For tax to be in point, the seller must either be trading or must realise a capital gain.
A person who is trading must pay income tax on his or her profits. Therefore, the first stage in deciding if an Income Tax liability is in point is to determine whether an e-bay seller is actually trading. The line between offloading some old stuff on a regular basis and starting to trade can be a fine one and it will not always be apparent when the line has been crossed.
For a trade to exist there has to be a two-way relationship between the trader and the customer, and the trader must provide goods or services to the customer on a commercial basis. To help decide if someone is trading, the courts have identified nine badges of trade which, essentially, are indicators that a trade is being carried on. However, it is not essential that all the badges are present for there to be a trade – a trade may exist if only one or two of the indicators are present. The badges are as follows:
Badge of Trade
An intention to make a profit supports trading
Number of transactions involved
Systematic and repeated transactions support trade
Nature of goods sold
Are the goods only capable of being turned to advantage by being sold or do they yield income or give enjoyment through ownership
Existence of similar trading transactions
Was this a one off transaction or part of a pattern that suggests trading
Changes to the goods
Were the good repaired, modified or improved to sell them more easily
The way that the sale was carried out
Were the goods sold in a way that indicates trading or to raise cash in an emergency
Source of finance
Was money borrowed to buy the goods? Were any profits used to repay the loan
Interval of time between purchase and sale
Goods traded are usually bought then sold quickly
Method of acquisition of the goods
Goods acquired by an inheritance or as a gift are les likely to be the subject of a trade
A person who sells goods bought for resale, makes items to sell intending to make a profit, sells or buys goods on someone else’s behalf for financial gain or who provides a service for payment is regarded as trading. Such a person will be treated by HMRC as self-employed and will need to pay Income Tax on any profits along with Class 2 and Class 4 National Insurance contributions.
Conversely, a person who sells occasional unwanted items will not be treated as trading and will not be taxed on any profit made.
Polly has a large clear out prior to moving out. She sells some furniture, clothes and unwanted items on e-bay and makes £4,200. She is not trading. The sale of the items is a one-off payment rather than a regular occurrence. The items sold are personal items rather than goods purchased for resale. They are sold as part of a clear out. This is not a trade.
Louise makes jewellery as a hobby. She gives some of the items she makes to friends and family as birthday and Christmas presents. She occasionally sells items to friends and acquaintances.
Louise has some spare items left over, so she sells them on e-bay. The intention is to get rid of the items and to hopefully raise some cash towards her holiday.
The jewellery sells well and Louise realises that there is some potential to make some money from her hobby. She starts to make jewellery specifically to sell on e-bay. She sets the minimum bid at a price that will make a profit and, after some time, opens an e-bay shop.
Initially, Louise’s jewellery making was only a hobby and the sales to friends and acquaintances and initial sales on e-bay are not trading. These are simply a by-product of her hobby. She is not operating commercially or seeking to make a profit.
However, once Louise starts to make jewellery specifically to sell and with an intention of making a profit, she is trading. At this point she is starting to exhibit several of the indicators of trade. As well as a profit seeking motive, she is performing repeated similar transactions, making goods specifically to sell and selling the jewellery as soon as it is made. These factors are indicative of a trade. Louise must pay tax on any profits that she makes.
Implications of Trading
A person who is trading on e-bay will be treated by HMRC as self-employed. They will need to register with HMRC within three months of starting to trade or face a £100 fine. They will also need to pay Class 2 National Insurance contributions of £2.20 per week and complete a self-assessment tax return. Income Tax and Class 4 National Insurance contributions on any profits must be paid by 31 January after the end of the tax year to which the return relates. Depending on the tax bill, payments on account may need to be made in future years.
Failure to recognise trading can be costly. Fines are charged for failing to register as self-employed and for failing to make a tax return when due. In addition, interest is charged on tax paid late.
The trader may also need to consider VAT. VAT registration is compulsory if the value of taxable supplies exceeds the VAT registration threshold in any 12-month period. The VAT registration threshold for 2007—08 is £64,000. Once registered a business must charge VAT on supplies and can reclaim input tax suffered on purchases.
Most people selling unwanted household items through e-bay are likely to sell them for less than they actually cost. This means that Capital Gains Tax is unlikely to be an issue in most cases.
However, a Capital Gains Tax liability will arise if an asset has increased in value during the time it has been owned and is sold for more than it cost. However, no Capital Gains Tax liability arises in respect of personal effects or goods which are individually worth less than £6,000 or on sales of private cars. Further, Capital Gains Tax is only payable where gains exceed the exempt amount, which for 2007—08 is £9,200.
Luke inherits a sculpture from his uncle. At the time that he inherits it, the sculpture is valued at £15,000. Six months later, Luke decides to buy a house and sells the sculpture on an e-bay auction to raise money towards the deposit. The sculptor has become very popular following an exhibition of his work and the sculpture sells for £26,000.
Luke is not trading. He has made a one-off sale of an item that he inherited. However, the item was worth more than £6,000 when he acquired it and he makes a gain of £11,000. As this is more than the exempt amount, capital gains tax is payable on the excess.
Those using e-bay to make some money need to be aware that the rules on trading and capital gains apply to them as they do to people selling goods through other means. The principles of trading remain the same, whether the goods are sold through a high street shop or via an online auction and the tax principles apply equally. Failure to consider possible tax consequences could prove an expensive oversight.