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This is a very brief introduction to losses to help you understand what types of losses can arise in a business and what you can do with a loss once you have one. We have not covered all the ways that you can use losses - just the ones that you are most likely to encounter.
There is also a section on how tax credits are affected by losses in your business
Carrying on a business in a non-active capacity
For anyone other than a partner who carries on a business in a non-active capacity where non active means an average of less than 10 hours a week - the amount of loss relief you can claim in these circumstances will be reduced.
There will be an annual limit of £25,000 on the total amount of loss relief that you can claim from trades carried on in a non-active capacity. If HMRC consider the loss is part of a tax avoidance scheme - no loss relief claim will be allowed.
Extension of loss relief for business for 2009/10
For 2009/10 there will be special legislation which extends the ability of businesses to carry trading losses back against profits of earlier years to get a repayment of tax. For further details on this see below.
Trading losses - what are they?
If you are self-employed or a partner in a business, you will make a loss in your business, whenever your expenses and capital allowances are more than your income or turnover for your accounting date .
You work out your loss the same way as you would work out your profits for the year.
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Tom's accounting year ends on 31 March. In the year to 31 March 2011 Tom had the following income and expenses:
Turnover or income - £10,000
Expenses - £15,000
Capital allowances - £ 2,000
Tom's accounting year ends in 2010/11 and so this means that Tom has a loss of £7,000 (10,000-15,000-2,000) for that tax year – 2010/11
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What can I do with my loss?
Just to remind you - when we refer to a tax year we are talking about the year ended on 5 April - so 2010/11 is the tax year ended 5 April 2011.
There are a number of things you can do when you make a loss:
- You can use the loss in the current tax year and/or the previous tax year and set it against all your income including income from savings.
- You can carry the loss forward to later years and set it off then against any profits you make from the same business.
- For a new business - if the loss occurs in any of the first four tax years of trading, you can set off the loss against your total income (including savings income) of the three tax years immediately before the loss year - using income of the earliest year first
- If your business finishes and you make a loss in your last year, you can set this against your trading profits of the previous three years, latest year first.
(1) Using your loss in the current or previous tax year
You can set your loss against:
- Total income of the current tax year or;
- Total income of the previous tax year or;
- If the loss is larger than either income of the current or previous tax years, you can set it against both years
Total income is all your income including savings income.
If you carry back a loss to an earlier year and there was already a loss in that year, the loss of the earlier year is used before the loss you have carried back.
It is possible to use this type of loss against Capital Gains but we will not be covering that in this section.
Bear in mind that you may waste your tax free allowances as the loss has to be set against your income before you use your allowances. You should look at your income for both the current and previous tax year to see which year would limit the loss of allowances before you make any claim.
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Tom who we met in in the earlier example, makes a loss in the year to 31 March 2011 of £7,000.
Tom can get relief for his loss in either the current tax year 2010/11 or the previous tax year 2009/10 or both depending on the level of his other income.
Tom had inherited his parents' house a few years ago, which he rents out for £5,000 a year. He has no other income.
2010/11
Loss available £7,000
£5,000 is used against income from letting property
The loss left over of £2000 will be used by carrying it back to 2009/10
As Tom has no other income for 2010/11 he will waste his tax-free personal allowance of £6,475.
2009/10
Loss still available (7,000 - 5,000) = £2,000
This is used against part of the 2009/10 income from letting property, leaving £3,000 still taxable.
Tom will be able to use part of his tax-free allowance of £6,475 to reduce his remaining taxable income for 2009/10 to nil.
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(2) Carry the loss forward to later years
- You can simply carry your loss forward to a later year and set it against your profits from the same business.
- You have to set the loss against the next available profit and so on until it is used up.
- Again you need to bear in mind that you may end up losing your tax-free allowances as the loss takes priority and will be set against your profits first.
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Martin makes a loss of £6,500 in the 2010/11 tax year (based on his accounts to 31 December 2010). In 2011/12 (accounts to 31 December 2011) he makes a profit of £4,000. His accounts for his accounting year to 31 December 2012, which are taxable in 2012/13 will show a profit of £8,000.
Martin will use his loss of £6,500 carried forward from 2010/11 as follows:
- Profit for 2011/12 is £4,000. This is covered by £4,000 of the loss brought forward leaving £2,500 (£6,500 - 4,000) loss to carry forward for 2012/13.
- Profit for 2012/13 is £8,000. From this we take off the balance of loss available - £2,500 leaving a taxable profit remaining of £5,500.
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(3) New businesses
- This is an alternative type of claim to (a) above for new businesses making a loss in any of the first four tax years that they are trading.
- You can set this kind of loss against any of your other income for the previous three tax years - earliest year first.
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Mo starts up in business during the 2010/11 tax year. For that year she makes a loss of £5,500 and for 2011/12 her loss is £7,500.
Before starting her business Mo had always previously been employed.
Mo can use her 2010/11 loss of £5,500 against her total income for the tax years 2007/08 then 2008/09 and 2009/10 in that order.
She can use her 2011/12 loss of £7,500 against her total income for the tax years 2008/09 then 2009/10 and 2010/11 in that order.
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(4) Loss in year business finishes or you cease to be a partner in a business
- This is a bit more complicated to work out - so we will just cover the essential facts here.
- A loss in the year your business finishes is called a Terminal loss. You do not need to claim this relief - you can instead claim under (a) above as normal. You can also make this type of claim in addition to a claim under (a) if you have other income.
- Basically you can claim to set a loss for the last 12 months of trading against trading income (after capital allowances) of the tax year in which the business finishes and then the previous three tax years - latest first.
- You will be able to use your overlap relief (if you have any) as part of your terminal loss.
2009/10 losses - extension of loss relief carry back rules
Introduction
- The current rules allow you to set a trade loss for a tax year against your general
income (e.g. wages, benefits in kind, other non savings income including casual earnings and savings income including rents & interest) of the loss-making year and/or the previous tax year.
- For 2009/10 trade losses only, there will be an additional relief. This will mean that if you have any unrelieved losses, these can be carried back and set against profits of the same trade, profession or vocation for three years before 2009/10.
- No change is proposed to the current one year unlimited carry back of trade
losses. However for 2009/10 the amount of loss that can be carried back to the earliest two years of the extended period (2006/07 and 2007/08) is to be capped at £50,000 in total.
Will the rules apply to me?
- The extended loss relief (including losses of a furnished holiday lettings business) will apply where:
- a claim has been made to set a trade loss for 2009/10 against general income of 2009/10, the previous year 2008/09, or both, and relief for the loss cannot be fully given under the claim; or
- a claim has been made for set-off of a trade loss for 2009/10 against general income of 2009/10, a claim may also be made to carry back unrelieved losses against profits from the same trade for 2008/09, 2007/08 and 2006/07; or
- a claim has been made for set-off of a trade loss for 2009/10 against general income of the previous year 2008/09, or for both 2009/10 and 2008/09, a claim may also be made to carry back unrelieved losses against profits from the same trade in 2007/08 and 2006/07.
For 2009/10, losses carried back against trading profits of 2008/09, 2007/08 and 2006/07 (or only 2007/08 and 2006/07) will be set-off against the trading profit of a later year before an earlier year.
If relief for a loss for 2009/10 would be available but a claim has not been made because you have no income to claim against for either 2009/10 or 2008/09, a claim may still be made to carry back unrelieved losses against profits from the same trade in 2007/08 and 2006/07.
All the other current loss reliefs explained on this webpage remain available. For example, if a claim under the new relief is not possible because there are no trading profits in earlier years against which to set a loss, any unrelieved loss will remain available to set against trading profits in future tax years.
Claims for extended loss relief
- A claim to loss relief will normally be made in your tax return, but where
a claim will affect more than one year a stand-alone claim may be made outside of a return. The claim must specify the name of the business, the period for which the loss is made, the amount of the loss, and how the loss is to be used.
- A stand-alone claim may be made as soon as the basis period for which the
loss is made has ended and the loss has been calculated.
- The time limit for making a claim to the extended relief for a trade loss in tax year 2009/10 is 31 January 2012.
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Jack's profits, losses and other income are:
2006/07 Trade profit £ 80,000, wages £5,000
2007/08 Trade profit £60,000, wages £5,000
2008/09 Trade profit £30,000, wages £5,000
2009/10 Trade loss £100,000, wages £ 5,000
Jack makes a claim to set the 2009/10 loss against his general income of both the year of loss ( wages - £5,000) and the previous year 2008/09 ( profits and wages - £35,000).
The remaining part of the 2009/10 loss, up to a maximum of £50,000, is available to carry back to set against Jack's trading profits of 2007/08 and 2006/07 (in that order).
So Jack's total loss relief will be:
1) £5,000 employment income of 2009/10
2) £35,000 employment income + trade profit of 2008/09
3) £50,000 trade profit of 2007/08 – although the actual loss is greater - it will be capped at the £50,000 limit for the special relief.
Total losses relieved – £90,000
This then leaves £10,000 available to carry forward to set against trade profits in future years.
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Time limits for making your loss relief claim
Loss used in current or previous tax year
- You need to claim within one year from 31 January after the end of the loss making tax year.
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James made a loss for the tax year 2010/11. He will need to make a claim by 31 January 2013.
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Loss carried forward to later years
- You need to claim within five years from 31 January after the end of the loss making tax year.
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Sally made a loss for the tax year 2010/11. She will need to make a claim by 31 January 2017.
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New business losses
- You need to claim within one year from 31 January after the end of the loss making tax year.
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Carol made a loss for the tax year 2010/11. She will need to make a claim by 31 January 2013.
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Terminal losses
- You need to claim within five years from 31 January after the end of the tax year in which the business finishes.
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Pete made a loss for the tax year 2010/11. He will need to make a claim by 31 January 2017.
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How are tax credits affected by losses in your business?
In a number of situations, the way you get tax relief for losses you make in your business will be very different from the tax credit rules for using the same losses. In particular there are four areas where you need to bear this in mind. We refer to the normal income tax rules for loss relief as real tax to distinguish them from the rules for tax credits loss relief.
Carry back of losses
- For real tax, you may want to carry back your losses so that you can get a tax repayment in respect of the previous tax year.
- However you will need to remember that for tax credits, it is not possible to re-open claims for the previous year to take into account any losses you subsequently carry back from the current year. There is no carry-back of losses for tax credits.
- Losses that you have carried back for real tax purposes may still be set off against your tax credits income. This will first be done by setting against your other income of the year of loss. If you are making a joint claim with your spouse, civil partner or someone with whom you are living, you must set off your losses against your joint income for the tax year of the loss. Any surplus can be carried forward and set against income of the same trade for a future tax year.
Carry forward of trading losses
- For both real tax and tax credits, losses, which are not set off in any other way are carried forward and set against future profits of the same trade. However, the amount carried forward will often differ for real tax and for tax credits.
- This is primarily for two reasons:
- Where the person running the business is part of a couple, losses for tax credits must first be set off against other income of both partners in the couple for the current tax year, while for real tax only the other income of the partner carrying on the business can be used (see below under Joint claims); and
- the fact that for real tax, any surplus loss not set off against other income in the current tax year is first carried back against income of the previous year, while for tax credits - as we explained above - there is no carry back of trading losses.
Joint claims
- As mentioned above it is important to bear in mind that where there is a joint claim for tax credits, the order of set off of trading losses is firstly against current year income of the couple and then by way of carry forward against future profits of the same trade. This is because the tax credit rules say that any trading loss in a year has to be subtracted from the total of the other income of the couple. Each couple is treated as one claiming unit for tax credits.
- The set off against the couple's other income in the case of a joint claim for tax credits may result in a lower figure of losses for carry forward than the equivalent figure for real tax.
- Remember that from a tax point of view - each individual is looked at completely separately whereas for tax credits it is the claiming unit, whether single or joint whose income and circumstances must be taken into account.
If you have any doubts or concerns about the best way to use your losses you may need to get some professional advice. There is a useful albeit short section in the Revenue leaflet WTC2 - Child Tax Credit and Working Tax Credit - A Guide on pages 26/27 on losses you might want to look at as well.
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