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HMRC internal manual

International Manual

Non-residents trading in the UK: Is there a charge under domestic legislation: Trading in the UK: Whether trading

Mere purchase of goods does not amount to trading

The isolated activity of buying goods in the UK does not necessarily amount to trading in the UK. This principle was settled in the 1860 case of Sulley v Attorney General [2TC149]. A New York firm purchased goods in England for sale in America. It had an office here where the English resident partner saw to the purchasing and shipping of the goods. The Court of Exchequer (a Court of Appeal) found that `The profits of the firm in America do not accrue in respect of any trade carried on in this country, but in respect of the trade carried on in New York, where the main business is conducted’. Most other countries take the same view as the UK about the mere purchase of goods not usually amounting to trading.

Importance of contracts

The earliest case law on whether trades were carried out in the UK or not comes from cases settled in the late 19th century when business methods were far less complex than nowadays. Many of the early tax cases place great reliance on whether contracts, usually for the sale of goods, were made in the UK. 

Erichsen v Last

Erichsen v Last [TC351 and 4TC422] is an important 1881 Court of Appeal decision concerning whether trade was exercised in the UK by reference to the place of contract. The nature of the trade being the relaying of telegraph messages makes the facts unusual in relation to modern commerce. Nevertheless, the principle emerging from Erichsen v Last can be applied to modern circumstances.

Erichsen was the United Kingdom representative of the Great Northern Telegraph Company of Copenhagen. The company was not resident here but it had three cables running across the North Sea to bases in Scotland and it had a staff of operators here. Messages were collected through an arrangement with the Postmaster General. The Post Office collected the money and deducted its agreed remuneration before handing over the messages to the company’s operators here. The company’s own staff then transmitted the messages across the North Sea. Thereafter, depending on their destination, they passed through cables owned by the Danish and Russian governments to their destinations, which might have been as far off as Japan. The company claimed that it was not trading here but it went on to say that if it was, it ought to be taxed only on the profit arising from the relaying of the messages along the main cable to Denmark. It was making the point that some of the profit arose from the transmission along other cables which had absolutely nothing to do with the United Kingdom.

The judgement in the Court of Appeal made clear that the matter was wholly one of fact. The judgement then separated two questions for decision. First, is there trading in the United Kingdom? And second, if so how much were the profits chargeable in the UK? Brett LJ covered the first question on page 425. His words are important because it is here that the significance of contract - place of contract - begins.

`Now, I think it would be first of all nearly impossible and second wholly unwise to attempt to give an exhaustive definition of when a trade can be said to be exercised in this country. The only thing that we have to decide is whether upon the facts of this case it can be said that this company is carrying on a profit earning trade in this country. Now I should say that wherever profitable contracts are habitually made in England by or for a foreigner with persons in England, because those persons are in England, to do something for or supply something to those persons, such foreigners are exercising a profitable trade in England, although everything done by or supplied by them in order to fulfil their part of the contract is done abroad. The profit arises to them from the contract which they make. The profit which they derive can only be derived from the payment which is to be made to them by the person with whom they contract. In the given case they would not have any such contract as they are in the habit of making unless it was a contract made in England with a person who is in England because he is in England. Observe, if the person or someone acting for him were not in England he would not be wanting to send a telegraph message from England’.

Although the language is now very unusual its meaning is plain and answers the second question too on whether all of the profits were chargeable in the UK or some smaller part commensurate with the extent to which the cable was in the UK. The Court was saying- `You, the customer, are in England and because you are here you want goods here (or in the case in point, you want a message sent from here). The profit comes from the contract, the contract is here and there is trading in England and it is nonetheless trading in England even though the goods come from abroad or the service is provided through electric cables which are partly abroad. All of the profits from the contract made in the UK are chargeable profits in the UK’.

The principle of ‘place of contract’ was further developed slightly later in the so called ‘champagne cases’ which involved agents acting in the UK for the foreign trader. 

The “Champagne” cases

There were three ‘champagne cases’.  In the first two, both in 1888, the Inland Revenue succeeded in contentions that the French champagne houses concerned were trading in the United Kingdom through agents in London.  In the first case [Pommery and Greno v Apthorpe 2TC182] there were no express finding as to where contracts were made but most orders were met from stock held in the United Kingdom. 

In the second case [Werle v Colquhoun 2TC402] the Court of Appeal made it clear that they considered the contracts to be made by the agents here on behalf of their principal.  There was no attempt to tax profits of activities that were only conducted in France.  Fry LJ on page 413 said:

`A small shopkeeper………. is plainly carrying on a trade in the place where the shop is….. The question, however, becomes more difficult when the trade is carried on, as in the present case, in a far more complicated manner….. when the contract may be in one place, the goods in another, the principal in another and the goods may be delivered in some other place. We have, however, simply to do this, to take all the relevant facts and the mode in which the business is carried on, and to ask ourselves whether that business be or be not carried on within the United Kingdom. It appears to me that the same business may in some sense be carried on in many places. The Head Office of a firm, the place where the goods are manufactured, the place where the contracts are made, may all of them be places in which the business or parts of the business is or are carried on. Now, in the present case what we find is this, that the appellants reside in France, carrying on there the business of vineyard proprietors, champagne makers and champagne merchants, no doubt a large portion of that business is carried on within France, but a portion of that business is that of champagne merchants. Now, that means, as I understand, the selling of champagne and that business they carry into effect in England through the intervention of a firm of agents in this country.’

These two houses were producers of champagne as well as sellers of champagne and it is reasonably clear that the Revenue did not claim to tax the producer’s profit.  In the Pommery case at page 189, the Judge specifically referred to the difficulty of calculating the profit; he said that there might be some difficulty as to the manner of calculation in deciding what amount of expenditure to put against the profits and wondered whether it would be proper to look at the goods sent over to England and to put a fair valuation upon them as they arrived.  That he said was a matter of quantum, a matter for the consideration of persons skilled in such things.

The last of the champagne case is Grainger v Gough [3TC311 and 462] from 1896.  In finding that the contracts were not made in the United Kingdom the House of Lords drew the now classic distinction between trading in the United Kingdom, which creates chargeability, and trading with the United Kingdom which does not. Non-residents with customers here commonly rely on this distinction.

While it is still true to say that where contracts are regularly made in the UK whether by the principal himself or by the principal’s UK agent that is strong evidence of trading here, that fact is not decisive.

Place of contract may not be decisive

In line with commercial developments, the Courts began in later judgements to place less emphasis on the place of contract necessarily being the lone decisive factor as demonstrated in the seminal 1921 House of Lords decision in Smidth & Co v Greenwood [8TC193].

In this case a partnership of two Danish residents carried on a business of selling cement making and other types of machinery. They rented an office in London (UK) and employed a consulting engineer to be based there.  All negotiations, contracts and deliveries were conducted between the customer and Copenhagen. The employee in London was responsible for inspecting the sites of potential customers in the UK and feeding back to Copenhagen. Crucially however, he was not able to negotiate or conclude contracts on behalf of the business. 

Although the Revenue lost the case and it was found that the non-resident was not trading in the UK, the case is valuable precedent because of the comments of Lord Atkin, with the final sentence being particularly pertinent, as follows:

`It (the place of contract) is obviously a very important element in the enquiry and if it is the only element the assessments are clearly bad. The contracts in this case were made abroad. But I am not prepared to hold that this test is decisive. I can imagine cases where a contract of resale is made abroad, and yet the manufacture of the goods, some negotiation of the terms, and complete execution of the contract take place here under such circumstances that the trade was in truth exercised here. I think that the question is, where do the operations take place from which the profits in substance arise?’

We have come to adopt the test in this final sentence as the principal criterion for determining whether there is ‘trading in’ the UK.  This principal was further validated in the House of Lords decision in Firestone Tyre & Rubber Co. Ltd v Lewellin [37TC111] where Lord Radcliffe specifically referred to Lord Atkin’s observations in the Smidth case.  Of particular relevance are his comments, at page 142:

“It follows, then, that the place of sale will not be the determining factor if there are circumstances present that outweigh its importance or unless there are no other circumstances that can.”

Profits in substance - possibility of multiple locations

For the avoidance of doubt, the Smidth test of establishing where the profits in substance arise is equally applicable where the non-resident’s trade is merchanting. The decision in Smidth supports the conclusion that, where the activities are the buying and selling of goods at profit, the trade is normally exercised at the place where the contracts for sale are made - that is where the operations take place from which the profits in substance arise. But where there are other trade activities, apart from the making of sales contracts, you also need to consider where those operations are carried out. So a merchanting trade, in the same way as any other trade, could be carried on from more than one or even several locations or even countries.

Identifying the profit-making activities and where performed

As mentioned above where contracts are made abroad, that fact is not conclusive against trading in the UK by the non-resident. The trade will be exercised in the UK if there is significant economic activity here contributing to the making of profits. In the case of selling goods in the UK, there is likely to be trading here if in substance the selling takes place here even if formal conclusion of contracts takes place abroad.

In deciding whether the non-resident is carrying out a trade in the UK, the important Smidth v Greenwood principle is to establish where the operations take place from which the profits in substance arise. In order to go about that practically it is important to identify the precise nature of the trade of the non-resident so that you can understand what the essential profit-making operations might be. Then you should establish precisely what is done in the UK (and elsewhere if you can) to gauge the extent to which the operations contribute to the profit producing part of the trade. It will often be necessary to obtain full details of the personnel in the UK and establish what they actually do. If for example they are involved in selling goods in the UK it will be relevant to establish the extent to which they have authority to negotiate and conclude contracts.

In dealing with operations other than the sale of goods the place of contract is of less importance. For example where consultancy or services are provided or where construction work is performed in the UK the non- resident should be regarded as trading here no matter where contracts are concluded. There is support for this in WH Muller & Co (London) Ltd v Lethem 13TC151.

A full functional analysis of the business is crucial not only in establishing whether there is trade in the UK but also in attributing profit to the permanent establishment since the UK domestic charging provisions only permit profits arising to the non-resident through the UK activities to be subjected to tax.