Tax relief for trading losses

Trading losses can be used to reduce tax payable on income of the current year, the previous year or both. The trouble is this can mean losing at least some or all of the personal tax-free allowance.

Example 1 - existing rules. In 2020/21 Andy made a loss of £30,000 and had other taxable income, a salary of £20,000 on which the tax payable is £1,500 ((£20,000-£12,500 personal allowances) x 20% £1,500). The rules say that losses are deducted from Andy's income before personal allowances. Therefore, to get the £1,500 tax refunded he must use £20,000 of the loss relief. This means the £12,500 personal allowance is wasted.

New extended loss relief

The new loss relief rules are different in that traders can’t use them to reduce tax payable on other income. Instead, the loss relief can only be used against profits from the same trade. Ironically it’s this limitation that produces an opportunity for extra tax savings. The following example illustrates this. Bear in mind that to access the new loss relief the trader must either have no taxable income in the same and previous year as the loss, or have reduced it to nil for at least one of them by making a claim for sideways relief under the existing rules.

Example 2 - existing rules. Patil’s sole-trader business shows the following results:

Year	2020/21	2019/20	2018/19
Trading profit/(loss)	(£45,000)	£26,000	£20,000
Other income	£5,000	£12,000	£10,000

 

If she claims loss relief (under the existing rules) against her other income for both 2020/21 and 2019/20 she’ll have no taxable income in either year. she will have used all the loss but wasted her personal allowance for both years.

Example 3 - new rules. To access the new loss relief Patil must make a claim to use the loss in 2020/21 or 2019/20 under the existing rules. While the obvious choice is the year with the highest income, i.e. 2019/20, this would result in only £5,000 of the loss remaining to carry back to 2018/19 under the new extended loss relief rule.

A better result is achieved if Patil instead claims loss relief against other income for the year of the loss (2020/21).

Using this strategy seems counter intuitive because Patil’s income for 2020/21 is only £5,000 meaning that the claim results in no tax saving for 2020/21 as her income is already covered by personal allowances. However, by claiming the loss relief for 2020/21 she uses just £5,000 of it. This leaves £40,000 (£45,000 - £5,000) which can be carried back under the new rules, first against 2019/20 and then 2018/19. The relief can only be used against trade profits and so will cover those for 2019/20, but will leave her personal allowance intact to cover other income for that year.

Another angle

The “limitation to trade profits” rule can be used to increase loss relief carried forward. Say you made a loss in 2020/21 of £20,000 and had £1,000 other income. In 2019/20 your profits were £10,000 and you had other income of £10,000. Using the existing rules you could carry the £20,000 loss relief and so reduce your taxable income to nil. But if instead you claimed relief against the current year’s income, apparently wasting £1,000, you will limit the loss carried back under the new rules to £10,000 leaving £9,000 of it to carry forward.