What tax relief is available for opening year losses?
It is common in the early years of trading for a business to make a loss in an accounting period. Most companies will have various costs, not limited to:
Tools of the trade
Other related start-up costs
But if you have established your business either as a self-employed trader or a partnership, HMRC allows you to claim opening year loss relief to offset these and other expenses against your income tax bill.
It also allows relief to be claimed for relevant pre-trading expenses incurred in the seven years before the first year of trading.
Pre-trading expenses are allowed because in some industries it can take a long time to get things right before launching a new product or service.
As a leading small business accountant, our team are experts in tax advice and planning for SMEs. Loss relief, along with many other ways to reduce a company’s tax bill, can often be overlooked by small business owners. That’s where Accounts and Legal can help.
The tax claim is made on your tax return and is known as loss relief. The losses can be relieved in one of four ways.
1. Offsetting against income for the same tax year
If you have other income in the year, for example from a salaried position, the loss can be offset against this. This is known as “sideways loss relief”.
This is rarely used because most entrepreneurs do not have time to work in a salaried position and simultaneously manage a new business. The most common forms of tax relief are options two and three below.
2. Offsetting against income for the previous tax year
This is a common route for newer business owners and partners because they would usually have left a salaried position to set up in business.
It allows the tax loss to be used in the most effective manner because in most cases new entrepreneurs would have received, and already paid tax on, a full salary in the previous year.
3. Offsetting against income for the three previous tax years
Where there is insufficient income to take full advantage of the tax loss in the current year (option one) or the previous tax year (option two), it is possible to make a claim against the three previous tax years instead, starting from the earliest year.
In fact, this form of tax relief can be claimed in the first three years of trading if a loss is made in each year.
In this case, losses would be offset as follows:
Loss arising in 2018/19 against income for the year 2015/16
Loss arising in 2019/20 against income for the year 2016/17
Loss arising in 2020/21 against income for the year 2017/18
It should be noted that this form of tax relief can only be used for new business, whereas the loss relief claims for the current tax year and the previous tax year can be used for established businesses.
4. Offsetting against income for the same trade in future years
This is rarely used because it delays the tax relief until the future.
However, it may be the only viable solution if the individual has not paid tax in the preceding three years.
The expenses that can be claimed are no different from general allowable expenses. Some examples are as follows:
Overheads such as rent, rates, light and heat
Printing, postage and stationery (PPS)
Stock and raw materials
Staff salaries and subcontractor costs
In addition to general day-to-day running costs, you can make a claim under the Annual Investment Allowance (AIA) if you have invested in assets.
Examples of business assets would include tools and machinery, computer equipment and motor vehicles.
The claim is made on your self-assessment tax return. The self-employed section on the tax return has a section for trade losses and how you wish the loss to be applied.
Consideration should also be given to National Insurance Contributions relief, which can be applied independently of tax relief.
The starting figure to use is the actual tax loss suffered. You should then multiply this by the relevant tax rates for the year to which it is being applied.
As an example, if £10,000 was lost in year one, and you made an application to carry this back one year and offset it against income of £75,000, the appropriate tax rate would be 40 per cent. In this case, a tax repayment could be made for £4,000.
National Insurance relief could also be claimed by carrying the loss forward. This would generate at least nine per cent tax relief on future Class 4 NIC liabilities.