Riding the D-Train (part 1)
Because of the unique nature of every practitioner’s financial circumstances, it has seemed impossible over the past nine years to address, in a meaningful way in this column, one vital issue.
My failure to do so has caused a troublesome depression to set in during this period, especially as increasing numbers of artists have berated me for this omission. This curious incubation has finally produced a slow blues in E; but the key to it is learning to ride the D-train. (The lyrics have been borrowed.)
“Sometimes, feel so low down and disgusted,
Can’t help but wonder what’s happening to my companions.
Are they lost or are they found.
Have they counted the cost it’ll take to bring down
All their earthly principles they’re gonna have to abandon.
And there’s a slow, slow train coming
Round the bend.”
Nine years on, artists still need an answer to the same question: how to achieve Schedule D tax status – especially those who also teach. The answer is still the same: it depends, partly, but not so much, on what you do; mainly, on how you present it to your tax inspector. Riding the D-train.
First, we must look at the law, then at the problems of part-time teaching, with a case in point and commentary at the end.
The Act and its Schedules
Everyone is taxed according to the provisions of the Income and Corporation Taxes Act 1970, which has six Schedules specifying how tax inspectors should make income tax assessments. Each Schedule has a different regime for each source of income.
- Schedule A: Rents
- Schedule B: Woodlands
- Schedule C: Public Revenue Dividends
- Schedule D: (subdivided into six Cases):
- Case I: Profits from Trade
- Case II: Profits from profession or Vocation
- Case III: Interest, annuities and discounts
- Case IV: Income from the U.K. not covered in Schedule C
- Case V: Income from outside the U.K.
- Case VI: Annual profits not falling in any other Case or Schedule C
- Schedule E: Emoluments, wages, salaries and foreign earnings
- Schedule F: Dividends from companies in the U.K.
Artists perennially persevere in trying to achieve what they call ‘Schedule D status’. This can be tricky, as we shall see, but the benefits of convincing tax inspectors that income from practice as an artist falls into Schedule D Cases I or II can be great. Failure to do so is likely to result in practitioners being assessed as a ‘hobbyist’ and taxed under Case VI of Schedule D. Notice the common myth of ‘Schedule D status’: Case VI, very different from Cases I or II, is still within Schedule D. What artists really mean by their use of that hallowed phrase is ‘Schedule D Case I or II status’, the relative benefits of which we will explore later. First let us consider how to qualify under the three different Cases in question.
Case I or II: Qualifications
‘Trade’: includes ‘every trade, manufacture, adventure, or concern in the nature of trade’, or, in the learned words of Lord Denning, ‘we recognise trade, but we are hard pressed to define if. ‘Profession’: involves ‘the idea of an occupation requiring either purely intellectual skill, or of any normal skill controlled as in painting and sculpture or surgery, by the intellectual skill of the operator’, in the learned words of Lord Justice Scrutton.
‘Vocation’: involves ‘the way in which a man passes his life’. From this starting point, it should be pretty straightforward for tax inspectors to recognise which practising artists are professionals (perhaps also vocationally pursuing their trade), and which are not – the onus being on the inspector to justify any doubts in the matter on a reasonable basis. Not so. Unlike most other areas of law in the U.K., taxable persons are regarded as ‘guilty’ until they prove themselves ‘innocent’ i.e. the onus in practice lies on the taxable person to establish status under Schedule D Case I or II, to the satisfaction of the Inland Revenue acting through the inspector. This can be an arduous process, and artist practitioners need not concentrate on the three words discussed so far, so much as on the meaning of the word ‘profits’.
‘Profits’: Inspectors use the profits motive as their main criterion for assessing artist practitioners claiming Case I or II status: is the trade, profession or vocation (the artist’s practice) pursued ‘on a commercial basis with a view to the realisation of profits’? That being the test, how can artists prepare to pass it? Inspectors are more likely to be persuaded by good presentation of the following:
- Curriculum vitae: including educational background, honours, awards, grants, bursaries, prizes and publications;
- Artwork: slides or other presentation of a representative body or work;
- Studio: good evidence of the studio situation, especially where the studio is maintained separate from home; and even where properly set apart within residential accommodation;
- Insurance: evidence of comprehensive insurance cover for studio and contents, and of work;
- Exhibitions: solo/group, public/private; catalogues, price lists, private and press view documentation; publicity; and evidence of exhibitions planned or in train;
- Criticism or review: copies of notices, articles, listings criticising or reviewing work itself or exhibitions thereof;
- Awards: evidence of grants, awards, bursaries, prizes and sponsorship from any source; especially from ACGB, Crafts Council, RAA’s, local authorities. Government or quasi-Government departments and bodies; stressing their support only for professional artist practitioners;
- Standard commercial practices: evidence of compliance with standard business practices, such as carbon/photocopies of all correspondence (types); copies of written contracts of sale, commission, exhibition, consignment, copyright licences; business diaries and records; business bank account; accounts, including bills and receipts (an accountant experienced in this specialised field can be invaluable in assisting with this whole process);
- Hours of work: evidence of time devoted to the practice: studio usage; office usage; travelling time; research time – all of this as against time devoted to non-art related, income generating activity/work (such as teaching);
- Galleries/Dealers/Agents: evidence of representation; or of efforts to achieve this; or of plans and arrangements in train;
- Sales: evidence of numbers and types of sale, and prices; and of works lent or donated to significant collections or institutions; or of plans and arrangements in train;
- Commissions: evidence of numbers and types of commission, and income derived; stressing the significance of the collector/body/institution commissioning; or of plans and arrangements in train;
- Marketing and promotion: evidence of efforts made to market, promote and solicit interest in work, exhibitions, commissions, sales and copyright licences; or of plans and arrangements in train; plus the cost of these exercises;
- Copyright: evidence of the exploitation by the artist and others of work, through reproduction, publishing, broadcasting and merchandising; or efforts to do so; or of plans and arrangements in train;
- Type of expenditure: whether business expenditure has been largely connected with researching, producing, advertising, marketing and promoting work; as against being largely expended on office accommodation, stationery, telephone, motor vehicle and travelling;
- Continuous losses: generally, inspectors will tend to expect evidence of a profit made every five years; without which credibility can be reduced or lost;
- Profits in previous years: as against 16 above, evidence of continuous or regular profits made in previous years will tend to assist inspectors to accept later, even continuous, losses; especially where there is good evidence to explain or justify a downward turn in income e.g. the closure/bankruptcy of a gallery/dealer/agent; illness or incapacity; theft or destruction of works; serious bereavements; and so on.
Notice that the above list suggests, but does not require, the realisation of profits. The inspector’s main task is to be satisfied of the artist practitioner’s motives for producing work. The test is not simply, are there profits? It is rather; are profits intended? (As to this, see, later, the case in point.) Failure to satisfy the inspector of the bona fide profits motive is likely to render the artist relegated to the ignominy of ‘hobbyist’ to be taxed under Case VI of Schedule D, and with less benefits.
Case VI: Qualifications
Reserved, therefore, for ‘annual profits not falling in any other Case or Schedule’; failure to satisfy the inspector of Case I or II status leaves Case VI status as the only real option. In other words, the work is being made not on a commercial basis with a view to realisation of profits; and not as an employee (taxed under Schedule E, dealt with below).
Case I or II: Benefits
Satisfying the inspector as to Schedule D Case I or II status ensures access to the following benefits:
- Tax deductible expenditure. All the income derived from practise does not equal profit. From the income is deducted expenditure wholly and exclusively incurred in conducting the practice – studio rent, rates, heating, lighting and equipment, materials and so on. The difference between income and expenditure is profit; that is what the inspector is interested in taxing – losses are not taxed (but are extremely valuable, as we shall see).
- Roll-over relief. Losses in any one year can be carried forward to the next year; then can be used to reduce the would-be taxable profits in that next or subsequent year. The benefits can be enormous; such losses can be carried forward year after year until used up – or can be carried across (as to that, read on).
- Set-off relief. Losses in any one year can be set-off against other income earned as an employee, or by a spouse earning as an employee. This means that the Schedule D Case I or II artist practitioner who also has employment (the income from which will be taxed under Schedule E) or who has a spouse at work (taxed under Schedule E), can reduce the tax payable on that Schedule E income by setting against it the losses from Case I or II of Schedule D. The benefits can be enormous.
Case VI: Benefits
The ‘hobbyist’ does not do as well as the Case I or II practitioner, though there are two similar benefits.
- Tax deductible expenditure. As for Cases I and II, this is allowed because only profits are taxed i.e. income less expenditure equals profit.
- Roll-over relief. As for Cases I and II, this is allowed. But the buck stops there; there is no set-off relief. Thus, an artist’s own other Schedule E income, or that of their spouse, cannot be used to set-off Schedule D losses.
Because we will later examine more fully difficulties encountered by Schedule D practitioners arising from their other Schedule E income, we must briefly consider Schedule E: income from emoluments, wages, salaries and foreign earnings.
This Schedule sets out a scheme for assessing fees, wages, perks, basically from employees – as opposed to self-employed or freelance practitioners (taxable under Schedule D, dealt with above).
Schedule E: Qualifications
Essentially, the inspector will look to the contract which causes the income to be earned. A ‘contract of service’ is the legal phrase used to indicate an employee: this will mean that the worker is engaged by someone who exerts a high degree of control, determining place of work, hours, type of work; provides all materials, tools, items of equipment, protective/required clothing, travelling expenses, pension schemes, superannuation, holidays, sick pay, redundancy, and so on. Moreover, the employer must, under Schedule E, deduct income tax and national insurance contributions of the employee from the wages/salary before paying out; and must make an employer’s national insurance contribution for the employee. The inspector will look to all these factors in each case, to assess the status of anyone’s work for tax purposes.
Schedule E: Benefits
From the tax viewpoint, there are none to speak of; unless the payment of tax as you earn (the P.A.Y.E. collection system), national insurance, and so on, are regarded as being benefits. There is tax deductible expenditure, but the scheme is radically different to the scheme under Schedule D, and produces relatively little benefit. From the job security perspective, most employees do have employment protection i.e. job security, especially full-time employees. Notice that artist practitioners may derive income from two sources simultaneously, each taxed under a different scheme: say, making work (Schedule D, Cases I or II or VI) and part-time teaching (Schedule E). As to the problems raised by this scenario, read on Part II in the next edition.
© Henry Lydiate 1985
*© Special Rider Music 1979