In general terms, providing a business is undertaken on a commercial basis with a view to making a profit, tax relief should be available for trading losses incurred. It is usually possible to offset the loss against other taxable income from the same year, or the previous year. Other taxable income may include for example, a former employment (where tax was deducted under PAYE) or a pension.
This relief may be particularly beneficial for someone who is self-employed on a part-time basis. For example, where an individual earns £30,000 a year from employment, and makes a £2,000 loss from his or her part-time business, their tax bill for the year will be based on income of £28,000.
Where a loss is incurred in any of the first four tax years of a new business, the amount of the loss can usually be carried back and offset against total income of the three previous tax years, starting with the earliest year. Therefore, where an individual has paid income tax in any of the previous three years, he or she is likely to be entitled to a repayment of tax. The maximum amount must be offset each year – it is not possible to offset a proportion of the loss in order to spread the loss across three years to take advantage of beneficial tax rates. Again, relief will not be available unless the individual was trading on a commercial basis with a view to making a profit within a reasonable timescale. In practice, this requirement may be difficult to prove in the case of a new business and HMRC may want to see a viable business plan to support a claim.
It is worth noting that the income tax legislation sets out various specific reliefs that may be deducted in the calculation of income tax liability, including reliefs which can be relieved against general income. Before 6 April 2013 there was generally no upper limit on the amount of income tax relief which could be claimed. However, from 6 April 2013 certain restrictions apply to the amount of loss relief available. The primary reliefs affected by the cap are the trade loss reliefs outlined above, property loss reliefs that can be relieved against general income, and qualifying loan interest relief. A small number of other reliefs will also be affected. The cap is set at £50,000 or 25% of income, whichever is greater.
‘Income’ for the purposes of the new cap will be calculated ‘total income liable to income tax’. This figure will then be adjusted to include charitable donations made via payroll giving and to exclude pension contributions – this adjustment is designed to create a level playing field between those whose deductions are made before they pay income tax, and those whose deductions are made after tax. The result, known as ‘adjusted total income’, will be the measure of income for the purpose of the cap.
The cap will apply to the year of the claim and any earlier or later year in which the relief claimed is allocated against total income. The limit will not apply to relief offset against profits from the same trade or property business.
Anyone wishing to make a claim for loss relief needs to be aware of the time limits for doing so -HMRC must be informed within 12 months following 31 January after the end of the loss-making business year.