Kevin Read reminds readers of the options available for relieving losses in unincorporated businesses.
With the economy hit hard by Covid-19, many businesses will make losses this year. If a business is operated as a company, those losses are stuck within the company; they cannot be used against the owners’ personal income.
In contrast, a sole trader has great flexibility in how losses can be used, as outlined below. These rules also extend to members of partnerships and limited liability partnerships (LLPs), subject to restrictions for non-active partners.
Forwards and backwards
The tax legislation (ITA 2007, s 83) allows a trading loss not used in any other way to be automatically carried forward to set against the first available profits of the same trade. This only gives potential relief against one source of income in the future, rather than an immediate tax saving, so is usually the option of last resort. Currently, some businesses will be even wondering if they will ever make profits again.
If the trade ceases, terminal loss relief (ITA 2007, s 89) allows the loss incurred in the final twelve months of trade to be set against trading profits of the three tax years before the tax year of cessation, on a ‘last in, first out’ basis. This may generate large tax repayments if the trade has previously made significant profits.
Earlier year losses
Where a loss is incurred in any of the first four tax years of trade, ITA 2007, s 72 allows that loss to be carried back and used in the three tax years before the year of the loss, on a ‘first in, first out’ basis.
The loss is set against total income before deducting the personal allowance. You must relieve all three previous years if there is enough loss (i.e. you cannot choose one particular year in which to set the loss off) and the maximum possible loss must be set off in each year (i.e. the claim cannot be restricted to preserve personal allowances). This relief is particularly useful when someone has given up a high paying job to start their own business.
‘Sideways’ and capital gains reliefs
Once outside the first four tax years of trade, any loss relief against other income (‘sideways loss relief’) is given under ITA 2007, s 64. This relief is available against total income (before personal allowances) of:
- the tax year in which the loss-making basis period ends; and/or
- the tax year immediately preceding that year.
The loss can be used in either year first, with a separate claim made for the other year, if appropriate. Neither claim may be restricted to preserve personal allowance.
Further legislation (ITA 2007, s 71 and TCGA 1992, ss 261B, 261C) allow a section 64 claim to be extended to gains of either year (once income for the year has been extinguished). In practice, this option will rarely be used, as the capital gains tax rate is currently lower than income tax rates.
Following the last recession there was a temporary increase in the ITA 2007, s 64 carry back option to three years. It will be interesting to see if Rishi Sunak is similarly generous over forthcoming months.
Relief claims
Note that any sideways loss relief claim (including under both ITA 2007, ss 72 and 64) is restricted to the greater of:
- 25 per cent of the individual’s adjusted total income (i.e. total income less pension contributions) for the tax year; and
-
£50,000.
The time limits for claims are:
- ITA 2007, ss 64 and 72 relief - 12 months from 31 January following the year in which the loss is made (e.g. for a 2019/20 loss, 31 January 2022)
-
ITA 2007, s 89 – Four years from the end of the tax year in which trade ceased (e.g. 5 April 2024 for a cessation in 2019/20).
Practical tip
Consider disclaiming capital allowances to reduce a loss where a claim would otherwise waste personal allowance.
