Trading Losses

Carrying Losses Forward

Where there is a trading loss under the accounts as adjusted for taxation, there are a number of different ways in which the losses can be used. Losses can be augmented by capital allowances.

One option is to carry the loss forward against future trading profits. They must then be set against the first available profits of the same trade. If losses are carried forward, it is mandatory to use them, insofar as possible.

The losses cannot be claimed on a partial basis so as to say use allowances to reduce tax liability. The losses reduce the future profits to nil and the remaining unused loss (if any) is carried forward against further future profits and set off until the loss is fully extinguished. The carrying forward of losses is automatic. However, the amount claimed must be specified.

Setting Losses against Total Income

Taxpayers may alternatively use losses to offset against the payer’s total income in the year concerned and the previous year.   It is possible to choose to claim the relief against total income by choosing to set the loss off against profits of the year concerned or the previous year or either year in isolation.

Unrelieved losses (if any remain) can then be carried forward in the normal manner against the trade in which the loss was incurred. It is not possible to set off part of the loss against total income. It must be set off against the maximum possible extent for a given year.

Total income is income from all sources less charges. Personal allowances are deducted afterwards so a claim to offset losses may waste them. A specific claim is required for each year. It must be made within one year of the 31st January following the year of the tax loss.

Trading losses may be set off against chargeable gains subject to certain conditions. The total income must be first reduced to zero by use of the trading loss claim. The maximum relief is the amount of gains subject to capital gains tax. Relief against capital gains of the previous years may also be available.

Losses can only offset future trading profits from the same trade that generated the loss. Consequently, if there is a cessation of trade and a new trade begins, the loss from the previous trade will not be available for offset. Some relief for trade losses is available if there are multiple trades, but it cannot be used against other trades.

Capital allowances are considered a trading expense and can contribute to the creation of a trade loss. However, it is not mandatory to claim capital allowances. If a trading loss is incurred, it may be appropriate to claim some or no capital allowances. Any unclaimed capital allowances can be carried forward for future use.

The ability to set off losses against total income arises only if the business is conducted on a commercial basis with a genuine intent to make a profit. Losses generated through tax avoidance arrangements are not eligible for this relief. Farmers and market gardeners are also not eligible if they have incurred losses in the previous five years, regardless of capital allowances.

If a claim is made to set off trading losses against total income, they can be deducted from total income. However, there is a limit on the amount that can be used in the case of a non-active trader. These restrictions on the total amount of income tax reliefs that can be claimed may affect the ability to make a claim.

The total loss can be set against the tax liability for the current year and the previous year, or both years. To make this claim, it must be done by January 31st of the second tax year following the year in which the loss was incurred. It’s also possible to claim for one of the available years and not the other. Unclaimed relief can be carried forward.

A trader can claim all relief except for non-relief against capital gains. This claim must be made by January 31st of the second year following the tax year in which the trading loss occurred.

For early year’s loss relief, if a claim is made, losses are relieved against total income starting with the earliest year. This relief must apply to all years and cannot be selective. The maximum possible relief must be given in each year.

Relief is granted by deducting the amount of the trading loss from total income. This relief is only available if the trade is conducted on a commercial basis with a reasonable expectation of profit. Claims must be made by January 31st of the second tax year following the year in which the loss occurred.

Initial and Final Losses

There is a special relief to help new business in the initial years of trading. This relief allows the taxpayer to relieve a loss in the first four years of a trade against statutory total income of the three tax year proceeding the tax year of the loss. Certain rules and conditions apply.

A special relief is allowed where a trade ceases. A trading loss in the final 12 months can be set off against available profits on a last in first out basis for the last three years.

There are tactical considerations in relation to the making loss claims. Partnership loss is allocated between the partners in the normal way. Claims are available in the same way as those to sole traders. Partners joining will be entitled to make the claim in the first four years mentioned above in respect of new traders.

Terminal trade relief is applicable to trading losses incurred in the last 12 months of trading, excluding any losses that have already been relieved. Relief is given for later years first, and the maximum relief must be provided, even if it means some allowances go unused. This relief is by deduction from total income.

Post-cession expenses can be relieved initially against post-cessation receipts. However, if there is still a loss, it may be relieved against total income in the year it was incurred or set off against capital gains for that year. This treatment is available for expenses incurred within seven years of the cessation of the trade.

When a business is transferred to a limited company, relief exists. If the vendor continues to hold shares in the company and the company carries on the business, the vendor can set off unrelieved trading losses against the first available income received from the company.

If an individual subscribes to new shares in a specific unlisted company and incurs a capital loss, they may set this loss against their total income as if it were a trading loss. This is available for companies that qualify for the Enterprise Investment Scheme.

Restriction of Reliefs

There is a limit on the amount of sideways relief that can be claimed by a non-active trader. This limit applies to individuals who run the trade but do not personally engage for at least 10 hours a week. The limit is £25,000 and includes sideways relief against total income, early trade loss relief, and relief of trade losses against capital gain. However, the limit does not apply to sideways relief for the same trade.

There is a limit on certain income tax reliefs. The maximum relief is the higher of £50,000 or 25% of total income. This covers qualifying loan interest and most trading losses.

In 2013, there is no limit on the deductions against total income. This applies to specific specified reliefs, including trade loss relief, total income early trade loss relief, post-cession trade relief, and losses for shares in unlisted companies for eligible interest.

The total relief that can be deducted is the greater of £50,000 or 25% of the individual’s adjusted total income. Adjusted total income is the total income for the year minus the gross amount of pension contributions.