What can be done with business losses?

Providing a business is being undertaken on a commercial basis with a view to making a profit, it is generally possible to claim relief for trading losses.

Relief for trading losses may be obtained in a variety of ways, including:

  • set-off against other income in the same or preceding tax year, for example against employment or pension income;
  • carry-forward against subsequent profits of the same trade;
  • carry-back in the early years of a trade;
  • set-off against capital gains of the same or preceding tax year; or
  • carry-back of a terminal loss.

It is worth noting here that anti-avoidance rules mean that loss relief will be restricted for individuals who carry on a trade but spend an average of less than ten hours a week on commercial activities.

Cap on relief

Trade loss relief against general income, and early trade losses relief are two areas where claimable relief is capped. The cap is set at £50,000 or 25% of income (as defined in the legislation), whichever is greater.

The cap applies to the year of the claim and any earlier or later year in which the relief claimed is allocated against total income. The limit does not apply to relief that is offset against profits from the same trade or property business.

Early years of trade

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.

This relief often helps new businesses in the first few years of trading. If tax has been paid in any of the previous three years, for example from a previous employment, the taxpayer should be entitled to a repayment of tax.

Set against total income

Relief for the trading loss of a tax year can be claimed against the taxpayer’s total income of that tax year and/or the preceding tax year, in any order. This gives a certain amount of scope to maximise loss relief in the most beneficial way.

Where a claim is made to relieve profits in one basis period by losses of both the same basis period and a subsequent period, the claim for the loss in the same period takes precedence.

Where basis periods overlap, and a loss would otherwise fall to be included in the computations for two successive tax years (e.g. in the opening years of a business), it is taken into account only in the first of those years.

Relief is not normally available for farming and market gardening losses, where losses were also incurred in the previous five years (calculated before capital allowances).

Carry forward of losses

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.

Setting losses against capital gains

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.

Incorporation

Where incorporation is being considered, it is usually permissible to carry forward any unused losses of the pre-incorporation business and set them off against the first available income derived from the new company.

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Using the cash basis – is it for you?

The cash basis is a simpler way of working out taxable profits compared to the traditional accruals method. The cash basis takes account only of money in and money out – income is recognised when received and expenses are recognised when paid. By contrast, the accruals basis matches income and expenditure to the period to which it relates. Consequently, where the cash basis is used there is no need to recognise debtors, creditors, prepayments and accruals, as is the case under the accruals basis.

Example

Ben is a self-employed plumber. He prepares accounts to 31 March each year. On 28 March 2019 he fits a new shower, invoicing the customer £600 on 29 March 2019. The customer pays the bill on 7 April 2019.

He purchased the shower for £400 on 25 March 2019, receiving an invoice from his supplier dated the same date. He pays the bill on 8 April 2019 after he has been paid by the customer.

On the cash basis, the income of £600 and expenditure of £400 fall in the year to 31 March 2020 – they are recognised, respectively, when received and paid (in April 2019). By contrast, under the accruals basis, the income and expenditure falls into the year to 31 March 2019 as this is when the work was done and invoiced.

Who can use the cash basis?

The cash basis is available to small self-employed businesses (such as sole traders and partnerships) whose turnover computed on the cash basis is less than £150,000. Once a trader has elected to use the cash basis, they can continue to do so until their turnover exceeds £300,000. These limits are doubled for universal credit claimants.

Limited companies and limited liability partnerships cannot use the cash basis.

Advantages of the cash basis

The main advantage of the cash basis is its simplicity – there are no complicated accounting concepts to get to grips with. Because income is not recognised until it is received, it means that tax is not payable for a period on money that was not actually received in that period. This also provides automatic relief for bad debts without having to claim it.

Not for everyone

Despite the advantageous associated with its simplicity, the cash basis is not for everyone. The cash basis may not be the right basis for you if:

  • you want to claim a deduction for bank interest or charges of more than £500 (a £500 cap applies under the cash basis);
  • your business is more complex, for example, you hold high levels of stock;
  • your need to obtain finance – banks and other institutions often ask for accounts prepared on the accruals basis;
  • you want to claim sideways loss relief (i.e. set a trading loss against your other income) – this is not permitted under the cash basis.

Need to elect

If the cash basis is for you, you need to elect for it to apply by ticking the relevant box in your self-assessment return.

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