When HMRC become interested in your hobby

Credit: plex @sxc

As we alluded to in our article on the Rise of Tax Investigations, HMRC will soon be launching a campaign using web bots to trawl through e-marketplaces such as eBay, Etsy and Amazon. They will be targeting those who run businesses through such sites, but clearly there is scope for those who simply sell goods on a regular basis to be caught by the campaign.

At what point, though, does selling handmade birthday cards on Etsy or your services as a photographer constitute self-employment rather than just a hobby?

How do I know if I'm trading?

The line between hobbies and trading can be a blurred one. It is judged by several criteria known as the “badges of trade”. These include:

  • Profit seeking motive
  • Frequency and number of similar transactions
  • Nature of the asset being sold
  • Length of ownership of that asset
  • Reason for the acquisition/sale of the asset
  • Connection with an existing trade
  • Advertising

Just one of these badges may be enough to show trading, but more usually a combination is considered. HMRC are most concerned with profit seeking motive as if there is no profit there's nothing to tax. Such a motive will arise when you seek to do more than simply cover the cost of your materials.

What are the tax implications?

If you have determined that you are trading you will be liable to income tax and National Insurance Contributions if you earn over certain thresholds. Even if these thresholds aren't met, you must inform HMRC within 6 months of the end of the tax year or you may be fined £100 for failure to notify. Registering as self-employed can be done by completing form CWF1 (pdf) or online. Once registered, you will need to complete a self assessment tax return by the 31st January following each tax year.

Income tax

Any profit you make will be taxable if your total earnings (including any other employment) exceed the personal allowance (£7,475 for 2011/12). Whether or not you make a profit, though, you will need to record your income and expenses on your tax return. Assuming you complete this online your income tax liability will then be calculated for you.

If you make a trading loss then this can be offset against your other income for the year, or carried forward or back against income for other years subject to various rules. However, if HMRC determine that there is no profit seeking motive to your hobby they will disallow any losses from it.

National Insurance

Self-employed people are generally required to pay both Class 2 and Class 4 National Insurance Contributions (NIC). However, if you are earning below the small earnings exception (£5,315 for 2011/12) you can elect not to pay Class 2 NIC by completing form CF10 (pdf) and if you earn below the lower profits limit (£7,225 for 2011/12) you don't have to pay Class 4 NIC.

The rates for National Insurance Contributions are set out on HMRC's NIC page.

VAT

If your “hobby” has grown into a fully-fledged business you might have to start to think about VAT. If your turnover for the previous 12 months exceeds £73,000 (2011/12) or will exceed that amount in the next 30 days alone (perhaps due to a big order for your birthday cards) then you will need to register for VAT. This will usually make your goods more expensive for your customers (assuming they're not VAT registered themselves) but if so you will generally be able to claim back input VAT on your supplies.

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Inheritance Tax: Big Changes Ahead?

One of the first acts of the Coalition Government was to launch a tax simplification drive, spearheaded by the new Office of Tax Simplification (OTS). This was met with some cynicism by both the press and the tax profession, with a fellow tax adviser quipping “I love it when they announce tax simplification. It ensures me business for the next 10 years!”

However, some of their efforts are now seeing the light of day, with potential changes afoot in income tax and pensions. Tellingly, though, the review of inheritance tax has not been mentioned recently, hinting that far bigger changes are being contemplated.

Simplification is never simple

Tax simplification

Tax simplification is a notoriously difficult thing to achieve. Changing the tax code is fraught with difficulties, as any change always creates winners and losers. If a simplification proposal has the effect of penalising a certain segment of the population it will inevitably meet resistance. This can be mitigated by ensuring that nobody is made worse off by changes, but this lowers tax receipts – an expensive option in a time of austerity.

The other factor confounding simplification is the clamp-down on tax avoidance. Closing loopholes inevitably involves adding to the tomes of legislation and the Government have not always done a great job with new anti-avoidance measures. A prime example of this is the new disguised remuneration rules we have covered previously.

Changes proposed for income tax and pensions

The Office of Tax Simplification (OTS) are hoping, though, that these obstacles do not prove insurmountable as they look to tackle the complexities of two major areas: the taxation of pensioners, and a possible merger of income tax and national insurance.

Pensioners currently face a bewildering array of reliefs and exemptions, which currently leads to over a third them paying the wrong amount of tax. According to the National Audit Office, 1.5m pensioners are paying on average £171 too much in tax. Even more are missing out on age-related allowances – an estimated 3.2m. The OTS have yet to make their recommendations, but various possibilities being mooted include an expansion of self-assessment, a single tax code for retirees and a one-size-fits-all age allowance1.

Bigger still are the potential changes to income tax and national insurance. Currently run as two completely separate taxes, with different rates, bands, timescales and administration, there is plenty to simplify. Talk of a full merger between the two may be a little fanciful given how many people would be affected by such a move, but there is ample scope to better align the two taxes, so saving time and administration costs.

Big implications for inheritance tax?

The OTS originally called for a review of inheritance tax (pdf, 1.04MB) at the same time as the above reviews, but has since gone somewhat quiet on the matter. Rather than looking at individual reliefs, the OTS had announced that it considered “that a more appropriate approach may be to review the whole of IHT” and that they “envisage this as a longer term project.” That we have heard nothing would seem to indicate that this longer term project is indeed underway, so inheritance tax could be in for a dramatic upheaval.

1. Pensioner Tax Review, Accountancy Magazine Sept 2011

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