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 income before personal allowances. Therefore, to get the £1,500 tax refunded Andy 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 they can't 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 relief under the existing rules.

Example 2 - existing rules. Jimmy’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 he claims loss relief (under the existing rules)against his other income for both 2020/21 and 2019/20 he’ll have no taxable income in either year. He will have used all the loss but wasted his personal allowance for both years.

Example 3 - new rules. To access the new loss relief Jimmy 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 Jimmy instead claims loss relief against other income for the year of the loss (2020/21). This seems counter intuitive because Jimmy’s income for 2020/21 is only £5,000 meaning that the claim results in no tax saving for 2020/21 as his income is already covered by his personal allowances. However, by claiming the loss relief for 2020/21 Jimmy 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 his personal allowance intact to cover his other income for that year.

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