Loss relief options available to a sole trader

If a taxpayer suffers a trading loss, the loss can be relieved as follows:

a) S64 of Income Tax Act 2007 (ITA 2007) allows the trade loss to be offset against net income of the loss-making year, and/or of the previous tax year. The two claims are independent and can be made in any order. The claim is not mandatory, and the taxpayer can decide not to make it. This would be the case, for example, if the income is already covered by the personal allowance so there would be little point in making the claim.

b) Trade loss relief against general income is not available unless the trade is carried out on a commercial basis and with the view of making a profit.

c) From 6 April 2013, the total amount of certain income tax reliefs that can be used to reduce total taxable income is limited to the higher of £50,000 or 25% of the taxpayer’s adjusted total income. The remaining loss can be carried forward.

The limit on reliefs has no effect on the following:

• relief for a tax year in which adjusted total income is less than £50,000
• losses created by overlap relief or to the extent that the loss is augmented by overlap relief
• losses used against profits of the loss-making trade
• losses treated as an allowable loss for capital gains tax purposes.

d) There are further restrictions on relief in the case of farming or market gardening, known as ‘restriction on relief for “hobby farming”’. The way the loss is calculated is before capital allowances and balancing charges. 

The farming loss restriction only applies after five successive tax years of losses. So the loss relief would be given if the trade was started at any time within the five tax years before the current tax year.

There is anti-avoidance provision which prevents a farming business from being transferred between a husband and wife or to or from companies controlled by the same persons, which had the purpose of resetting the five year time clock.

e) No partial claims are permitted. It is not possible to restrict the loss relief to the taxable income only and retain the benefit of personal allowances, thereby increasing the losses available to set against income in other years. It is an all or nothing claim.

f) From a tax planning point of view, it is more advantageous to relieve the loss earlier rather than later. Any tax refunded is calculated using the previous year’s rates and allowance.

a) Where a taxpayer has claimed trade loss relief against other income (under s64) and is unable to make full use of the loss, he may be able to treat the unused part as an allowable loss for capital gains tax purposes under s71 of ITA 2007.

b) Before the claim can be extended to capital gains, the taxpayer needs first to make a claim under s64 to offset the loss against net income. This would result in the loss of personal allowance.

c) The relief under s71 would be the lower of:

• the remaining loss under s71 and
• the net gains in the tax year less losses brought forward.

A partial claim would not be permitted. As a result, it is possible that a claim under s71 could potentially waste both the personal allowance and all or part of capital gains tax exemptions.

Under s83 ITA 2007, losses carried forward can be set against future profit of the same trade.

Once an s83 loss relief claim has been made, the carried forward loss must be set off against the next available trading income.

S64 claims must be submitted by 31 January, which is 22 months after the end of the tax year of the loss.

S83 loss claims (carry forward) are automatic, but a claim must be made to establish the amount of loss to be carried forward. The claim must be made within four years from the end of the tax year in which the loss arose.