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.
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.
| Tom's accounting year ends on 31 March. In the year to 31 March 2014 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 2013/14 and so this means that Tom has a loss of £7,000 (10,000-15,000-2,000) for the current tax year – 2013/14 |
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 2013/14 is the tax year ended 5 April 2014.
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.
| Tom who we met in the earlier example, makes a loss in the year to 31 March 2014 of £7,000. Tom can get relief for his loss in either the current tax year 2013/14 or the previous tax year 2012/13 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. 2013/14 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 2012/13 As Tom has no other income for 2013/14 he will waste his tax-free personal allowance of £9,440. 2012/13 Loss still available (7,000 - 5,000) = £2,000 This is used against part of the 2012/13 income from letting property, leaving £3,000 still taxable. Tom will be able to use part of his tax-free allowance of £8,105 to reduce his remaining taxable income for 2012/13 to nil. |
(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.
| Martin makes a loss of £6,500 in the 2013/14 tax year (based on his accounts to 31 December 2013). In 2014/15 (accounts to 31 December 2014) he makes a profit of £4,000. His accounts for his accounting year to 31 December 2015, which are taxable in 201516will show a profit of £8,000. Martin will use his loss of £6,500 carried forward from 2013/14 as follows: - Profit for 2014/15 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 2015/16.
- Profit for 2015/16 is £8,000. From this we take off the balance of loss available - £2,500 leaving a taxable profit remaining of £5,500.
|
(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.
| Mo starts up in business during the 2013/14 tax year. For that year she makes a loss of £5,500 and for 2014/15 her loss is £7,500. Before starting her business Mo had always previously been employed. Mo can use her 2013/14 loss against her total income for the tax years 2010/11, then 2011/12 and 2012/13 in that order. She can use her 2014/15 loss of £7,500 against her total income for the tax years 2011/12, then 2012/13 and 2013/14 in that order. |
(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 (1) above as normal. You can also make this type of claim in addition to a claim under (1) 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.
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.
| James made a loss for the tax year 2013/14. He will need to make a claim by 31 January 2016. |
Loss carried forward to later years
You need to claim within four years from the end of the loss making tax year.
| Sally made a loss for the tax year 2013/14. She will need to make a claim by 5 April 2018. |
New business losses
You need to claim within one year from 31 January after the end of the loss making tax year.
| Carol made a loss for the tax year 2013/14. She will need to make a claim by 31 January 2016. |
Terminal losses
You need to claim within four years from the end of the tax year in which the business finishes.
| Pete made a loss for the tax year 2013/14. He will need to make a claim by 5 April 2018. |
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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.
You can find more about how to report losses for tax credits on form TC825. There is also a useful albeit short section in the HMRC leaflet WTC2 - Child Tax Credit and Working Tax Credit - A Guide on page 23 on losses you might want to look at as well.
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Cap on Income Tax Reliefs
With effect form 6 April 2013 there will be a cap on the amount of income tax relief that an individual can benefit. This limit or cap will restrict the amount of loss relief an individual can claim. The maximum relief an individual can claim from April 2013 is the greater of £50,000 and 25 per cent of their annual income.
The new legislation is contained in Finance Bill 2013.
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