In the event that a loss arises in a trade or profession, consideration should be given as how best to obtain relief for that loss. As with many things, there is no ‘one size fits all’ and the best option will depend on the trader’s particular circumstances.
Option 1 – Relief against general income
If the trader has other income, one of the easiest (and quickest) ways to obtain relief for the loss is to set against general income. However, this option is only available where accounts are prepared using the traditional accruals basis; traders using the cash basis cannot relieve a trading loss in this way.
A claim can be made to relieve the loss against:
- Income of the same tax year;
- Income of the previous tax year;
- Income of both the current and the previous tax years.
If the trader wishes to relieve the loss against the income of the current and the previous tax year, they must choose which year has priority. The income of the priority year must be completely extinguished before the balance of the loss can be set against the other year; it is not possible to make a partial the claim and tailor the relief, for example, to preserve personal allowances.
If the individual does not have sufficient income in the current or previous tax year, but has a capital gain, the relief can be set extended to capital gains (net of capital losses but before the annual exempt amount).
When choosing whether to relieve the loss in this way, consideration should be given to preserving personal allowances. If other income in the year is sheltered by personal allowances, there is little benefit in making a claim against general income.
Option 2 – Against later profits of the same trade
A loss arising in a trade or profession can be carried forward and set against future profits of the same trade. However, the loss must be set against the first tax year in which a profit arises – again it is not possible to tailor claims to preserve personal allowances. If the loss is not fully utilised against the first year in which a profit arises, the unused balance must be set against the next tax year in which a profit arises.
Option 3 – Relieving an early year loss
If the trade is relatively new, the trader may be able to benefit from a special relief that applies to losses made in the early years of the trade. Under this relief, a loss that is made in the year that the trader starts to trade or any of the three subsequent years (i.e. the first four years of the trade) can be carried back and set against total income of the three years before the tax year in which the loss was made, with earlier years taken in priority to later years.
This option is not available where accounts are prepared using the cash basis.
Option 4 – Terminal loss relief
In the event that a loss is made in the final 12 months of trading, relief can be claimed under the terminal loss relief provisions against the profits from the same trade taxed in the four years to cessation.
The best option will depend on the trader’s personal circumstances. Consideration should, however, be given to preserving personal allowances, obtaining relief at the highest possible rate and obtaining relief as early as possible.