Sarah Bradford explains how the new rules that extend the period for which losses can be carried back might be used to generate a useful tax repayment.
Many businesses have, unfortunately, incurred losses because of the Covid-19 pandemic. Tax relief is already available for losses, and there are various ways in which losses can be relieved.
The options available for relieving a particular loss depend on a number of factors, such as: whether it is incurred by a company or an unincorporated business; for unincorporated businesses, whether the business prepares accounts on the accruals basis or the cash basis; and when in the business lifecycle the loss is incurred (with special rules applying to losses in the early years and to terminal losses).
However, there is now a ‘new kid on the block’, which extends the period for which losses incurred in a set window can be carried back. The extended carry back period is available for both income tax and corporation tax purposes. Taking advantage of the extended carry back period may generate a useful tax repayment.
Legislation to give statutory effect to the rules was published in Finance Bill 2021 (which was awaiting Royal Assent at the time of writing).
Unincorporated businesses: Income tax
Under existing rules, an unincorporated business can obtain relief for a loss against income of the current and/or the previous tax year. Where the accruals basis is used, the loss can be set against other income of the same and/or previous tax year, and relief may be extended to capital gains. However, if the cash basis is used, the loss can only be set against profits of the same trade: sideways relief is not permitted; nor can the relief be extended to capital gains.
The extended carry back rules build on this existing relief and are available for a 2020/21 loss and a 2021/22 loss. Where the business is established, a 2020/21 loss is a loss for the accounting period ending in the 2020/21 tax year (i.e. between 6 April 2020 and 5 April 2021), and a loss for 2021/22 is a loss for an accounting period that ends in the 2021/22 tax year. Different rules apply to determine the basis period in the early years of the business.
The extended carry back rules allow a loss for 2020/21 and a loss for 2021/22 to be carried back and set against profits of the same trade for the previous three years. Relief is given only to the extent that the loss has not been used against income or profits of the current or previous tax year under the existing rules and is set against profits of the same trade for a later year before an earlier year.
The amount of the loss carried back must be set against available profits in full; the relief cannot be tailored to preserve personal allowances. Consequently, carrying back a loss for an extended period will not always be beneficial if personal allowances are wasted as a result, and where it is expected that the business will return to profitability, it may be better to carry the loss forward and relieve it against future profits of the same trade.
The normal loss relief cap of the higher of £50,000 and 25% of adjusted total income applies to losses carried back under the existing rules but does not apply to a loss carried back under the extended carry back rules. Instead, the amount of the loss that can be carried back for each year is capped at £2 million.
Carrying back a 2020/21 loss
A loss for 2020/21 can be set against other income of 2020/21 (accruals basis) and/or income of 2019/20. Where the cash basis is used, the claim is restricted to profits of the same trade.
To the extent that 2020/21 is not fully relieved against income or trading profits of 2020/21 and 2019/20, the extended carry back rules allow the unrelieved loss to be carried back and set first against trading profits of the same trade for 2018/19 and, to the extent that any of the loss remains available, against trading profits from the same trade for 2017/18. Any remaining loss must be carried forward and set against future profits of the same trade.
Carrying back a 2021/22 loss
The rules work in a similar way for a 2021/22 loss, such that a loss can be carried back under the extended carry back rules to the extent that it is not relieved under the existing rules against income/trading profits of 2021/22 and 2020/21.
The remaining loss can be set first against trading profits of the same trade for 2019/20 and, to the extent that any of the loss remains unrelieved, against trading profits of 2018/19. Any loss still unrelieved can be carried forward and set against future profits of the same trade.
Where a claim has been made under the existing rules to set a 2020/21 loss against income/trading profits of 2019/20, this takes precedence over a claim under the extended carry back rules to set a 2021/22 loss against trading profits from 2019/20.
Example 1: Consecutive losses of sole trader
Zak is a sole trader. He makes a loss for 2020/21 of £50,000 and a loss for 2021/22 of £40,000. He previously made a profit of £20,000 for 2019/20, £50,000 for 2018/19 and £50,000 for 2017/18. He has no other income.
2020/21 loss
The 2020/21 loss is £50,000. He claims relief under the existing provisions, carrying back £20,000 of the loss to 2019/20, reducing income for that year to nil, and generating a repayment of tax. The unrelieved balance of the loss is £30,000 (i.e. £50,000 - £20,000). Under the extended carry back provisions, he carries this back to 2018/19, reducing the loss for this year to £20,000, generating a further repayment of tax.
2021/22 loss
As a result of claims already made in respect of the 2020/21 loss, income for 2020/21 and 2019/20 has been reduced to nil. He can opt to use the extended carry back to carry £20,000 of the loss against the remaining income of 2018/19. However, the balance of the loss for 2021/22 must be carried forward as he cannot carry a 2021/22 loss back further than 2018/19.
Carrying the losses back in this way will generate tax repayments but will also mean that Zak wastes his personal allowance for 2019/20 and 2018/19. Consequently, the repayment comes at a price. Carrying the loss forward will allow him to keep his personal allowances for these years but will not give him the tax repayment, which in loss-making times may be very useful.
Companies: Corporation tax
Companies are also able to benefit from an extended carry back period for losses for accounting periods ending between 1 April 2020 and 31 March 2022.
Under these rules, losses for accounting periods that fall within this window can be carried back three years rather than the usual one. A cap of £2 million applies to the loss for all relevant accounting periods ending between 1 April 2020 and 31 March 2021, which can be carried back for the extended period, with a further cap of £2 million applying to losses for all relevant accounting periods ending between 1 April 2021 and 31 March 2022 relieved under these rules.
Losses must be set against the profits of a later accounting period before those of an earlier accounting period.
Example 2: Relief for a company’s ‘bad’ year
ABC Ltd prepares accounts to 31 December each year. The company realises a loss of £310,000 for the year to 31 December 2020. It made profits of £150,000 for the year to 31 December 2019, profits of £400,000 for the year to 31 December 2018 and profits of £220,000 for the year to 31 December 2017.
Under existing rules, it can carry back £150,00 of the loss for the year to 31 December 2020 against the profits of £150,000 for the year to 31 December 2019, generating a repayment of corporation tax of £28,500 (i.e. £150,000 x 19%).
The company takes advantage of the extended carry back rules to carry back the remaining loss of £160,000 (i.e. £310,000 - £150,000) against the profits for the year to 31 December 2018 of £400,000, generating a further corporation tax repayment of £30,400 (i.e. £160,000 x 19%).
Practical tip
Taking advantage of the extended carry back rules can generate a useful tax repayment. However, for income tax purposes, this may also result in personal allowances being wasted.
