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Profit from loss

Last week, I looked at the provisions determining how trading losses incurred by UK companies could be used to bring tax relief to the companies incurring them.

It is generally true that capital losses cannot be set off against trading profits. However, as I noted last week, corporate trading losses can be set against realised capital gains. This seems only fair given that companies cannot access the favourable 18 per cent tax rate on capital gains and that all capital gains made by UK firms, regardless of size, are subject to corporation tax in the same way as trading profits.

Take, for example, a company that has sold a property and made a large capital gain, generating cash as a result, but did not invest the cash in a way that would generate a corresponding tax deduction in the year in which the gain was made. In the following year, the available cash (subject to satisfying the normal conditions) could be used to fund or partially fund a deductible contribution to a registered pension arrangement. Any trading loss created could then be carried back to set against the capital gain realised on the sale of the property that generated the cash to make the contribution. Of course, these circumstances may not be “everyday” but are worth knowing, nevertheless.

Having looked at incorporated businesses let’s now take a look at the basic reliefs available for unincorporated businesses (sole traders, partnerships and limited-liability partnerships) for trading losses, ie. losses sustained in the carrying on of a trade, profession or vocation for profit.

  • First, set off against general income, meaning the loss is deducted from total income. Basically, total income is taxable before allowable deductions and personal allowances.

  • If a trading loss or part of a trading loss is not relieved it can be carried forward indefinitely. It is set against future trading profits from the same trade with the loss being deducted from the earliest available profits.

  • As a general rule – see below for a temporary extension of this – a loss can be carried back if it is not to be set against the current year’s profits or if it is to be set against the current year’s profits and some loss remains to be relieved.

  • The special temporary extension referred to above is that, for a limited period, a trading loss may be carried back for a period of three years rather than just to the immediately preceding year. Only a maximum of £50,000 may be carried back for any one tax year beyond the immediately preceding year, and only when trading profits for that year have been offset in full. Such losses should be set against later years first. This rule applies for tax years 2008/09 and 2009/10.

  • Where a business makes a loss on ceasing to trade, this terminal loss can be set off against trading profits of the same trade of the current tax year and the three preceding tax years. Losses have to be set off against later years first.

  • Subject to the satisfaction of certain conditions, losses made in any of the first four years of trade can be set against general income of the three tax years preceding the tax year in which the loss arises.

    The loss must be set against income of earlier tax years first. The conditions for this relief are: the loss must arise during the first four tax years of the trade; the trade must have been carried on during the period of loss on a commercial basis with a reasonable expectation of profits during that period or within a reasonable period afterwards; and where a spouse (A) acquires a trade from his or her spouse (B) the four-year period is measured from the time A acquired the trade and not from when B started trading, unless spouse A took over the trade on B’s death.

    In most cases, loss relief claims have to be made within one year from 31 January following the tax year of loss, ie. 22 months. For example, a loss occurring in 2009/10 needs to be claimed before January 31, 2012. Claims in respect of carried forward losses and losses carried back on the cessation of trade have to be made within the five years from January 31 following the tax year of loss/cessation, that is, five years, 10 months. For example, a loss occurring in 2009/10 needs to be claimed before January 31, 2016.

    A valid claim for a loss must state the source of the loss, the year of the loss and either the year of claim or the statutory reference under which the claim is made.

    A claim for loss relief can give rise to a repayment of tax. Interest is paid gross by HMRC on such overpaid tax. The interest is paid from the “relevant time” – generally the date of payment of the tax – to the date on which the order for repayment is issued. The interest is not subject to income tax and the rate of interest payable is based on the average lending rates of certain clearing banks less 1 per cent, then reduced by 20 per cent. For example, at January 6, 2008 the rate was 3 per cent, whereas in early June 2009 the rate of interest is zero.

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