Trading or investing – how is the income taxed?

Article updated August 2020

Once you’ve established whether you are trading or investing, your thoughts will inevitably turn to how the income is going to be taxed.

The two types of income have quite different tax treatments and it’s important that you consider which approach to take based on your circumstances. If you don’t, you may find that HMRC challenge this in the event of an enquiry and if they disagree with your approach, you may receive a hefty tax bill!

If you are carrying on an income generating activity (i.e. trading) you will be liable to Income Tax and National Insurance, whilst investors will be liable to Capital Gains Tax.

If you are using a corporate structure (e.g. limited company) to conduct your trading/investment activities, this would be liable to Corporation Tax on any profits or gains at precisely the same rate.

Looking at trading first of all, the main advantages are that:

  • You can claim more in expenses against the income which will reduce your tax bills. Expenses that you can claim for include office rent, utility bills, professional subscriptions, research material and any share dealing expenses along with any employees' salary.
  • You have flexibility with offsetting trading losses as these could be offset against other income received in the same year. You can carry these back to the previous year or carry them forwards to offset against future trading profits. All of these will either reduce your tax bill (perhaps a future one) or generate a refund.

However, the disadvantages are also that:

  • You will have to pay National Insurance at self-employed rates on any profits made in addition to your income tax bill if you are self-employed, and any trading losses made in previous or subsequent years will not reduce this liability.
  • You could potentially lose your annual Capital Gains Tax allowance each year (unless you have other sources of investment income).
  • If you make more than £150,000 income (from all sources), you could end up with a substantial tax and National Insurance bill (although if you are not spending all of these profits personally you could make a decent saving in your tax bill by using a corporate structure).

Looking at the investing 'alternative', the advantages are:

  • The headline rates of Capital Gains Tax appear to be much more favourable as if you are a higher rate taxpayer, there is currently no upper limit on the tax payable on the gains and there’s simply a tax rate for basic rate tax payers and another rate for higher rate tax payers – regardless of the total investment income.
  • You get an annual CCGT allowance each year which is exempt from tax.

However, whilst this approach can appear more beneficial in the majority of cases, there are disadvantages that need to be considered:

  • You can only claim dealing costs and stamp duty (if applicable) as expenses against the gains.
  • If you make a loss on your investment activities during the year, these losses can only be carried forward and offset against future losses which means short term tax refunds are much less likely. 

At first it may appear that the overall tax bills are lower as an investor, but this isn’t necessarily the right option for you as it does depend on how you are approaching the financial trading activity.   

Of course, swapping between the options each year would also be very tax efficient, but unfortunately is also very likely to attract the attention of HMRC if you do not have very good reason for doing so!

If you don’t know whether you are an investor or a trader, refer to our article here on the differences.

If you need support in submitting your tax bill and ensuring you don’t pay more tax than you have to, contact us on enquiries@a4g-llp.co.uk or call 01474 853 856.

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