It is a well-known fact that at times, the resultant of a trade is a loss and not a profit. For the traders who face losses in their trade and are less familiar with the regulations for loss relief, the blog will explain the available reliefs for the losses. The payment of tax is not taken back from HMRC as a result of the loss, rather the acquisition of relief can be done when a loss is set against the trading profits, against other income or against capital gains, so that the payment of tax is not required on them. There are some restrictions on the amount of loss relief that can be claimed in a tax year.
One important thing to consider is the choice between different reliefs. The aim is to make use of a loss to extract as much savings of tax as possible, the sooner the better.
General Overview of Losses
The relieving of the losses in trade may be done against the future profits of the same trade, against capital gains and against the general income.
The blog involves the discussion of calculation of losses and the ways in which a taxpayer who suffered loss can make use of that very loss to lessen their liability of tax. The losses in trade, professions and vocations will be the main focus.
The rules mentioned in this blog are only applicable to the individuals carrying out a trade either alone or in a partnership. The loss reliefs in case of companies are entirely different.
During the calculation of taxable trading profits, if the profits turn out to be negative, meaning a loss has occurred in the basis period (here basis period is used to link account period with tax year) of a business register with companies house UK. A tax year is operational from April 6 to April 5, but most of the businesses register with companies house UK do not have accounting periods that end on April 5. There should be a link between the period of account of a business and the basis period for a tax year. The taxation of the profits for a basis period is done in the corresponding tax year. The basis period for the first tax year runs from the date of beginning of trade to the next April 5th or to the cessation of trade if the trade does not last until the end of the tax year. The computation of loss is done in exactly the same manner as that of a profit, making the same adjustments to the loss or profit of accounts.
Calculating the Loss
The trading losses for a tax year are the trading losses in the basis period for that tax year. However, if there is an overlapping between the basis periods, then a loss in the overlap period is considered as a trading loss for the earlier tax year only.
The calculation and relieving of the losses suffered in overseas trades with overseas trade is done in a similar way to those of the trades based in UK.
The rules for relieving losses from a property business UK are the same for the losses on a foreign property business when a person in UK is involved in it, for instance, in an offshore company formation UK. The relieving of the losses on furnished holiday lettings can only be done by making use of the carry forward loss relief against the future income from furnished holiday lettings. The dealing of the losses on UK furnished holiday lettings and EEA furnished holiday lettings is done separately.
In case of the occurrence of loss on a profitable transaction, a taxable miscellaneous income will come into existence and it can be set against any other similar income in the same year, and any excess carried forward for the purpose of relief against miscellaneous income in the years to come.
Trading Loss Carried Forward
When a trading loss is made to be carried forward, then it should be set against the profits of the same trade when first available.
After create company UK or offshore company formation UK, during the calculation of net trading income, a loss in trade, whose relieving is not done in any other way, should be carried forward to be set against the profits of same trade when first made available. There is no restriction in the number of years for which the losses can be carried forward. It can be any number.
Relief for Trading Loss against General Income
When the claim for a relief is made, the losses of trade can be set against general income (and also gains upon a further claim) in the present year and/or general income (and also gains upon a further claim) in the previous tax year.
Rather than carrying a trading loss forward against upcoming trading profits, its relieving may be done against the general income.
Relief for the Loss
It should be noted that a relief is against the income of the tax year in which the loss took place. Additionally, or instead, the claim of relief may be made against the income of the previous year.
If losses are noted continuously for two years, and the claim for relief is made against the oncome of the first year both for the loss of first year and the loss of second year, then the provision of relief is done for the loss of first year prior to the loss of second year.
If you wish to make a claim for a loss, then it should be made by the January 31st which is 22 months after the end of the tax year of loss: e.g. by January 31st 2016 for a loss suffered in 2013/14.
The choice of the amount of loss to be relieved is not in the hands of the taxpayer: so it may be required to set the income against the part of which would have been covered by the personal allowance. However, the taxpayer does not have a choice whether to make a claim for entire relief in the present year and then relief in the past year for any loss that remains, or other way round.
During the computation of the liability of income tax, the loss is set against the non-savings income, followed by the savings income and at last, against the dividend income.
The availability of relief can be found by carry forward for any loss that has not been relieved against the general income.
Claim of Capital Allowances
The size of the total loss relief claim may be adjusted by the trader by not making a claim of all the capital allowances they have an entitlement of: a reduced claim will lead to the increment of balance carried forward to the computation of capital allowances for the next year. This can prove as an essential point for the planning of tax where the effective rate of relief for the capital allowances in the periods to come will be more than the rate of tax relief for the loss relief.
Relieving Trading Loss against Capital Gains
When the claim of relief is made against general income for a specified year, a further claim may be included by the taxpayer to set the loss against their chargeable gains for the year minus any allowable capital losses for the same year or for preceding years. The computation of this amount of net gains is done by ignoring the annual exempt amount.
First, the trading loss is set against the general income of the year in which claim is made, and only any excessive loss is set against the capital gains. The taxpayer cannot make a specification of the amount to be set against capital gains, so the yearly exempt amount may go to waste.
Restrictions in case of Relief for Trading Loss against General Income
After create company UK, the claim of loss relief cannot be made against the general income unless the conduction of the loss-making business is done on a commercial basis.
The claim of relief cannot be made against the general income until and unless the conduction of the loss-making business takes place on a commercial basis with a view to realize the profits throughout the basis period for the tax year.
The Relief Cap
The deduction of only greater of £50,000 and 25% of adjusted total income can be done by an individual taxpayer while making a claim for loss relief against the general income.
There exists a restriction on some particular subtractions that may be made by an individual from the total income for a tax year. The restricted subtractions concern the trade loss relief against general income (whether the claim is made for the tax year of loss or the preceding year), early relief for trading loss, share loss relief against the general income and the subtraction of interest for qualifying aims. The total subtractions in a tax year cannot be more than the greater of £50,000 and 25% of the adjusted total income of the taxpayer for the tax year.
The adjusted total income is defined as the total income plus payroll giving less the gross amounts of personal pension contributions. In case if a relief is claimed against the general income in the preceding year, then there holds no restriction on the amount of loss that can be utilized against the trading income of the same trade. The restriction is only applicable to any other income in the same year. Any loss that is more than the maximum subtraction can still be carried forward against the future profits from the same trade.
The limits are applicable in each year for which a claim for relief is made. If the claims for present and previous years is made, the relief in the ongoing year is restricted to the greater of £50,000 and 25% of the total adjusted income in the present year. The relief in the previous year is subject to restriction of greater of £50,000 and 25% of the total adjusted income in the previous year. The restriction is only applicable to relief against income, not if there is an extension in the claim to capital gains.
Another point under consideration is that a trading loss is not allowed to be set against the capital gains of a year until and unless the claim of relief is first made against general income of the same year. It may prove worth making the claim against income and wasting the personal allowance so that a liability of a capital gains tax can be avoided. However, it should be kept in mind that making use of a loss against capital gains will only lead to a maximum 28% saving of tax, while setting the losses against income can result in a maximum of 45% savings of tax.
Finally, it is very important to take into consideration the fact that how offsetting a loss against income will have an effect on the taxation of any income that remains liable to tax. For example, when you set a loss against non-savings income, it might mean that the savings income becomes liable to tax at the starting rate, instead of the basic rate, or the higher rate income becomes liable to tax at the basic rate. It should be remembered that the tax applicable on the dividend income in the band of basic rate will be covered under the 10% credit of tax.