Running a business, whether as a sole trader or in a partnership, can sometimes lead to trading losses. While they may appear as setbacks, trading losses can actually offer strategic tax relief opportunities, helping you reduce future tax liabilities. In this guide, we’ll explore key tax relief strategies and show how managing trading losses effectively can keep your tax situation as advantageous as possible.
Default Tax Relief for Losses: Carry Forward
The most common approach to handling trading losses is carrying them forward, where they offset future profits from the same trade. This reduces taxable income in future years and lowers tax bills. However, carrying forward comes with limitations:
- Same Trade Requirement: Losses can only be offset against future profits from the same trade. If your business pivots or changes direction, you may no longer be able to offset these losses.
- Terminal Loss Relief: If your business ceases trading, you can apply terminal loss relief to offset losses against profits from previous years.
One drawback is that carry-forward relief can lead to wasted personal allowances. Losses reduce profits before any personal allowance is applied, which might not be the most efficient approach to using your allowances.
Incorporation as a Tax Strategy
Incorporating your business can preserve losses and offer additional tax benefits. When you transfer your sole trader or partnership business to a company, you exchange the business for shares in the new company.
- Preserving Losses: While these losses can’t offset the company’s profits, they can be set against the director’s income (e.g., director’s fees), provided the trade remains consistent.
If the company continues the same trade, this can provide significant tax relief without forfeiting accumulated losses.
Sideways Loss Relief: An Alternative Approach
Instead of carrying losses forward, sideways loss relief allows you to offset trading losses against other income sources, including:
- Offsetting losses in the same year they occur
- Offsetting against the previous year’s income
- Spreading losses across both years if they exceed taxable income in one year
Sideways relief is beneficial if the business was profitable in the previous year, as you may receive a tax refund by carrying the loss back. From the 2024/25 tax year onward, sideways relief will be available regardless of whether losses are calculated using the accruals or cash basis.
However, note that this relief has limits: the claim is capped at the greater of £50,000 or 25% of your adjusted total income.
Special Rules for New Businesses: Early Loss Relief
New businesses often face early-stage losses. If you incur a trading loss within the first four years of operation, early loss relief allows you to offset losses against your total taxable income from the previous three years.
- Order of Relief: Losses must be applied to the earliest year first, carrying any remaining losses forward.
- Accruals Basis Requirement: Losses up to the 2023/24 tax year must use the accruals basis, but from 2024/25, either the accruals or cash basis is accepted.
Terminal Loss Relief: When Your Business Ceases Trading
When a business stops trading, terminal loss relief can be applied. Losses from the last 12 months of trading can be offset against profits from the year trading ceased, and also from the previous three years. This can result in a significant tax refund if the business was profitable in previous years.
Claiming Relief After Submitting a Tax Return
If you’ve submitted your tax return and incur a loss afterwards, you can still amend it. Tax returns can be revised up to 12 months after the January 31 deadline for that tax year. After this window, you’ll need to write to HMRC to make your claim.
Making the Most of Trading Losses
By understanding and leveraging options for managing trading losses, you can minimise tax liabilities and set your business up for future success. Whether you use carry-forward relief, sideways relief, or early loss rules, these strategies can help ensure your losses benefit your tax position.
For personalised advice on managing trading losses and tax planning strategies, contact our team here at Yorkshire Accountancy today.
