When I refer to “Ali” I’m not referring to the late great Muhammad Ali recreating the “Thrilla in Manila” when facing HMRC as his opponent before departing this world last year. What I’m referring to is a defining tax case that a Mr Akhta Ali won after appealing a decision made by HMRC.
This tax case is of interest to all active day traders and dispels certain myths that exist regarding the tax treatment of day trading profits and losses.
Mr Ali is a day trader who appealed to the First Tier Tribunal to challenge a decision made by HMRC.
Mr Ali’s appeal was successful and allowed the profits and losses he earned from day trading to be treated for tax purposes as “trading” profits and losses.
This meant that his day trading profits were classed as profits earned by an individual carrying on a trade, in the same way any other self-employed individual engaged in a business activity is carrying on a trade.
This ruling enabled Mr Ali to offset his day trading losses, which ran into the hundreds of thousands of pounds, against profits earned by his other business.
This reduced his overall tax liability substantially and in certain preceding tax years reduced his tax liability to almost nothing.
Day trading tax decision on appeal
Mr Ali appealed HMRC’s original decision when they disagreed with Mr Ali that the profits and losses he made from day trading should be treated as trading profits or losses.
When giving evidence in his appeal Mr Ali described how he ran a successful Pharmacy business. Mr Ali also wanted to trade shares in a professional manner as a second business, alongside his existing Pharmacy business.
During 1995 and 2002 he considered himself to be “investing” in shares.
Between 2000 and 2005, Mr Ali’s activities changed from “investing” to “trading” in shares.
Whilst he was investing in shares, Mr Ali reported the profits and losses made from share investing using the capital gains tax rules. However, around 2005 Mr Ali decided to become a day trader, stating that he conducted his day trading activities on a commercial basis with a view to making a profit.
It was from this point that Mr Ali claimed that he was carrying on a trade and that any profits and losses should be taxed under the business tax rules rather than treated as capital gains or losses.
Self-employed day trader
HMRC’s decision was consistent with what many outside the tax authorities have believed from some time, which is that HMRC take the view that day traders invariably make greater losses than profits and as such are reluctant to class a day trader as being self-employed.
Being self-employed means that the day trader is carrying on a trade and that the day trader’s profits or losses will be dealt with under the business tax rules.
Giving trading status to day traders making significant losses would enable day traders to offset any losses against other income.
HMRC would then forgo the tax revenues they would have collected had the losses not been made available for offset.
Previously many have considered this potential for lost tax revenue the reason that HMRC are not interested in a day trader’s activities; making this the reason that they do not report profits and losses made from day trading on their tax return.
The outcome of this tax case has thrown this view into question.
From investor to day trader
Looking at Mr Ali’s case from HMRC’s perspective, one can appreciate how HMRC would have been unnerved when Mr Ali appeared to move seamlessly from being an investor to someone carrying on a trade.
One year Mr Ali’s tax return would have taxed his profits and losses under the capital gains tax regime and the following year his tax return applied the business tax rules.
The result of which was to show significant losses in the years following the commencement of Mr Ali’s day trading venture; significant losses which he expected to offset against the profits he made from his Pharmacy business.
Non-existence of a clear set of day trading tax rules
Many commentators of this tax case have been surprised at HMRC’s decision being overturned on appeal. It should be noted that the First Tier Tribunal, who upheld Mr Ali’s appeal against HMRC’s decision, drew upon the same precedents set in case law to arrive at their decision that HMRC would have used to disagree with Mr Ali in the first place.
This tax case highlights the fact that the non-existence of a clear set of rules as to how to tax a day trader’s profits and losses has caused even HMRC to make a decision that didn’t hold up and which was eventually overturned by the First Tier Tribunal.
The diversity of a day trader’s activities does not lend itself to a one-size-fits-all approach to determining the tax treatment of day trading profits and losses. Whilst others have considered the outcome of this tax case surprising, I find it of no surprise at all.
Whether a day trader should be classed as a private investor or whether he or she is self-employed and, therefore, “trading” is a question not easily answered.
A favourable outcome
The outcome for Mr Ali was eventually favourable. However, had Mr Ali presented the facts of his day trading activities to HMRC, citing relevant case law, prior to submitting his first tax return which changed his status from investing to trading; then Mr Ali may well have avoided years of disagreements with HMRC.
When presented with the facts of Mr Ali’s day trading activities and being asked, before the event, what the tax treatment of profits and losses earned from Mr Ali’s intend activity would be, HMRC may well have come to the same conclusion that the First Tier Tribunal came to years later.
Mr Ali eventually got a ruling in his favour in 2015.
HMRC made their original decision disagreeing with Mr Ali’s tax returns in 2012 and were claiming penalties and additional taxes from the tax year 2006/07. A relationship with HMRC of this nature is something I think we’d all like to avoid.
When it comes to HMRC I don’t accord with the adage that “It’s easier to ask forgiveness than it is to get permission”. When your hard earned money is at stake and HMRC are in the mix, I think that it’s always better to ask permission.
If you’re day trading activities are more than just a hobby or you treat your day trading activities as an occupation, then it would be prudent to consider how HMRC views your day trading profits and losses. For day traders wondering what impact, if any, this tax case has on them there are specialist tax advisers out there that can help.