Tax-wise, which is best - trading or investing?

Unfortunately, there is no clear answer to this question and differing personal circumstances will inevitably make one route more attractive than the other, although of course ultimately, it may not necessarily be your decision if you are subject to an HM Revenue & Customs enquiry!

However, it is important to realise that if you are treated as trading you would be liable to Income Tax and National Insurance, whilst investors would 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 much more in the way of tax relief for expenses with regards to your trading activities such as office rent, utility bills, any professional subscriptions, research material, Bloomberg subscriptions, any share dealing expenses along with employees' salary
  • you have more flexibility on how to offset any trading losses by either offsetting the loss against the other income that you received during that tax year, carry it back against the income in the previous tax year or carry it forward against the future profits arising from the same trading activities, thus either reducing your tax bill or giving yourself a refund.

However, the disadvantages are also that:

  • you will have to pay National Insurance at up to 8% on any profits made in addition to your income tax bill if you are self-employed, and any losses made in previous or subsequent years will not reduce this liability
  • you could potentially lose your Capital Gains Tax exemptions each year of up to £10,100 (although this may be otherwise utilized by holding another form of investment for a longer period which could be treated as investments instead)
  • if you make more than £150,000 income (from all sources), you could end up paying up to 51% in tax and National Insurance (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 in that if you are a higher rate taxpayer, CGT will be payable at 28% with only 18% for basic rate taxpayers
  • the first £10,100 per tax year of any gains are exempt from tax
  • there is no current higher rate of Capital Gains Tax if your income and gains exceed £150,000 - instead this remains taxable at 28%

However, whilst this would appear obviously more beneficial in the majority of cases, it is worth considering the disadvantages:

  • the level of expenses that you are able to claim against profits is vastly reduced with effectively only dealing costs and stamp duty (if applicable) being deductible against any gains
  • if you were to make a loss on your investment activities during the year, these losses can only be carried forward against future losses and therefore you are much less likely to be able to obtain any tax refunds in the short term

Therefore, whilst at first it might appear advantageous to attempt to treat yourself as an investor, in some cases this may not be the most efficient option.

Of course, swapping between the options each year would also be very tax efficient, but unfortunately is also very likely to attract the attentions of HM Revenue & Customs if you do not have very good reason!

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