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Key points
- One person can have more than one business.
- Profit or gain is a question of fact.
- Effect of the mutual trading principle and private use.
CAN A SOLE trader who operates as a service provider charge her business rent for the premises which she owns? This was the subject of a Readers' forum query 'Office transfer', (T16,538), Taxation, 13 January 2005, page 358. There were three responses, two of which started from the premise that one cannot contract with oneself and all of which suggested hiving off the business to a partnership or a company.
I recently had a call from someone who said that a Revenue Officer is quoting the Readers' forum item against him, as evidence that other accountants hold the same opinion as herself.
As I do not hold that opinion, I thought that I might belatedly challenge what appears to have been the unanimous view of the respondents to the Readers' forum query.
You can have two businesses
Any individual can carry on two distinct businesses at the same time, bearing in mind that, for self assessment returns, a completed set of self-employment pages has to be completed for each business that person is involved in. The proposition in the Readers' forum was, however, that if a person carries on two distinct businesses, it is not permissible to submit accurate accounts in respect of either, as transactions between the businesses somehow fall to be ignored.
Suppose, for example, a garage owner decides to set up a taxi business as well. He employs people to run the garage and he also employs people to drive the taxis. Is it the case that if one of the taxi drivers fills up his taxi at the garage and pays for his petrol, the sole trader cannot claim the cost of the petrol as an expense of his taxi business and, presumably, should not treat the receipt as part of the turnover of the garage business? If so, I find that an extraordinary proposition.
Alternatively, suppose a sole trader accountant also owns and operates the village shop next door and one of the employees of the accountancy practice does the accounts of the village shop. Is the shop not permitted to claim a deduction for the accountancy fees, and should the practice not include the fees from the shop in its turnover? If so, what about the employee's salary? Has he been employed for a dual purpose, so that none of his salary is deductible or has he been employed exclusively for the accountancy business and the proprietor has used part of his services for a non-accountancy business purpose? If for some reason the business does not qualify as a small or medium-sized enterprise, the transfer pricing rules would require the profit of both businesses to reflect the market value of the accountancy services provided to the shop. It seems to me incredible if the law will not allow the owner to achieve the same effect where the business is a small business.
According to the law …
What does the law actually say? It states that tax is charged on the profits of a trade, profession or vocation (ITTOIA 2005, s 5) and that it is charged in the full amount of the profit of the tax year (s 7). 'Profits' are not defined. It must surely therefore have the normal day-to-day meaning. The law also states that the profit must be calculated in accordance with GAAP, subject to any adjustment required or authorised by law (s 25).
As an accountant I would not consider that the profits of the garage business can be calculated without including the sales to the taxi business, or that the profits of the accountancy practice can properly be computed without including the work done for the village shop. Indeed in Sun Insurance Office v Clark (1912) 6 TC 59 Lord Haldane opined that, 'It is plain that the question of what is or is not profit or gain must primarily be one of fact and of fact to be ascertained by the tests applied in ordinary business'. That is surely still good law today. Nothing has happened in the intervening 95 years to override it.
Whose expense?
So what is the proposition? The Officer's proposition in the case that has come to my attention seems to be, not that the charge for the petrol is not properly income of the garage business, but rather that the cost of the petrol is not an expense incurred wholly and exclusively for the purpose of the taxi business within ITTOIA 2005, s 34, and that the law therefore requires an adjustment to be made to disallow it. This is bewildering. The only reason for buying the petrol is for the purpose of the taxi business. To be fair, in the case I have in mind, the taxi driver did not pay for the petrol: the adjustment between the two businesses was made by means of a book entry. But I cannot see how that can make a difference. The fact that a cost is paid by way of a book entry does not make it any less of an expense. My dictionary defines an expense as a cost, and a cost as a price to be paid for a thing. The book entry surely reflects the price to be paid for the petrol.
I have used a garage and a taxi business to illustrate the principle involved. The query addressed in Taxation concerned rent. Is the principle any different? Surely not! The profits of a property rental business must be computed in precisely the same way as those of a trade.
Mutual trading principle
The only other possibility that I can envisage is that the profit from the sale of the petrol, the receipt for the accounts or the receipt of the rent is not taxable under the mutual trading principle. But again that seems to me an extraordinary proposition. The leading case on mutual trading is probably Styles v New York Life Assurance Co (1889) 2 TC 460. But that was a case, as described by Lord Watson, 'where a number of individuals agree to contribute funds for a common purpose … to some or all of them … and stipulate that their contributions, so far as not required for that purpose, shall be repaid to them'. In such circumstances, he (and most of his fellow Lordships) did not regard the activities as a trade.
The contrast was made in that case with the position in Last v London Assurance Corporation (1885) 2 TC 100, where the House of Lords held that the company was carrying on a trade and the profits of with-profits policyholders were profits of that trade.
In other words, the principle seems to be not that I cannot trade with myself but rather that if a group of us sets up a business to trade with ourselves then it is not a trade at all (except in relation to any transactions with third parties) but a cost sharing arrangement. If it is not, an individual transaction that happens to be a mutual one cannot be excluded from the profits of that trade. If that were not the case, it is difficult to see why Lady Wernher should have been taxable on moving her racehorse from her stud to her racing stable.
Furthermore, I have never heard it suggested by HMRC that a shopkeeper should exclude from his takings purchases that he himself has made from the business. Indeed if the shopkeeper does not charge himself for a provision to him by his business, HMRC require a notional trading transaction to be introduced to reflect private use.
It also needs to be borne in mind that the principle of mutual trading is specifically excluded in calculating the profits of a UK property business (ITTOIA 2005, s 321). The reason for this is fairly clear. HMRC regard it as a concept that can apply only to traders, so taxing a property business, as a trade ought not to extend to it the mutual trading principle.
Trade away
I accordingly conclude that not only can I trade with myself (in the course of a larger trade) but that the taxman will want his share of the profit from my doing so.
It must surely follow that if one of my businesses trades with another of them I am as entitled to deduct the cost in the same way that I deduct it where I buy goods or services from someone else.
