Trading Taxes in the UK
UK trading taxes are a minefield. Whether you are day trading CFDs, bitcoin, stocks, futures, or forex, there is a distinct lack of clarity, as to how taxes on losses and profits should be applied.
However, with day trading promising an enticing lifestyle and significant profit potential, you shouldn’t let the UK’s obscure tax rules deter you. This page will break down how trading taxes are exercised, with reference to a landmark case. Finally it will conclude by offering useful tips for meeting your tax obligations.
Part of the confusion around HMRC day trading taxes comes because everyone’s activities are different. Some who trade forex will be given a tax exemption by HMRC, whereas others will face expensive obligations.
UK tax implications are equally as concerned with how you approach your trading activities as to what it is you’re 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 you fall under this bracket any day trading profits are free from income tax, business tax, and capital gains tax. As you can probably imagine, falling into this category isn’t a walk in the park (more on that later).
The second category taxes trading activity in precisely the same way a normal self-employed individual undergoing business activity is taxed. You will be liable to pay business tax, or the obligations of those who fall under the third tax bracket.
3. Private Investor
If you are classed as a private investor your gains and losses fall under the capital gains tax regime. The benefits and drawbacks of which are detailed further below.
It’s worth bearing in mind that because trading activity fluctuates, you could well fall within any and 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 hold shares as his stock like a hardware store holds power tools. Whereas, an investor, will hold shares for use as assets to then generate income, dividend income, for example.
This is important because a share trader will pay income tax, whilst an investor will pay capital gains tax.
Which Classification Is Advantageous?
Prior to 2008, there were no substantial differences between each status.
If you were classed as a trader you were able to offset more expenses. Share investors, however, allowed for tapered relief and your 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, April 2008 brought with it change. Gone was tapered relief and in its place, a fixed 18% capital gains tax rate was introduced. This gives 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, it’s not all bad news. As a trader, you have more flexibility in regard to the treatment of losses. Instead of being carried forward to be offset against further capital gains, you can offset the loss against any other income for the tax year of the loss. So, if day trading isn’t your only course of income, you could potentially offset losses against employment income and interest income, for example.
It’s worth noting that if you claim a trader status to benefit from loss relief, HMRC often 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’ in order to determine whether you’re 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 vital 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 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 will consider the following:
- How you acquired the shares – Did you purchase or inherit them? If you sold inherited shares you would obviously be less likely to be classed as trading, and it’s 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 in your chosen instrument? This is one of the most important areas of consideration.
Whilst all of the above factors are taken into account to determine your financial trading tax obligations in the UK, on the whole, 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 will lead the HMRC to take a closer look and consider the argument for ‘trading’.
So, stocks do bring with them some advantages in comparison to options trading taxes, for example.
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.
What he won, was 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 has 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 simply offset these losses against other forms of income.
It’s 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. So, what should you take from the case? Mainly, that getting into a disagreement with HMRC can be a long-winded and expensive process. If Mr. Ali had asked permission beforehand, instead of seeking forgiveness afterwards, this whole episode could have been avoided.
The solution then – always query with HMRC and seek advice first. It could save you considerable time and significant money.
Different Instruments, Different Taxes?
As you may have already gathered from this page, CFD trading tax implications in the UK will be the same as those interested in FX, binary, bitcoin, and commodity trading taxes. HMRC is less concerned with what you’re trading, and more interested in how you’re trading it. Share trading tax implications will follow the same guidelines as currency trading taxes in the UK, for example.
I hate to be the bearer of bad news, but those hoping to start trading forex tax-free aren’t going to have much luck either. 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.
Even with all the information at your disposal, day trading and UK tax is still an unsteady tightrope to walk. That’s why you need to act sensibly. Fortunately, there are two main tips to follow.
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. You should keep an account of the following:
- Purchase and sale date
- Entry & exit points
With this information to hand, you’ll save yourself a large headache when you file your tax returns.
You can also get your hands on software which makes this process hassle-free. Taxes on day trading bitcoin can be automatically identified if software has access to your trade history, for example.
2. Seek Advice
With so much capital on the line, is it really worth risking any mistakes? If you are unsure you can always contact HMRC to seek clarification. There are also numerous tax advisors that specialise in tax for day traders. It’s easy to think you don’t want to fork out the extra cash, but you may find they can save you sizeable sums.
UK taxes on forex, stocks, options, and currency day trading are not crystal clear. You will need to carefully consider where your activities fit into the categories above. It’s also worth bearing in mind that failure to meet your tax obligations can land you in extremely expensive hot water, and even prison. So, if you want to stay in the black, take taxes seriously.
This page is not trying to give you tax advice. It simply looks to paint a clearer picture of HMRC’s approach to trading activity. Finally, before you file your tax returns, it’s always advisable to seek professional tax advice.