Sarah Bradford outlines the tax relief available to business owners for terminal losses.
The tax legislation provides various reliefs for business losses, both for income tax and corporation tax purposes. The provisions include a specific relief for terminal losses.
In the current climate, terminal loss relief is likely to be of particular relevance to businesses which found themselves struggling as a result of the Coronavirus pandemic before making the difficult decision to cease trading.
Income tax relief for terminal losses
For income tax purposes, relief is available for an individual, partner or trustees who make a terminal loss in a trade, profession or vocation which is permanently discontinued. This specific relief allows the taxpayer to claim relief for the terminal loss against:
- profits of the same trade for the year of cessation; and
- by reference to profits of the same trade for the three tax years prior to the tax year in which the discontinuance occurred.
Where the terminal loss is set against profits of earlier tax years, as far as is possible, the relief must be given against profits of a later year before giving relief against profits of an earlier year.
A claim for loss relief may be made where a person:
- permanently ceases to carry on a trade in a tax year; and
- makes a terminal loss in that trade.
A deduction for a terminal loss can only be made from profits from the same trade; a terminal loss cannot be set against other income that the taxpayer may have.
What is a ‘terminal loss’?
Each of the following are a terminal loss:
- a loss (if any) made in the trade in the period beginning with the start of the final tax year and ending with the date of cessation; and
- a loss (if any) made in the trade in so much of the period in the previous tax year that falls in the 12 months prior to the cessation.
If the result of either is a profit, it is taken to be ‘nil’ when calculating the terminal loss.
If the period of account does not coincide with the terminal loss period (i.e. the last 12 months of the trade) the following steps may be taken, as necessary, to determine the profit or loss for the terminal loss period:
- apportioning the profit or loss for a period of account between the part of the period that falls in the terminal loss period and the part that does not; and
- adding the profit or loss of a period (or part of a period) of account to the profit or losses or other periods of accounts (or parts).
Adjustment for overlap profits
Where there are overlap profits to be relieved (e.g. profits taken into account twice in the early years of the trade, or if the accounting date was changed), these are deducted in computing the terminal loss.
Example 1: Calculating the terminal loss
Amy has been trading as a beautician for many years. As a result of the Coronavirus pandemic, she was unable to trade for a number of months and made the decision to close her business on 31 August 2020.
She prepares her accounts to 31 January each year.
Amy made a profit of £30,000 in the year to 31 January 2020, and a loss of £7,000 for the seven months to 31 August 2020.
She also has overlap profits of £2,500 to relieve.
The final tax year is 2020/21.
The loss for 2020/21 is the loss from 6 April 2020 to 31 August 2020, i.e. 5/7 x £7,000 = £5,000.
The overlap relief of £2,500 is added to this figure.
Thus, the loss for 2020/21 is £7,500.
The second element of the loss is in the previous tax year (in Example 1, 2019/20) during the period that falls in the 12 months prior to cessation. This is the period from 1 September 2019 to 5 April 2020.
This comprises two parts – the period from 1 February 2020 to 5 April 2020 for which there is a loss of £2,000 (i.e. 2/7 x £7,000), and the period from 1 September 2020 to 31 January 2020, for which there is a profit of £12,500 (i.e. 5/12 x £30,000). The net result is a profit of £10,500. As it is a profit, it is taken as ‘nil’ in the computation of the terminal loss.
The terminal loss is therefore £7,500 (i.e. £7,500 plus nil).
Relieving the loss
There are various options to relieve the loss; it could, for example, be set against general income for the year of the loss and the previous tax year. However, it should be noted that this option is not available where accounts are prepared using the cash basis.
Alternatively, terminal loss relief can be claimed and the terminal loss can be relieved against profits of the trade in the final tax year and those of the previous three years, setting the terminal loss against profits of a later year before an earlier year.
Example 2: Relieving the loss
Assume the facts are as in the above example and that Amy has no other income, meaning a claim for sideways relief is not possible. The terminal loss is £7,500.
Amy’s taxable profits before loss relief are as follows:
Tax year Basis Profits
2020/217 months to 31/8/20Nil
2019/20Year to 31/1/20£30,000
2018/19Year to 31/1/19£28,000
2017/18Year to 31/1/18£25,000
Amy makes a claim for terminal loss relief, and the terminal loss of £7,500 is set against the profits of £30,000 for 2019/20, reducing them to £22,500. Amy will receive a repayment of the tax that she has paid for that year – which will come in handy.
Claims cannot be tailored
It is not possible to tailor a claim to preserve the personal allowance.
For example, if a trader ceased trading in 2020/21 with a terminal loss of £20,000 and profits of £25,000 for 2019/20, it is not possible to restrict the claim against the 2019/20 profits to £12,500, so as to take the profits to the level of the personal allowance for that year, carrying £7,500 back to 2018/19. Instead, the profits of 2019/20 are reduced by the full amount of the terminal loss of £20,000, reducing profits to £5,000 and losing £7,500 of the personal allowance.
Corporation tax relief for terminal losses
Where a company makes a loss whilst continuing to trade, the loss can be set against other profits or gains of the same accounting period. It can also be carried back and set against profits of the previous accounting period. If neither of these are an option, or are not desirable, the loss can be carried forward and set against total profits of the same trade (CTA 2010, s 45A).
As for income tax, special rules are available providing further relief where a company ceases to trade and makes a loss in the final 12 months of trading. Many companies may find themselves in this position as a consequence of the Coronavirus pandemic.
The terminal loss relief provisions, as they apply for corporation tax purposes, allow the company to carry a terminal loss back and set it against profits in some or all of the previous three years. However, there are some limitations:
- the loss can only be set against profits of the same trade;
- the loss must be set against the profits of the most recent year before it can be carried back to an earlier year.
Where there has been a change in the accounting date and such accounting periods are not 12 months in length, apportionment is necessary.
Practical tip
Where a trade is permanently discontinued and there was a loss in the final 12 months of trading, consider whether it is beneficial to claim terminal loss relief. Carrying the loss back may generate a welcome tax repayment.
