Only fools and horses

If you’re thinking of setting up a new business venture as a side line, it’s vital to structure it carefully and in a tax effective manner.

The taxman will not be sympathetic if it all goes horribly wrong and this was highlighted in a recent tax case. So what was the case?

Well it involved Ewan McMorris - a doctor and horse racing enthusiast. He bought a half-share in a racehorse called Hermes for the princely sum of £8,000.

As part of the deal he agreed to meet half the costs of training, livery and racing. Things got off to a promising start initially, culminating in an unsolicited offer of £50,000.

This was rejected because the trainer was convinced Hermes had more (money earning) potential - a tie in with a luxury brand was even in the offing.

Unfortunately, Hermes’ achievements on the racetrack proved to be short-lived. Not only did his value plummet, he suffered the ignominy of being sold as a polo horse for the paltry sum of £1,000.

So why did the taxman get hot under the collar?

Well, Mr McMorris tried to recoup his costs by claiming tax relief for business losses on his tax return.

He described the trading activity as ‘Racehorse’ and this probably raised alarm bells with HMRC. As he was a hospital doctor (and not a jockey or stable owner), HMRC refused Mr McMorris’s claim. They argued it was a hobby and not a trade.

Losses from a trade are potentially tax deductible against other income, whereas losses from a hobby are not.

Mr McMorris was unhappy with the taxman’s stance and appealed against their decision.

The taxman applies various tests (‘badges of trade’) to determine whether a business activity is taxed as a trade. The Tribunal therefore applied the ‘badges of trade’ to Mr McMorris’s activity and concluded that a number of factors counted against him.

What were those factors?

Well, the deal was a one-off transaction (numerous transactions point towards trading), no commercial lending had been entered into for the venture and everything appeared to have been arranged informally. There wasn’t even a proper long term business plan.

It also didn’t help that Mr McMorris, in the tribunal’s words, “clearly derived pleasure” from this activity. This simply underlined the fact that in the tribunal’s eyes, it was a hobby and not a proper trading venture.

Mr McMorris lost his appeal and presumably will be steering clear of racecourses in future.

Whilst we don’t think it’s a crime to enjoy your business, we do consider it’s necessary to have a formal structure in place. This could prove vital in securing any tax relief should your new business venture go pear-shaped.

Our advice? Don’t back the wrong horse. Contact our friendly tax adviser Richard on 01202 048696 or [email protected].

And remember, these tips are not a replacement for professional advice tailored to your precise needs and circumstances.