In this case, the First Tier Tribunal was asked to consider whether trade losses can be set off against general income in the context of whether or not the trade in question was commercial.

Background

The taxpayer appealed against HMRC's decisions to amend his self-assessment tax returns for 2007/08 and 2009/10, and to issue a further assessment for tax in 2008/09. HMRC's decisions resulted in a revised figure for tax due in each of the years in question. The issue involved was whether he was entitled to set off the trading losses in the aforementioned years which arose from his yacht charter business as a sole proprietor against his other income.

Before commencing the charter business the taxpayer devised a business plan with his accountant where he identified a break-even point of 20 day charters per annum estimating that the ship would be available for charter on 137 days per annum of which 122 days would be in the season of April –October. Prices were fixed having regard to the charges made by his competitors.

From August 2006 to May 2009 he operated a classic yacht charter business for private customers in West Somerset as a sole trade. Corporate charters were carried out under the structure of a company, B Original Ltd, of which he was the sole director and shareholder. This was because he believed that a corporate image was better suited to corporate clients.

The taxpayer contended that his business was carried out on a commercial basis with a reasonable expectation of the realisation of profit. In those circumstances he contended that the trading losses in each year could be set off against his general income for the year in question.

HMRC did not agree and stated that his trade was not commercial within the meaning of section 66 of the Income Tax Act (ITA) 2007. He was thus entitled to carry forward the trading losses incurred in the Yacht Charter Business and set them against any future profit in the same trade but not permitted to set off the losses against general income in the years in question.

As part of the evidence in the case the log book was examined which detailed the numbers and frequencies of the charters for the year ended 31 March 2008. The log book showed that there were 18 sailings and three private charters as compared with at least 15 corporate charters.

HMRC pointed out that there were ten sailings during 2008 without guests. The taxpayer explained that these occasions related to days spent on systems testing, crew training, and travelling to and from places for the charter. HMRC also suggested that some sailings took place for his private use.

No analysis of the log book was supplied for the years 2009 and 2010 hence the income received in those years was estimated by the Tribunal to be one or two private charters in 2009, and around nine in 2010. When challenged on this the taxpayer stated that the poor performance of the chartering businesswas due to the recession and the recent unpredictable summer weather conditions characterised by heavy rainfalls arguing that he could not have anticipated an economic meltdown and the adverse weather conditions when he set up the business in 2006.

Decision

The commercial test in section 66 ITA 2007 involves two distinct elements which both have to be satisfied in order to meet the test. The two elements are set in section 66(2) ITA 2007 which provides as follows:

“The trade is commercial if it is carried on throughout the basis period for the tax year—

1. on a commercial basis, and
2. with a view to the realisation of profits of the trade”.

The judgment in Wannell v Rothwell (1996) 68 TC 719 was cited as explaining the meaning of commercial basis:

“the best guide is to view ‘commercial’ as the antithesis of ‘uncommercial’ A trade may be conducted in an uncommercial way either because the terms of the trade are uncommercial or because the way in which the trade is conducted is uncommercial in other respects (for instance, the hobby Art Gallery or Antique Shop where the opening hours are unpredictable and depend simply on the owner's convenience). The distinction is between a serious trader who, whatever his shortcomings in skill, experience or capital, is seriously interested in profit, and the amateur or dilettante”

The second element of the test with a view to the realisation of profits, is expanded upon in section 66(3) of the ITA 2007 which states that

“if at any time a trade is carried on so as to afford a reasonable expectation of profit, it is carried on at that time with a view to the realisation of profits”.

Under section 66(4) ITA 2007 where a trade forms part of a larger undertaking, the Tribunal stated it is entitled to consider the profits of the trade as referring to the profits of the undertaking as a whole. Thus in this case, the “commercial basis” element could only be considered from the perspective of the sole proprietorship, whereas the “realisation of profits” element could take account of the profits for both the sole proprietorship and B Original Limited.

Finally, section 66 ITA required the Tribunal to examine the commercial test throughout the basis period for the tax year. Thus the test has to be considered afresh for the basis period of each tax year under appeal.

The Tribunal acknowledged that the taxpayer approached the private charters in a business-like manner in respect of his training as a skipper of a commercial vessel, maintaining the vessel to the standards required for the carrying of fare paying passengers, the formulation of business plans and the pricing of charters based on research of his competitors.

These facts were, however, outweighed by the organisation of the venture with the split between private and corporate charters which were delivered by separate legal entities, the sole trade and B Original Limited.

The allocation of business expenses between the two entities did not reflect a fair attribution in accordance with their respective uses. In addition, the taxpayer failed to observe the terms of an agreement with B Original Limited by not billing the company from time to time for the outgoings and others expenses associated with the vessel. A higher trading profile was also afforded to B Original Limited in respect of the website, advertising and invoicing which had the effect of minimising the business opportunities for the sole trade.

The Tribunal was also required to assess whether the sole trade business was carried out on a “commercial basis”. The Tribunal found that that the arrangements with B Original Ltd were such that the sole trade was starved of business and used for the offsetting of expenditure.

Thus the Tribunal was satisfied that in 2007/08 and 2008/09 the sole proprietorship was not being run in such a way that a profit could be made and, therefore, it did not meet the “commercial basis” element of the test as laid down in section 66(2) ITA 2007.

In view of this there thus was no obligation on the Tribunal to consider whether the “view to the realisation of profits” element was met in regard to the undertaking of the whole in 2007/08 and 2008/09.

The Tribunal considered that different circumstances applied to the situation for the year 2009/10. At that time the business was run under the one umbrella of the sole proprietorship. In so doing the taxpayer reduced the business expenditure by over a third, raised the trading profile of the sole proprietorship and ensured the proper allocation of business costs. The business was also relocated to a more developed infrastructure and bigger visitor and corporate markets.

The Tribunal found that that these changes enabled the taxpayer to carry out its chartering business on a “commercial basis”.

The issue in 2009/10 was then whether the business was carried out with “a reasonable expectation of profit”. The sole trade did not make a profit in that year which was principally due to another fall in the number of charters. However, the scale of the losses had been reduced from the previous year as a result of the costs reduction programme associated with the relocation and running the business under one umbrella.

The Tribunal formed the view on the evidence that despite making a loss in 2009/10 there was a reasonable expectation of making a profit from the chartering business in that year. The costs reduction programme brought down the break-even point between income and expenditure. Had the sole trade achieved that level of sales in 2007/08 the sole trade would have made a small profit.

The relocation should have resulted in more business. The fact it did not was likely to have been due to factors outside the taxpayer's control, weather being cited as one factor.

The Tribunal was therefore, satisfied that the business in 2009/10 was commercial within the meaning of section 66 ITA 2007. In view of its findings the Tribunal allowed the appeal in part.

The full text of the case is available from http://www.bailii.org