If a sole trader or a partnership makes a loss in their trade, that loss can be carried forward against future profits, or set against other income for the tax year concerned or for the previous year, and also against capital gains of the tax year. This relief against other income or gains is sometimes referred to as ‘sideways’ loss relief.
There are various restrictions on sideways loss relief, and one is that the loss-making trade must have been carried on ‘on a commercial basis and with a view to the realisation of profits of the trade’ (see section 66 ITA 2007).
It is important to realise that these rules only restrict sideways relief. There is no restriction on carrying losses forward against future profits.
A recent case (Murray v Revenue & Customs (2014 UKFTT 338 (TC)), involved losses of a business described as ‘Race Horse Bloodstock Breeding and Training’. There is special legislation and agreed HMRC practice relating to stud farms (which are a type of ‘farming’ for tax purposes) that restricts setting losses against other income after eleven years of continuous losses, but HMRC refused relief for the tax year 2010/11 after the trade had only been carried on for six years, and on the more general grounds of ‘commerciality’ and ‘realisation of profit’.
In the year they picked, there was no income at all, and expenses of over £28,000. The breeding side of the business did not look hopeful as Mr Murray’s stock of horses in the year in question consisted of an infertile mare and three geldings. The business plan for the ‘training’ appeared to involve entering the geldings for races in the hope of enhancing their value for sale. Racing horses (as distinct from being paid to train other people’s horses to race) has long been held not to be a trade, so Mr Murray had little hope of success and he lost his case.
HMRC should not, however, simply attack loss claims on the basis that the trade has not made a profit yet – the test is whether it is reasonable to expect to make a profit in the future, and whether the trade is being carried on in a businesslike way. HMRC tend to go overboard on this second point, demanding profit forecasts and cash flow projections and when these are not available asserting that the trade is not being conducted ‘on a commercial basis’.
Hansard, the official parliamentary record, can be used to assist in interpreting the meaning of tax legislation, and it is sometimes useful to remind HMRC that when the legislation was introduced into parliament the Chancellor of the Exchequer said:
“We are after the extreme cases in which expenditure very greatly exceeds income or any possible income which can ever be made in which, however long the period, no degree of profitability can ever be reached.”
This can be found in paragraph BIM85705 of HMRC’s Business Income Manual.
There are not many decided cases on ‘uncommercial’ trades and HMRC seem generally reluctant to go to the Tribunal to defend their refusal of sideways relief.
The most vulnerable taxpayers are those effectively financing their hobbies by seeking to get paid for some aspect of them. Horses are often involved in one way or another but I have also come across car rallying, dog training, and, once, ballooning! Just because you enjoy your work, however, does not mean it is ‘uncommercial’.
Practical Tip :
Provided there is some prospect of future profits, and provided you are trying to run the venture in a businesslike way, do not be intimidated by an HMRC challenge. Make sure you quote the Hansard extract to them, and present a robust case for your business being commercial and potentially profitable.
