Q. I have recently set up my own business after having been employed for many years. Although I am hopeful that I will eventually make a profit, I anticipate that I am likely to make a small loss in each of my first three years of trading. What is the best way for me to utilise these losses for tax purposes?
A. If a business is being carried on a commercial basis with a view to making a profit, it is generally possible to claim relief for a trading loss in one tax year against other taxable income (for example PAYE income or a pension) from the same year, or the one before. You will be free to decide which year to claim the losses against. You should note that HMRC will restrict loss relief if you carry on a trade but spend an average of less than ten hours a week on commercial activities.
Where a loss is incurred in any of the first four tax years of a new business, the loss can be carried back against total income of the three previous tax years, starting with the earliest year. Therefore, if you paid tax in any of the previous three years, you should be entitled to a repayment of tax, which may be especially welcome in those often difficult early years of trade. You must offset the maximum for each year - it is not permissible to offset just 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 you were 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 you may need a viable business plan to support a claim.
A cap on relief was introduced in April 2013, which applies to certain previously unlimited income tax reliefs that may be deducted from income. Trade loss relief against general income, and early trade losses relief, as outlined above, are two areas where this relatively new restriction will apply. The cap is set at £50,000 or 25% of income (calculated using a specific formula), whichever is greater.
Where a trader makes a loss in a year, but does not have any other income against which the loss can be set, he or she can carry it forward indefinitely and use it to reduce the first available profits of the same business in subsequent years.
A taxpayer can also set any losses arising from a business against any chargeable capital gains. The relief can be claimed for the tax year of the loss and/or the previous tax year. However, the trading loss first has to be used against any other income the taxpayer may have for the year of the claim (for example, against earnings from employment) in priority to any capital gains.
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