Day Trading and UK Tax
UK tax law is written over thousands of pages detailing what individuals must do to comply. However, within these thousands of pages of tax law there is no definitive answer as to how a day trader should tax the profits derived from day trading. Therefore, it is down to us tax advisers to be knowledgeable about HMRC guidance and case law in this area and provide our day trader clients with a clear understanding of the tax implications of their day trading activities.
The tax implications of Day Trading
One might assume that if you are day trading full-time you will automatically be considered a self-employed day trader. This isn’t the case. It is true that when your day trading activities are your only source of income we must consider whether your activities constitute a “trade”; in the same way any self-employed individual carrying on a business activity carries on a “trade”. However, there are many factors that determine whether someone is self-employed in the eyes of HMRC.
If HMRC ever queried your day trading activities they would first look into the way in which you carried out your day trading activities. HMRC would then refer to their Business Income Manual and more specifically the Badges of Trade, contained within the manual, in order to determine the correct tax treatment of your day trading profits or losses. The Business Income Manual is internal guidance used by HMRC and published for use by taxpayers and their advisers. You can take a look at the Business Income Manual and the Badges of Trade below:
You can see that the Badges of Trade contain a number of areas, all of which must be considered when deciding whether to register your day trading activities as a self-employed business. Self-employed day traders are liable to Income Tax. You can read more about self-employment and day trading in our factsheet.
What if after having reviewed the Badges of Trade it transpires that even though day trading is your only source of income, you’re not classed as being self-employed? There are two other ways in which day trading profits and losses are treated for tax purposes. The first is that the day trader will be treated as a private investor, where gains made from day trading will be liable to Capital Gains Tax. The other possibility is that day trading activities are deemed to be speculative in nature and similar to gambling, such that any profits from day trading will not be taxable. You might think that having your day trading profits treated as gambling and not taxable would be the best scenario, however, this isn’t always the case, you can read more here.
An important point to note is that when considering the Badges of Trade, it is the day trader’s approach to trading that determines the tax implications. The financial instrument that the day trader is trading, be that cryptocurrencies, binary options, FOREX, shares or another financial instrument, is only one factor amongst the many that have to be considered when determining the tax implications of day trading. A day trader can’t assume that he/she is self-employed, a private investor or a gambler in isolation of the Badges of Trade. A day trader might think that his/her approach to day trading is the exact dictionary definition of “gambling”. However, it is not the dictionary definition or even what is generally understood by gambling, self-employment or investing, that will satisfy HMRC; it is how HMRC defines these terms that we must understand and adhere to.
If there aren’t clear guidelines as to what HMRC want you to do, why should you do anything?
The UK has operated the self-assessment tax system for individuals for over 20 years. Under self-assessment it is the taxpayer’s responsibility to “self-assess” and accurately report and pay the correct amount of tax by the due date. Fines for late tax returns and interest and penalties for the late payment of taxes are levied on those that don’t meet the deadlines.
HMRC have increasing powers to detect undeclared income. Those that are well informed of the perils of getting on the wrong side of HMRC would always opt to ensure that they met all their obligations when reporting to HMRC. Then there are some people who might have every intention to gain an understanding of the tax implications of their day trading activities, but put it off, for one reason or another. Whilst others might think that they don’t have to do anything until HMRC come knocking. In both cases, the day trader is exposing themselves to questions from HMRC or a full-blown enquiry into their tax affairs. If HMRC do come knocking years after the day trader first began day trading, not only will they expect the day trader to have reported and paid all the tax due from the date he/she first began day trading, but they will expect the day trader to have correctly determined whether he/she is liable to Income Tax or Capital Gains Tax. If the day trader finds themselves in the unfortunate position of not having reported their day trading profits correctly to HMRC, then HMRC will demand payment for back taxes in addition to interest and penalties. You can read about the day trader who was taken to court when HMRC didn’t agree with the day trader that his day trading losses had come from a self employed day trading business – A Ali v HMRC (2016).