If a business is being undertaken on a commercial basis and with a view to making a profit, it is generally possible to claim relief for a trading loss in one tax year against the individual taxpayer’s other taxable income (for example, PAYE income or a pension) from the same year, or the one before. The taxpayer can decide which year to claim the losses against.
However, note that loss relief will be restricted for individuals who carry on a trade but spend an average of less than ten hours a week on commercial activities.
Early years of trading
In addition, where a loss is incurred in any of the first four tax years of a new business, the loss can be carried back against total income of the three previous tax years, starting with the earliest year. Therefore, if tax has been paid in any of the previous three years, the taxpayer should be entitled to a repayment of tax, which may be especially welcome in those often difficult early years of trade. The taxpayer must offset the maximum for each year – it is not permissible to offset just a proportion of the loss in order to spread the loss across three years to take advantage of beneficial tax rates.
Again, relief will not be available unless the taxpayer was trading on a commercial basis and with a view to making a profit within a reasonable timescale. In practice, this requirement may be difficult to prove in the case of a new business, and the taxpayer may need a viable business plan to support a claim.
Cap on relief
A cap applies (from 6 April 2013) to certain previously unlimited income tax reliefs that may be deducted from income. Trade loss relief against general income, and early trade losses relief as outlined above, are two areas where this relatively new restriction will apply. The cap is set at £50,000 or 25% of income, whichever is greater. ‘Income’ for the purposes of the cap is calculated as ‘total income liable to income tax’. This figure is then adjusted to include charitable donations made via payroll giving and to exclude pension contributions – the adjustment is designed to create a level playing field between those whose deductions are made before they pay income tax, and those whose deductions are made after tax. The result, known as ‘adjusted total income’, will be the measure of income for the purpose of the cap.
The cap applies to the year of the claim and any earlier or later year in which the relief claimed is allocated against total income. The limit does not apply to relief that is offset against profits from the same trade or property business.
Carry forward of losses
Where a trader makes a loss in a year, but does not have any other income against which the loss can be set, he or she can carry it forward indefinitely and use it to reduce the first available profits of the same business in subsequent years.
Setting losses against capital gains
A taxpayer can also set any losses arising from a business against chargeable capital gains. The relief can be claimed for the tax year of the loss and/or the previous tax year. However, the trading loss first has to be used against any other income the taxpayer may have for the year of the claim (for example, against earnings from employment) in priority to any capital gains.
Practical Tip:
A sole trader or partner who wishes to incorporate the business, can usually carry forward any unused losses of the business and set them off against the first available income derived from the company.
