Sarah Laing looks at the rules for carrying back losses in the early years of trading.
Subject to satisfying certain conditions, a useful relief – known as ‘early trade losses relief’ – applies to losses sustained in the tax year in which a trade is first carried on, or in any of the next three tax years.
The provisions may be particularly helpful to new businesses, as they may be used to generate an often much-needed cash boost in the form of a tax repayment.
How the relief works
Broadly, a business loss incurred in any of the first four tax years of a new business may 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 from HMRC.
In contrast to the mechanics of certain other loss reliefs, it is not possible to apportion an ‘early trade loss’ for use over a number of years, so as to leave personal reliefs and allowances intact, or to take advantage of beneficial tax rates. However, if losses remain after exhausting all the income for the previous tax years, the remaining losses may be the subject of a separate claim (for example, carried forward for set off against future profits from the same trade).
Example: Loss relief in action
Peter starts to trade on 1 November 2018 and incurs a loss in the tax year 2020/21. If he makes a claim for early trade loss relief, the loss must first be set against income for 2017/18. Once the loss has been used against all income for that year (without restriction as regards personal allowances), the remaining part can be set against income for 2018/19 and then 2019/20.
If Peter’s total income of all three of those years is insufficient to absorb the whole loss, he can make a separate claim in relation to the remaining part of the loss.
Cap on relief
The amount of income tax relief that an individual can set against their total income is capped (from 6 April 2013), with one of the reliefs affected being that for losses in the early years of trade.
The limit is the greater of £50,000 or 25% of the individual's ‘adjusted total income’ for the tax year. ‘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.
Time limit for claims
A claim for early trade losses relief must be made by the first anniversary of the normal self-assessment filing date for the year in which the loss is incurred.
Other ways to obtain relief
Where a loss is made in a tax year but the trader does not have any other income against which it can be set, the loss can be carried forward indefinitely and used to reduce the first available profits of the same business in subsequent years.
Losses arising from a business may be set off against any chargeable capital gains. Relief may 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.
