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Trading and investing are some of the most commonly used ways to make extra money, especially for high earners. Whether you’ve bought shares in your favourite company as a one-off investment or been mining crypto tokens as your side gig, it’s vital that you know which category your activity falls under. Why?
Because of tax.
Both income sources are taxed very differently, and if you don’t know which approach to take based on your circumstances, you could find yourself in trouble with HMRC. Not to mention receiving a nasty tax bill!
As a basic rule to follow, the main difference between trading and investing is the type of tax you will pay on any profits you make.
If you’re a regular trader, you will be liable to pay both Income Tax and National Insurance (NI). This is because HMRC views multiple trading transactions as a source of income-generating activity. Whereas with investing, these tend to be seen as more one-off type transactions. The lack of regular activity with investing is why they are subject to Capital Gains Tax instead of Income Tax and NI.
If you trade/invest through a limited company, any profits or gains you make will also be subject to Corporation Tax at the same rate.
Because trading is subject to Income Tax and NI, this means that you can claim more in expenses against the income you make, helping you to reduce your overall tax bill! For example, types of expenses you can claim include things like:
Being taxed as a trader also means that you have more flexibility when it comes to offsetting your trading losses – which can help you to reduce your tax bill or generate a refund.
Self-employed traders have to pay National Insurance rates (Class 2 or 4) on any profits made in addition to their Income Tax bill. And unfortunately, any losses you may have made in previous years will not stop you from being liable to pay the NI in full.
If you make more than £125,140 from your trading and other income sources, you’ll end up with a very big income tax and National Insurance bill to pay. This is because your Personal Allowance will drop to zero, and you will also pay a higher rate of tax on income over £100,000.
Paying Capital Gains Tax on investments is seen to be more ‘beneficial’ if you’re a high earner. Here’s why:
However, there are some disadvantages to paying CGT as an investor.
For starters, you can’t claim as many expenses as a trader. Instead, you can only claim dealing costs and stamp duty against your gains. And if you make a loss on your investment, this can only be carried forward and offset against future losses, meaning short-term tax refunds are very unlikely.
Swapping each year between paying tax as a trader and then as an investor the next sounds pretty tax-efficient right? Well, it’s also very illegal and likely to attract the attention of HMRC. Don’t do it!
If you’re unsure whether you’re classed as a trader or investor or don’t know how much tax you need to pay, then don’t worry! Whatever your tax-based problem is, feel free to get in touch for some simple, one-off tax advice from our accredited accountants. You can learn more here. Be sure to take a look at our tax calculators on our website too!
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