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. If you’re a day trader how do you know what taxes to pay and what the UK tax authorities expect of you? In the absence of specific tax legislation in this area, we refer to the sources made available by HMRC and precedents set in tax case law.
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 activities they would first look into the way in which you carried out these 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 activities as a self-employed business. If you are self-employed you will be liable to Income Tax. You can read more in our self-employment 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 could be treated for tax purposes. The first is that the trader will be treated as a private investor, where gains 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 will not be taxable. You might think that having your 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 trader’s approach to trading that determines the tax implications. The financial instrument that is being traded, 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 trader can’t assume that he/she is self-employed, a private investor or a gambler in isolation of the Badges of Trade. He/she might think that the way in which they carry out their activities 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 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 the latter two cases, the trader is exposing themselves to questions from HMRC or a full-blown investigation into their tax affairs. If HMRC do come knocking years after the trader first began day trading, not only will they expect the trader to have reported and paid all the tax due from the date he/she first began day trading, but they will expect the trader to have correctly determined whether he/she is liable to Income Tax or Capital Gains Tax. If the trader finds themselves in the unfortunate position of not having reported their day trading profits correctly, then HMRC will demand payment for back taxes in addition to interest and penalties. You can read about the defining UK tax case where day trader was taken to court when HMRC didn’t agree with him that his losses had come from a self employed day trading business – A Ali v HMRC (2016).