Profits, gains and income: which is which and why it matters.
David Whiscombe revisits a question as old as Income Tax itself.
“Income Tax, if I may be pardoned for saying so, is a tax on income.” So said Lord Macnaghten in 1900. Equally unsurprisingly, Capital Gains Tax (“CGT”) is a tax on capital gains.
In view of the disparity between the rates at which Income Tax and CGT are charged, it is as well to understand which tax applies where an asset is sold at a profit. But it’s particularly important if you happen not to be a resident of the UK for tax purposes.
Historically, non-residents have not been liable to CGT except on gains made on the disposal of assets which have been employed as capital assets in a UK business. That changed in 2015 when gains on residential property were brought into charge, and again in April 2019 when the charge was extended to non-residential property and to interests in certain assets deriving 75% or more of their value from UK land. But, subject to those exceptions, non-residents don’t pay CGT. This is so, regardless of whether the assets in question are located in the UK at the time of disposal: as a non-resident, you can safely send your Rembrandt for auction in London without fear of picking up a CGT bill.
However, non-residents do pay Income Tax on “UK source income”. That includes (among other things such as rent from UK land and buildings), profits of a trade (or profession or vocation) that is carried on in the UK. If you are resident in a country that has a full double tax treaty with the UK (most do), you are exposed to UK Income Tax on such profits only to the extent that they derive from a “permanent establishment” in the UK. If you are either resident in a country with no such treaty, or as a “tax nomad” you are resident nowhere, then you are liable to UK tax to the extent that you carry on your business in the UK whether or not you do so through a “permanent establishment”.
(We should add that special rules apply to “transactions in UK land”, which we aren’t covering here).
All of which invites the question – how do you differentiate between a profit on sale that is exempt as a capital gain and one which is taxable as income from a trade?
The question has given hours of lucrative fun to tax lawyers for well over a century. Very broadly, buying something with a view to turning it at a profit is likely to be trading – the more so if it’s a short-term deal or a repeated one, or if you enhance, modify or repair the asset, or break bulk, or buy and sell in different marketplaces, or if you are already trading in some closely-related field: but case law shows that in extremis, one deal of buying and selling a single asset can create a trade and a liability to Income Tax.
By contrast, buying something that you keep for a reasonable period of time before disposing of it at a profit looks more like an “investment” dealt with under the CGT code – especially if the profit is unforeseen or if, during the time you own it, the asset generates some income or affords you pride of possession or pleasure of use.
At the margins, of course, there can be room for judgement as to the right treatment and fine nuances can make all the difference. For more information, take a look at our tax consultancy services page or contact us using our enquiry form.