Sarah Bradford takes a look at some of the implications of closing your business if you are a sole trader or run an unincorporated business.
The Covid-19 pandemic has adversely affected many businesses. Unfortunately for some, the impact of the pandemic has meant that their business is no longer viable.
Closing down a business has a number of tax implications, and it is important to be aware of these. This article looks at issues affecting the self-employed.
1. Don’t lose out
If the decision has been made to close down a business because it is no longer financially viable, it is likely that the business has been generating losses. From a tax perspective, relief is available for losses and there are various options available.
Where a business has made losses, the challenge is to ensure that the best possible relief is obtained for them.
(a) ‘Sideways’ loss relief
The first option if the taxpayer has other income or made a profit in the previous tax year is to set the loss against other income of the current or previous tax year. This is known as ‘sideways’ tax relief. The taxpayer can choose to set the loss against either or both years, but where a claim is made against both years the claim must specify which year takes priority. However, this option is only available if the accounts are not prepared on the cash basis.
Where a claim is possible, it will not always be beneficial if it means that personal allowances are wasted. It is not possible to tailor a claim to reduce income down to the level of the personal allowance and then set the balance of the loss against the other year.
(b) Terminal loss relief
A special relief is available for a loss made on the cessation of a business. This is known as a ‘terminal loss’. A claim for terminal loss relief can be made if the person permanently ceases to carry on a trade and makes a terminal loss.
The terminal loss is the loss made:
- in the tax year in which the trade ceases; and
-
the loss made in the part of the penultimate year beginning 12 months before the date of cessation.
If the result for either period is a profit, it is taken as a nil loss in calculating the terminal loss. The terminal loss includes any unused overlap relief.
The terminal loss may be relieved against the profits of the trade for the final tax year and previous three tax years. Relief is given against a later year before an earlier year.
Example 1: Terminal loss relief in action
Mandy operates as a self-employed hairdresser. As a result of a loss of business due to the Covid-19 pandemic, she decides that her business is no longer viable and ceases to trade. She closed her business on 30 June 2020. She prepares accounts to 31 March each year. She has no unused overlap relief.
In the three months to 31 June 2020, she makes a loss of £12,000. This is a loss of the 2020/21 tax year.
Her results for the previous three years are as follows:
2019/20: profit of £16,000
2018/19: profit of £20,000
2017/18: profit of £18,000
The terminal loss must be used against the profits of 2017/18 first. The loss reduces the profits of 2017/18 to £6,000. It is not possible to tailor the claim to preserve all of her personal allowance for 2017/18 (set at £11,500 for that year). The loss relief claim will generate a tax repayment of £1,300 (i.e. 20% (£18,000 - £11,500)).
2. Business asset disposal relief
Business asset disposal relief was formerly known as entrepreneurs relief prior to 6 April 2020. It potentially reduces the capital gains tax (CGT) payable on the sale of a business or business assets.
Where a sole trader closes their business and disposes of their business assets, they may be eligible for the relief. To qualify, an individual must have owned the business directly or been a member of a partnership that owned the business for a period of at least two years to the date on which the business ceases, and the assets must be disposed of within three years of the date on which the business ceases.
Thus, if a sole trade ceases trading on 31 July 2020, they must have owned the business since 1 August 2018 at least. Further, the disposal of the assets must take place no later than 31 July 2023. Business assets that qualify for the relief include the business premises and plant and machinery.
The effect of the relief is that CGT is charged at the rate of 10% on gains up to the lifetime limit, which is £1 million from 6 April 2020 onwards. Spouses each have their own limit.
Example 2: Business asset disposal relief claim
As a result of the impact of the Covid-19 pandemic, Bill ceases trading on 31 July 2020. He has been in business for eight years.
He sells his business premises and other assets used in the business in October 2020, realising a gain of £80,000. He has not used his annual exempt amount for 2020/21 of £12,300, which is set against the gain. The chargeable gain of £67,700 qualifies for BADR. He pays CGT on the gain at 10% - a CGT bill of £6,770.
Relief may also be available where business assets are sold on a part-disposal of a business; however, the relief is not available if assets are sold while the business is continuing.
3. Post-cessation receipts
Amounts that are received after the permanent cessation of the business and which arise from the trade carried out prior to cessation are taxable if not otherwise charged to tax.
This may include debts paid or released after cessation and receipts related to post-cessation expenses.
4. Expenses incurred after cessation
Relief can be claimed for certain expenses that relate to the business and which would have been deductible in calculating the profits of the trade.
Examples of expenses that fall within this category include costs of remedying defective work and associated legal and professional fees, and collected debts taken into account when computing profits prior to the discontinuance of the trade. However, relief is not available for expenses connected with the cessation.
Relief can be given in various ways; as a deduction from post-cessation receipts, as losses against total income (post-cessation loss relief), as a deduction against chargeable gains or carried forward and set against future post-cessation receipts from the same trade.
5. Compliance obligations
You need to tell HMRC when you stop trading and cease self-employment.
You can inform HMRC you are stopping self-employment by completing a form online (see www.tax.service.gov.uk/shortforms/form/CeaseTrading).
You will also need to file a self-assessment tax return for the tax year in which your self-employment ceased. Where the self-employment ceased in 2020/21, the return must be filed by 31 January 2022.
However, if profits from self-employment are less than £1,000, you do not need to report them to HMRC.
6. VAT and cessation
If the business was registered for VAT, it must be cancelled when the business ceases. This can be done online. You will have to submit a final VAT return for the period up to the cancellation date. If VAT was deferred due to Covid-19, this must still be paid.
You must also account for any stock and other assets that you had on the cancellation date if you could reclaim VAT when you bought them and the total VAT due on those assets was over £1,000.
7. National Insurance contributions
If you cease trading, you will no longer be liable for Class 2 National Insurance contributions (NICs).
However, these are due for the weeks up to the date the self-employment ceased. If you have made a profit in the final tax year and this is more than the lower profits threshold for Class 4 NICs (set at £9,500 for 2020/21) you will be liable for Class 4 NICs on your profits.
Class 2 and Class 4 NICs for 2020/21 are due by 31 January 2022.
Practical tip
There is lots to think about when stopping self-employment. Make sure all available reliefs are claimed, and all tax obligations are met.
