Chris Thorpe points out how business losses can be used.
Even the most successful business can go through lean times, through no fault of their own, and end up with a tax loss. Whilst other concerns will arise due to this, a consoling factor for the owner is that the loss can be used to get tax relief.
What are the options for relieving losses?
The most valuable are the ‘sideways’ loss allowances, i.e., where the loss can be offset against other sources of income besides that of the business. ITA 2007, s 64 allows relief against other profits in the same year of loss or that of the previous year. Section 72 allows a new business to carry back the first four years of loss against income in the three years prior to commencement (earliest year first).
Some losses can only be offset against profits from the same trade as that loss. Section 83 carries forward losses and offsets them against future profits from the same trade, and section 89 allows businesses permanently ceasing operations to carry back losses in their final 12 months against profits in the previous three years (latest year first).
Quite a handy relief is contained in ITA 2007, s 86, which allows sole trade or partnership losses to be carried forward and offset against dividends, salary, rent and interest received from the company into which the business has incorporated. This is only available, though, if 80% or more of the remuneration on incorporation takes the form of shares – large directors’ loan accounts may disqualify one from this relief otherwise.
When are losses allowed?
A loss must be a genuine, commercial loss before it can be utilised under any of these sections. If HMRC believes that the loss stems from a ‘hobby’ or something not being operated on a commercial basis, it may seek to disallow the loss. The enterprise need not be immediately profitable to qualify – likewise, a giant venture with premises and employees may still be a hobby. The oft-cited words of Walker J in Wannell v Rothwell [1996] 68 TC 719 sum it up:
“The distinction is between a serious trader who, whatever his shortcomings in skill, experience or capital, is seriously interested in profit, and the amateur or dilettante. There may well be many borderline cases for the Commissioners to decide, and such borderline cases could as well occur in Bond Street as at a car boot sale.”
It may be that the business is being run in an amateurish way, or it could be that despite the best efforts and intentions, the business can never make profits (e.g., because of the overheads). If it will never make a profit, it cannot produce a relievable, commercial loss.
Farmers - watch out!
As well as these commerciality rules, under the ‘hobby farmer’ rules (ITA 2007, ss 67-70, but replicated for companies in CTA 2010), farmers cannot claim sideways loss relief under section 64 for year six if the previous five years have produced an accounts loss, and a reasonably competent farmer could have realised a profit after that time.
There is some flexibility depending on the nature of the farm, e.g., at one time HMRC automatically allowed stud farms to produce 11 years’ worth of losses before restricting losses. The Court of Appeal reminded us, in Naghshineh v HMRC [2022] EWCA Civ 19, that when looking at the five-year window, one must assume the farm is in a position to start trading – the preparation time (e.g., in turning a conventional farm into an organic one) is not to be considered.
Practical tip
Consider the use of loss reliefs depending on your client’s wishes and their business’s future profitability, e.g., they may want to carry all losses forward if the future is looking rosy; however, sideways reliefs may well give an immediate tax refund which will aid cashflow.
