware of one Irish High Court case, Thornton and McDermott v Revenue Commissioners [2022] IEHC 396 (the “Thornton” case), that has sought to rely on the Badges of Trade when determining trading status. In the Thornton case, Egan J referred to the fact that they “are of course no more than a guide…”
For completeness we note that the Irish case, Perrigo Pharma International DAC v McNamara (2020) IEHC 552 (the “Perrigo” case) does refer to the Badges of Trade in a trading context, but that case ultimately did not involve any decision on trading.
Revenue Guidance
Revenue’s Tax and Duty Manual Part 02-02-06 (the “Guidance”) on trading outlines considerations which in Revenue’s view, are important for the purposes of determining whether the activities of a company constitute a trade. The Guidance does seek to rely on the Badges of Trade.
The Guidance places particular focus on the level of activity and the application of Noddy Subsidiary Rights Co Ltd v Inland Revenue Commissioners (the “Noddy” case). It is worth noting that the Guidance was updated in February 2024 to include additional commentary with respect to the Noddy case. Interestingly, the increased focus on Noddy and the level of activity sighted by Revenue would appear to be as a result of taxpayers citing this case in discussions with Revenue.
These changes, in our view, indicate that in the case of exploiting an asset for profit in a trading context (a common occurrence in financial services), Revenue would seek to apply their view of principles derived from the Noddy case and so would look for a “high degree of activity” associated with the management of the underlying asset. The authors do not necessarily agree with this, as explained below.
In our view, Noddy was considered trading by the UK High Court as Mr Broadribb was given a mandate to exploit the company’s interest in its copyrights for profit. The arguments made to support the trading position arose fundamentally as a result of the decision to exploit the copyrights with view to making a profit.
In our view, the Revenue interpretation of Noddy has reversed the logic of the UK High Court. It was the subjective decision to trade that resulted in the activity, and that level of activity should be appropriate for the trade. It is true that activity, more loans, more transactions, sales, profits are evidence of trading but that depends on the trade, the trading strategy and the market. A financing company can make a choice between one large loan or eight small loans. The latter has more activity and requires more work, but each is a legitimate business decision to maximise profit, with different costs, risks and potential profit. Why would the tax system treat one different to the other?
Where taxpayers seek to implement Revenue’s view by focusing on substance and activity from the start, taxpayers run the risk of creating artificial substance and artificial activity, both of which are uncommercial and evidence of non-trading, in our view.
UK and Irish case law
We have outlined below, what are in our view the key cases when considering trading in a financial services context.
In Simmons v Inland Revenue Commissioners (1980) 2 All ER 798, Wilberforce LJ noted that “Trading requires an intention [emphasis added] to trade..”.
In James Mara (Inspector of Taxes) v Hummingbird Ltd (1982) ILRM 421, Kenny J stated that: “The ways of conducting business have become very complex and the answer to the question whether a transaction was an adventure in the nature of trade nearly always depends on the importance which the judge or commissioner attaches to some facts … The line between questions of law and those of fact can rarely be drawn firmly so as to separate one from the other.”
In Airspace Investments Ltd v M Moore (Inspector of Taxes) (1994) ITR 3, Lynch J said that: “In relation to the first question as to whether or not the company was carrying on a trade, this is a mixed question of fact and law.”
In the recent Irish Perrigo case, Judge McDonald D stated that: “In the absence of a comprehensive statutory definition of ‘trade’, the question whether a particular transaction forms part of a trade for tax purposes requires individual consideration of the underlying facts and circumstances. Essentially, a case by case analysis must be carried out.”
Whether a business is trading for tax purposes is ultimately a mixed question of fact (what do they do and why?) and law (is what they do and why they do it sufficient to be trading or is it capital or non-trading?).
In the author’s view, a taxpayer’s intention is the key determining factor in assessing trading status
(see Simmons v Inland Revenue Commissioners where Wilberforce LJ noted that “Trading requires an
intention [emphasis added] to trade). The key question for taxpayers is how they demonstrate that
subjective fact (i.e. their intention).
From a financial services perspective, where for example the use of special purposes vehicles (“SPVs”) with no direct employees is common due to commercial non-tax driven reasons, robust corporate governance and documentation will be central to supporting the trading position of the activities such businesses are engaged in.
Qualifying Finance Company
In Budget 2024, the Government announced a review of Ireland’s complex interest deduction rules. This review resulted in a new provision in the Irish code that somewhat ameliorated the previous situation with the introduction of section 40 of the Finance (No 2) Act 2023 and an interest deduction for qualifying finance companies (“QFCs”).
It is important to note that there is nothing in section 76E TCA 1997 that implies that it supersedes any existing tax rule or that it impacts entities that are carrying on a Case I trade and claiming an interest deduction on trading interest. There is no mention of Case I in the new section. The new section does not purport to change the treatment of entities that are not QFCs.
Public Consultation
The taxation and deductibility of interest under Irish tax law is a complex area. In light of this, the Department of Finance recently held a public consultation to review the taxation and deductibility of interest by business in Ireland.
Where interest is considered non-trading, it creates additional complexities for taxpayers; particularly around the deductibility of interest payments. Where a taxpayer applies a first principles approach as outlined in this article and as a result concludes that interest is trading for its business, the complexity is significantly reduced.
Closing comments
As tax practitioners we must be able to solve complex problems for our clients. Our default problem
solving position is to reason by analogy, that is to compare the solutions to one problem and apply
that solution to a similar problem.
As tax practitioners and taxpayers, it is important that we always reason from first principles. By
applying first principles to facts, it provides long term certainty on a position taken and enables less
reliance on Revenue Guidance which can change or become outdated. While guidance and safe
harbours are helpful in assessing Revenue’s view at a particular time, they are not themselves legal
precedent and while they may be of value, they should not be solely relied upon by tax advisors.
By properly analysing case law and following a first principles’ review of their clients’ activities, we as
tax practitioners can provide more certainty to those clients by providing reasoned opinions on those
activities rather than seeking to rely on Revenue’s views, which may change or become obsolete.
As outlined in the article, in our view a taxpayer’s intention to trade represents the criterion when
determining trading status. While other factors are relevant and supportive, they are secondary and
typically serve only as objective evidence of the company’s underlying subjective intention to trade
from the outset. Being able to support the subjective intention through strong corporate governance
and documentation will be critical in verifying intention.
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