(Updated 1st Nov 2021)
Over the course of the Covid-19 pandemic we have seen numerous Government measures designed to help businesses, from the furloughing scheme and deferred VAT payments to subsidised business loans. Many businesses will have made use of some of these schemes, and perhaps also received a (taxable) business rates grant. Nonetheless, many healthy and until now, profitable businesses will have seen a big hit to the amount of revenue coming in over the last few months. Bills still need to be paid, and following the end of the furlough scheme, costs will be rising. This means that in accounting terms, and possibly in terms of cash, there will be many businesses currently operating at a loss.
It is therefore critical that business owners utilise any tax losses as efficiently as possible. Some thoughts on this are set out below. Of course, there are always other steps which can be taken to minimise the overall cost burden on the business, for example, reducing overheads through reigning in discretionary spending on such areas as marketing, but one of the most important areas to consider is the utilisation of tax losses.
Different rules apply to different business structures and different types of loss, so the following need to be considered separately:
|Self-employed/partnership trade losses||Trading company losses|
|Investment (typically property) business losses||Investment company losses|
|Capital losses||Capital losses|
Trading loss relief for individuals/partners
Hopefully, the business will have some books and records showing how large the loss is at present and when the losses started to arise. The first commercial decision is whether the business will survive or not? For example, people will always need their hair cut, so businesses like hairdressers should flourish following the easing of lockdown restrictions. Others might decide the best option would be to cease trading altogether, in which case terminal rules need to be considered.
‘Sideways’ loss relief
Under the usual rules, if the business is to continue despite being loss-making for the current tax year, then a trading loss can be set off against:
- Other income arising in the current tax year or previous tax year, subject to a limit of the greater of £50,000 of tax or 25% of total income; and
- Capital gains made in the current or previous tax year.
This is known as ‘sideways’ loss relief. The taxpayer can choose whether to offset the loss against income of the current tax year and/or the previous tax year. A loss (or profit) is ‘of’ a tax year if it arises in the accounting period ended in the tax year. Many individuals will make up accounts to 5 April each year (or 31 March, which is normally treated as if it were 5 April), but if accounts are made up to, say, 30 June each year, the loss for the accounting period to 30 June 2020 is a current year loss in 2020/21.
For example, a trading loss in 2020/21 may be offset against:
- Other Income of 2020/21;
- Other income and then gains of 2020/21;
- Other income of 2019/20;
- Other income of and then gains of 2019/20;
- Other income of both 2019/20 and 2020/21; or
- Other income and then gains of both 2019/20 and 2020/21.
Any unused loss for the current / previous tax year which is not set against income may be offset against gains of that year. However, a claim to relieve the loss against capital gains can only be made once other income has been reduced to nil by the loss. Further, partial claims are not allowed: the claim must either utilise all of the available loss or extinguish all of the available income. This could lead to personal allowances being wasted.
Extension of unincorporated loss relief for losses in 2020/21 and 2021/22
Following the legislation released in Finance Act 2021 a temporary extension was announced on the carry back rules for losses in 2020/21 and 2021/22.
For trade losses of tax years 2020/21 and 2021/22 it is intended to provide additional relief by allowing unrelieved losses to be carried back and set against profits of the same trade for three years before the tax year of the loss.
The amount of loss for tax year 2020/21 that an individual can carry back to the earliest 2 years of the extended period (2017/18 and 2018/19) is to be capped at £2m in total.
Unlike with companies in groups, there is no partnership level cap.
The proposed extension will build on the existing trade loss relief against general income in section 64 of ITA07. It will apply where a claim has been made under section 64 of ITA07 to set a trade loss for 2020/21 or 2021/22 against general income of the current year, the previous year, or both, and relief for the loss cannot be fully given under that claim.
Where a section 64 claim has been made for set-off of a trade loss for 2020/21 against general income of the current year, the previous year, or both, a claim may also be made under the new provision to carry back unrelieved losses against profits from the same trade for 2019/20, 2018/19 and 2017/18.
Losses carried back against profits of the trade in 2019/20, 2018/19 and 2017/18 (or only 2018/19 and 2017/18) will be set-off against the profits of the most recent year before earlier years.
For example, an individual trader’s profits, losses and other income are:
2017/18 – Trade Profit £1,200,000 – Employment Income £50,000
2018/ 19 – Trade Profit £1,200,000 – Employment Income £50,000
2019/20 – Trade Profit £500,000 – Employment Income £50,000
2020/21 – Trade Loss £3,000,000 – Employment Income £50,000
The trader makes a claim under section 64 of ITA07 to set the 2020/21 loss against general income of both the year of loss (£50,000) and the previous year 2019/20 (£550,000).
The remaining part of the 2020/21 loss, up to a maximum of £2,000,000, is available to carry back to set against trading profits of 2018/19 and 2017/18 (in that order), and the trader makes a claim under the new provision.
Loss set against:
1) £50,000 general income of 2020/21
2) £550,000 general income of 2019/20
3) £1,200,000 trade profit of 2018/19
4) £800,000 trade profit of 2017/18 (cap applied)
£400,000 of the loss remains available to be claimed to carry forward and set against trade profits in future years
Separate rules apply for losses arising in the first four years of trading. Broadly, a loss may be carried back and offset against other income of the previous three years tax years, starting with the earliest year. Once claimed, relief must be taken in all three tax years. In other words, it is not possible to specify that the loss should be offset against the income of only one tax year, if that year’s income is insufficient to fully absorb the loss. It is not possible to offset losses in early years against gains.
The rules for terminal loss relief are complicated, but broadly enable a loss in the final period of trading to be carried back and offset against trading profits of the previous 36 months. For example, for a business which makes up accounts to 31 March each year, if the trade ceased on 31 March 2020, a loss arising in the year to 31 March 2020 could be carried back and offset against losses arising in the accounting periods ended 31 March 2019 (2018/19 tax year), 31 March 2018 (2017/18 tax year) and 1 March 2017 (2016/17 tax year), taking later years before earlier years. Accounts should be prepared as soon as possible so that a claim can be made for a refund of income tax paid on business profits in 2018/19, 2017/18 and 2016/17.
Carry forward of unrelieved losses
Unused trading losses are carried forward and offset against future profits arising from the same trade, without time limit.
Trading loss relief is only available where the business is carried out on a commercial basis with a view to the realisation of profits. There are different rules for losses from farming, market gardening and holiday lets or if you have elected for the cash basis. There are also separate rules for ‘non-active’ partners and members of limited liability partnerships and specific advice should be sought. Sideways loss relief is not available where the individual works for less than 10 hours a week in the business.
Claims must be made by 31 January following the first anniversary of the tax year in which the loss arose. No claim is required to carry a trading loss forward. Claims are generally made in the individual’s tax return, but can be made separately by writing to HMRC.
Investment business loss relief for individuals/partners
The most likely situation where investment business losses will arise is for landlords whose tenants can’t pay, or who have agreed a rent deferral. A rent deferral does not have any effect on rental income for tax purposes unless there is subsequent doubt over whether the rent will ever be received. An exception to this is property businesses with annual rental turnover of below £150,000 where accounts are prepared on the cash basis.
Assuming the property business does not have loss of rent insurance cover, then a loss may arise due to interest charges and other expenses. Property business losses are not as flexible as trading losses and can only be carried forward to use against future profits of the same property business. There is no option to carry property losses back to earlier years.
A property loss can only be set off against other current year income to the extent it is attributable to capital allowances (not available for residential lettings business) or certain agricultural expenses.
Trading loss relief for Companies
The loss relief rules for companies are relatively straightforward. The priority is cash management, therefore the first step should be to assess the period in which losses arise, and be prepared to shorten the current accounting period. This will mean having to prepare financial statements and file them at Companies House, but the advantage is that the maximum loss will be packaged into as early a period as possible for tax purposes.
Offset against current/prior year profits
The tax-adjusted loss arising can be carried back against the total profits of the company (including chargeable gains) of the previous 12 months. Assuming the business was profitable in the previous accounting period, this will give rise to a tax repayment, which is triggered by amending the prior period’s tax return online. For businesses within the quarterly instalment payment regime, the loss carry back will also potentially reduce future instalment payments.
Trading losses can also be set off against:
- Current year income or capital gains of the company, or of any other company which is in a tax group with it under ‘group relief’ (a tax group broadly consists of a holding company and its 75% subsidiaries);
- Carried forward to be used against the future total profits (including gains) of the company; or
- Carried forward and offset as group relief against the current year income and gains of a company in the same tax group.
Extension of company trading loss relief for losses in 2020/21 and 2021/22
As with the current one-year carry back, the extended loss relief is limited to trading losses.
For accounting periods ending between 01/04/2020 & 31/03/2022, the usual 1 year carried back rule will be extended to 3 years, with trading profits being offset in most recent years first.
The losses able to be carried back 3 years is subject to a cap of £2m in each period.. Anything above the £2m will be subject to the current unlimited 12 month carry back rules.
For groups, the cap will still be £2m for the entire group
Where the group cap applies, a nominated company will be required to submit an allocation statement to HMRC showing which companies have been allocated amounts of the £2m cap.
The group cap will also not apply if all group companies are only able to make de minimis claims, even if the claims exceed £2m in total.
All other current loss reliefs will remain available.
De Minimis Limit
A de minimis of £200,000 operates to enable smaller claims to be made freely by groups and stand-alone companies. As previously noted, group companies are not subject to the group cap and separate reporting requirements if each of their claims do not exceed the de minimis amount. If a company has more than one accounting period ending within a relevant period, the total claims may not exceed the de minimis.
A de minimis claim may be made if the total amount of relief given by the claim does not (or could not) exceed £200,000. In calculating this, the company must take into account any available amounts that could be claimed as capital allowances of the period (or any other claim or relief that would result in an increase in the amount of the loss) and amounts remaining after carry back to the previous accounting period but before any surrenders of group relief.
Example 1 – Single Company
Company A has current year (CY) trading losses of £3,300,000 and profits of previous periods as follows:
CY-1 – £1,100,000
CY-2 – £1,750,000
CY-3 – £1,250,000
Current rules which allow £1,100,000 of CY trading loss to be carried back to CY-1 remain unaffected and therefore uncapped.
The legislative changes would allow Company A to carry back £1,750,000 (limited to the profits of the period) of CY trading loss to CY-2 and £250,000 (limited to unused amount of the £2,000,000 losses available for carry back) of loss to CY-3.
The remaining £200,000 of CY trade loss will be carried forward under current rules for relief under s45A and s45B CTA 2010.
Example 2 – Group
Five companies (A, B, C, D and E) make up a group for the purposes of section 269ZZB CTA 2010. In the accounting period ending 31 March 2021, the companies have trading losses remaining after carry back to the previous accounting period as follows:
Company A – £150,000
Company B – £150,000
Company C – £200,000
Company D – £200,000
Company E – £1,500,000
Companies A, B, C and D have losses below the de minimis threshold, so are able to make claims in advance of submitting their return for the accounting period.
Company E has up to £1,500,000 of losses to relieve. Since this amount exceeds the de minimis, Company E has to submit its claim in its return alongside an allocation statement (if it is the nominated company) showing all claims made within the group. The other claims total £700,000, so the group cap applies to restrict the amount Company E can relieve to £1,300,000.
Any unused trading losses are carried forward and offset against future profits of the company. ‘Profits’ includes not just trading profits but also chargeable gains and any profits from non-trading activity, such as rental income.
If the company ceases to trade, then any loss from the final 12 months can be carried back against profits for the previous 36 months, taking later accounting periods before earlier periods.
There are restrictions on losses if the trade is transferred or if there is a change of ownership of the company, or if losses are above £5m within a tax group.
Different rules applied for trading losses arising prior to 1 April 2017. Losses brought forward at this date may only be offset against future trading profits of the same trade, and carried forward losses are not eligible for group relief.
To offset losses against the profits of the current or previous accounting period, a claim should be made in the company’s tax return within two years of the end of the accounting period giving rise to the loss. A claim for group relief must generally be made on the first anniversary of the filing date of the company claiming the loss.
Investment business loss relief for Companies
The same rules apply to non-trading losses realised by companies as to trading losses, except for the terminology where the loss will be due to excess management expenses, a property letting business or non-trading loan relationship debits (interest), and there is no terminal loss relief.
Capital losses arise on a disposal of chargeable assets such as property or certain shareholdings. The amount of the loss can be affected by roll-over relief claimed in the past, or capital allowances adjustments. The rules for individuals and companies are broadly similar, although the company rules have additional flexibility in that a gain arising in one group company can be treated as arising to another in order to utilise that other company’s capital losses (capital losses cannot be group relieved).
Capital losses can be used against items taxed as chargeable gains in the same tax year (for sole traders / individual partners) or accounting period (for companies). If the capital loss cannot be used against gains arising in the same tax year or accounting period, the loss can be carried forward indefinitely to be used against future gains.
For companies, from 1 April 2020 there are restrictions on the utilisation of capital losses to reduce a company’s chargeable gains where losses exceed £5m.
For individuals, certain capital losses on the disposal of shares in unquoted trading companies can be used against income.
If you have any further questions / would like to discuss the options for your business please do not hesitate to get in contact with our Tax Partner Jacquelyn Kimber, email firstname.lastname@example.org or via phone 0116 254 9262.