Trading Taxes in the UK
UK trading taxes are often misunderstood. Whether you are day trading CFDs, stocks, forex, or futures, there is a lack of clarity as to how taxes on losses and profits should be applied.
This article will break down how trading taxes work, with reference to a landmark case. Our team also offer tips for meeting your tax obligations.
- His Majesty’s Revenue and Customs (HMRC) puts trading activity in the UK into three main categories: speculative, self-employed and private investor.
- Tax obligations often depend on whether someone is classified as a day trader or an investor, with the former typically paying income tax and the latter paying capital gains.
- Other factors that HMRC consider are the frequency of trades, how instruments were purchased and whether the motivation was solely to generate profit.
- Traders should keep a record of their yearly trading activity ahead of filing a tax return, including instrument details, entry and exit points, and price.
The Best Brokers In The UK
Part of the confusion around HMRC trading taxes comes because everyone’s activities are different. Some who trade forex are given a tax exemption by HMRC, whereas others can face expensive obligations.
UK tax implications are equally concerned with how you approach your trading activities as to what it is you are trading. The instrument is just one factor in your tax status.
However, case law and regulations have settled on breaking trading activity into three distinct categories, for the purpose of taxation.
The first category is speculative in nature and similar to gambling activities.
If a trader falls under this bracket any day trading profits are normally free from income tax, business tax, and capital gains tax.
The second category taxes trading activity in the same way a normal self-employed individual undergoing business activity is taxed.
Traders may be liable to pay business tax, or the obligations of those who fall under the third tax bracket.
3. Private Investor
If a trader is classed as a private investor, their gains and losses normally fall under the capital gains tax regime. The benefits and drawbacks of which are detailed further below.
It is worth bearing in mind that because trading activity fluctuates, it is possible to fall within all of these three categories over a given period.
Day Trader vs Investor Status
Whether you’re classed as a day trader or an investor could make a serious difference to your tax obligations.
The crucial distinction is that a ‘trader’ will not hold on to shares in the long-term. Whereas, an investor will hold shares for use as assets to then generate revenue, dividend income for example.
This is important because a stock trader will often pay income tax, whilst an investor will more likely pay capital gains tax.
Which Classification Is Advantageous?
Prior to 2008, there were no substantial differences between each status.
Traders were able to offset more expenses. Stock investors, however, allowed for tapered relief and their annual exemption to be offset.
Consider that many currency, options, and stock speculators only hold onto assets for a short period of time, this means for both investors and traders the tax rate could be 40% (assuming they were both higher rate taxpayers).
Having said that, there were genuine investors who held onto shares and assets for a long period of time. This qualified them for a more beneficial capital gains tax rate of 24%, or just 10% if they invested in AIM shares.
However in April 2008, a fixed 18% capital gains tax rate was introduced in place of tapered relief. This gave the majority of investors a substantial tax advantage over traders. The additional tax relief on expenses probably would not make up for the significant reduction in the tax rate for investors.
Fortunately, traders now have more flexibility regarding the treatment of losses. Instead of being carried forward to be offset against further capital gains, traders can offset the loss against any other income for the tax year of the loss.
So, if day trading isn’t their only course of income, they could potentially offset losses against employment income and interest income, for example.
It is worth noting that if you claim trader status to benefit from loss relief, HMRC may take a closer look. Due to this supposed advantage of investor status, day trading tax rules in the UK may toughen up in coming years.
HMRC consider the ‘badges of trade’ to determine whether your activity will be classed as trading or investment in nature.
Whilst tax rules and regulations remain somewhat grey, judicial decisions and best practice have clarified certain criteria and factors.
Despite being one of the hardest areas to make an accurate determination on, this is a key component.
If HMRC believes your motivation for trading is to generate profits, this will impact on whether they consider your activity as trading for the purposes of taxation.
Of course, they do not simply take your word for it. Instead, they look at the facts surrounding your transactions. They may consider the following:
- Was it a one-off trade? Alternatively, have there been numerous trades of the same nature, carried out in a similar manner to ordinary traders?
- Is this your sole occupation? Alternatively, do you have other employment, suggesting you don’t trade purely to make a living?
- What do you do with your profits? Do you re-invest them into more trading activity?
HMRC can examine the circumstances surrounding the transaction to identify a trading motive. They may consider the following:
- How you acquired the shares – Did you purchase or inherit them? If you sold inherited shares, it would probably be less likely to be classed as trading, and is more likely to be considered investment activity.
- Timing – What was the length of time between the purchase and sale date?
- Means – Did you use finance to buy your instrument?
- Cause – Did a sale take place in an emergency? If so, it’s less likely to be considered as trading.
- Frequency – Is there evidence of a pattern of trading behaviour? Are you regularly buying and selling your chosen instrument? This is one of the most important areas of consideration.
Whilst all the above factors may be taken into account to determine your financial trading tax obligations in the UK, overall, instruments that generate an income are classed as investment assets.
In particular, stock trading tax in the UK is more straightforward. This is because there is a higher chance share trading by its very nature will be classed as investments.
A judge highlighted the point by stating, “Where the question is whether an individual engaged in speculative dealings in securities is carrying on a trade, the prima facie presumption would be … that he is not.”
Having said this, a frequent pattern of buying and selling shares may lead HMRC to take a closer look and consider the argument for ‘trading’.
A Ali v HMRC
The case brought by Mr. Akhta Ali was a defining case in UK trading taxes. After Mr. Akhta Ali successfully appealed a decision brought by HMRC, a number of common misconceptions were put straight. The case brought much-needed clarity in considerations around day trading profits and losses, in particular.
Ali won the right to treat his profits and losses from day trading as ‘trading’ profits and losses. This meant they would be subjected to the same sole trader tax rate as ordinary businesses in the UK.
His losses, which were in the hundreds of thousands of pounds, were allowed to be offset against the profits earned by his other business. This resulted in significant deductions in his overall tax liability. In fact, in a number of preceding years, a tax calculator established his liability at virtually zero.
Mr. Ali ran a successful pharmacy business. He wanted to day trade shares as a second legitimate business. Between the years 1995 and 2002, he considered himself as an ‘investor’. Then, between 2000 and 2005 his activities changed from ‘investing’ to ‘trading’. So, whilst investing his shares he reported the profits and losses in line with capital gains regulations.
In 2005 he decided he was now a day trader. He argued his activities were done with the intention to generate income. He, therefore, believed he was carrying on a trade and any profits and losses should now fall under the business tax rules instead.
The HMRC ruling was in line with what many believed at the time. This was that losses would often exceed profits for day traders and therefore they were hesitant about classing day traders as self-employed.
The 2016 ruling meant HMRC will now have to sacrifice the considerable tax revenues they had previously generated from losses, as day traders can now offset these losses against other forms of income.
It is easy to see why HMRC were unwilling to accept such a seamless transaction from investor to trader. The lines are difficult to draw and will likely lead to less revenue for the tax man.
The simple truth is the diversity of a day trader’s activities doesn’t fit within a one-size-fits-all approach.
The best solution is to query with HMRC and seek advice first. It could save you considerable time and significant money.
Different Instruments, Different Taxes?
CFD trading tax implications in the UK will likely be the same as in FX, binary options, bitcoin, and commodity trading taxes. HMRC is less concerned with what you are trading, and more interested in how you are trading it.
Share trading tax implications generally follow the same guidelines as currency trading taxes in the UK, for example. Forex trading tax laws in the UK are in line with rules around other instruments, despite you buying and selling foreign currency.
However, if you remain unsure about tax laws surrounding your specific instrument, seek professional tax advice.
1. Keep A Record
Your trading activity over the course of a year can vary between ‘speculative’, ‘self-employed’ and ‘investing’ activity. That means when it comes to filing your tax returns you need a detailed account of all your trading activity, including details on:
- Purchase and sale date
- Entry & exit points
You can also make use of software which makes this process hassle-free. Some brokers, such as CMC Markets, also offer an integrated reporting tool which can provide a yearly summary of your trading activity.
2. Seek Advice
If you are unsure, we recommend contacting HMRC to seek clarification. There are also numerous tax advisors that specialise in tax for day traders.
UK taxes on forex, stocks, options, and currency day trading are not always clear. You will need to carefully consider where your activities fit into the categories above. It is also worth bearing in mind that failure to meet your tax obligations can lead to serious penalties.
This page is not trying to offer tax advice. It aims to clarify HMRC’s approach to online trading activity. Before you file your tax returns, it is advisable to seek professional tax advice.
- His Majesty’s Revenue & Customs (HMRC)
- HMRC Tax Assessment Guidance On Trading Profits
- A Ali v HMRC, Tax Journal
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