A special commissioner decided that a taxpayer had not set up and commenced his trade until after 6 April 1994 for the purposes of the Finance Act 1994, s. 218 where, before that date, he had nothing with which to trade and had merely incurred expenditure in preparation for trading rather than carried on operational activities.

Facts

The taxpayer invested significant time and energy in becoming an expert on the development of motorway service stations. He investigated a number of possible sites. In late 1993 he identified a possible site and had detailed discussions with the local landowners. On 23 January 1994 detailed heads of terms for options over the relevant land were agreed. On 15 April 1994 contracts were signed reflecting those heads of terms. Between December 1994 and February 1997 he turned his rights to account and received in total some £300,000 for his efforts. He identified a suitable site for development, arranged an option to purchase the relevant land and entered into an agreement with an oil company by which the oil company was granted a right to purchase the land if the option was exercised within a specified period.

There was no dispute that the taxpayer made profits from a trade (although there was some argument about what that trade was). However a question arose as to when that trade was ‘set up and commenced’. The importance of that issue lay in FA 1994, s. 218. FA 1994, s. 200 to 218 amended the basis on which the trading profits of an individual were assessed. Before then the tax charge for a fiscal year ending on 5 April had generally been based on the profits of the trade earned in the accounting year ending in the preceding fiscal year. Sections 200–217 replaced that regime and based the tax charge for a fiscal year on the profits of the accounting year ending in that fiscal year. Broadly, as a result of s. 218, if the taxpayer's trade was set up and commenced before 6 April 1994 he was taxed more favourably than if it was set up and commenced on or after that date.

The Revenue argued that his trade could not have commenced before the contract was signed on 15 April 1994. The taxpayer said that his trade was set up and commenced on or before 6 April. The taxpayer appealed to a special commissioner.

Issue

Whether the taxpayer's trade was set up and started before or after 6 April 1994.

Decision

The special commissioner (Charles Hellier) (dismissing the appeal) said that s. 218 spoke of a trade ‘set up and commenced’ before, or on or after, 6 April 1994. A trade could not commence until it had been set up (to the extent it needed to be set up), and acts of setting up were not commencing or carrying on the trade. Setting up trade would include setting up a business structure to undertake the essential preliminaries, getting ready to face customers, purchasing plant, and organising the decision making structures, the management, and the financing.

Depending on the trade more or less than that might be required before it was set up.

Before the trade could be said to commence, there had to be a fairly specific concept of the type of activity to be carried on. An activity which consisted merely of a review of the possibilities in the expectation or hope that information would be obtained to justify going into a business of some kind was not the carrying on of a trade. It was not always necessary that a sale was made or a service supplied before a trade could be said to be commenced. It was tempting to say that a trade commenced only when the first sale was made. In everyday language, a person started trading when he became entitled to money from his first customer. But it did not seem that making the first sale was necessarily the earliest time when a ‘trade is commenced’ for the purposes of s. 218. A trade commenced when the taxpayer, having a specific idea in mind of his intended profit making activities, and having set up his business, began operational activities, i.e. dealings with third parties immediately and directly related to the supplies to be made which it was hoped would give rise to the expected profits, and which involved the trader putting money at risk: the acquisition of the goods to sell or to turn into items to be sold, the provision of services, or the entering into a contract to provide goods or services: the kind of activities which contributed to the gross (rather than the net) profit of the enterprise.

Carrying on negotiations to enter into the contracts which, when formed, would constitute operational activity was insufficient. At that stage no operational risk had been undertaken: no obligation had been assumed which directly related to the supplies to be made. Not until those negotiations culminated in such obligations or assets, and gave rise to a real possibility of loss or gain had an operational activity taken place. Until then, those negotiations might be part of setting up the trade but they did not betoken its commencement.

The fact that, prior to 6 April 1994, the taxpayer had created a viable proposition which had value and could be sold independently of the option, on its own, was not enough to constitute carrying on a trade because the possession of that proposition had to be viewed in the context of the concept of the activity which was to be carried out in the mind of the putative trader. If that activity was merely the review of possibilities in the hope of profit, there was no trade; if it was identified as the sale of propositions as an introducer, it was possible that the taxpayer's possession of the proposition might indicate that trade had started; if it was identified as acquiring and turning for account interests in land then the taxpayer's possession of the proposition was less likely to indicate that a trade had started. In each of the latter cases the answer depended upon whether the trade could be regarded as having been set up and, if so, whether there had been operational activities in the course of that trade.

At some time before late December 1993, the taxpayer had in mind getting a profit from an introducer's fee but then abandoned that concept in favour of getting a land interest which he could turn to account; alternatively, his ideas were originally fairly nebulous and the concept of acquiring a land interest became clear only in December 1993. On either analysis, the concept of that trade was characterised by the acquisition, and the turning to account, of a land interest such as the options. But there was no operational activity in relation to that trade until the option agreements were made.

If it was possible to describe his activity from late 1993 onwards as being directed to the realisation of profit from the turning to account in some way of his expenditure and knowledge, it still seemed that that trade did not commence until after 6 April 1994. Once the heads of terms were agreed he had a specific site to market: he was ready – or almost ready – to approach his potential customers. He had a specific concept in mind, a site to apply that concept to, and had done his homework. He was ready for operations to begin. However operations did not begin with the agreeing of the heads of terms because nothing was acquired, nothing was expended or risked, nothing was ventured and nothing won until, at the earliest, the option agreement was made.

It was not until 15 April 1994, when the options were acquired, that operational activities began. Before then, the taxpayer expended time and money on his researches but, on the evidence, it was clear that, on the whole, it was not expenditure on operational activities but was limited to expenditure on travel and other matters in the pursuit of his researches. It was not in the nature of overhead costs and not expenditure directly on acquiring the particular thing which was to be turned to account: it did not directly produce that which was to be supplied. The activity in which that expenditure was incurred was preparing to trade (Birmingham & District Cattle By-products Co Ltd v IR Commrs (1919) 12 TC 92, Kirk and Randall Ltd v Dunn (HMIT) (1924) 8 TC 663, Khan v Miah [2001] 1 All ER 282, Slater v Commissioner of Inland Revenue [1996] 1 NZLR 759, Minister of National Revenue v MP Drilling Limited (1976) 76 DTC 6028 considered).

(2006) Sp C 551. Decision released 3 July 2006.