Losses

This is a short briefing on losses.

At a glance

Trading losses can be offset, in the current year, or previous tax year, against other income, unless any of the restrictions below apply.

The key restrictions cover non-commercial activities and tax avoidance using partnerships and leasing.

An unrelieved trade loss may also be used to offset capital gains.

Early years

Losses in the first 4 years of trade can be carried back against other income of the 3 previous years.
If a new loss-making trade commences it may be sensible to prepare separate accounts for it rather than to combine it with an existing business in order to isolate its opening year losses. In this way opening year losses can be carried back 3 years against total income.

Carry forward and back

Trading losses can be:

Carried forwards against the profits of the same trade.
Carried back against income from the previous tax year.
Trading losses incurred in 2008/09 and 2009/10 could be carried back 3 years, but only against profits of the same trade.

Cessation

Terminal losses can be carried back 3 years.
If the loss-making business is incorporated its losses can be carried forwards against the future income of which the individual derives from the new company as a director or shareholder.

Restrictions

Hobbies and non-commercial activities: no relief for trade losses unless activities are undertaken on a commercial basis with a view to realising profits.
Farming and market gardening: restriction if the trade has been making losses in each of the 5 preceding years.
Sideways loss relief (relief against other income or profits) may be restricted if tax avoidance is a motive (applies only to certain trades; ring fence income, commodity futures and exploitation of films)
Restrictions apply to partnership losses to the extent that sideways loss relief is restricted for non-working partnerships (this is to combat tax avoidance schemes).
Members of limited partnerships and LLPs have their losses restricted to the extent of their capital contribution.

Capital allowances

Capital allowances can be used to increase losses, these are also subject to restrictions.

A First Year Allowances (FYA) or an Annual Investment Allowance (AIA) may be used to create a trade loss.
Sideways loss relief created using the FYA or AIA is restricted for: individuals in partnership with companies and engaged in leasing or, when contrived by an individual in partnership or later as a sole trader and sold to a connected party or at an undervalue.
Capital allowances in leasing businesses cannot be used to increase a loss if the individual has carried on the trade for at least 6 months, and devotes substantially the whole of his time to the trade in the loss-making period.
A balancing charge or allowance may arise if the trade ceases, and this may increase a loss available.

Planning point:

Losses and tax risk: if an individual is making losses year on year, tax risk = high. What does this individual live on?

The relevant sections of the 1988 Income Tax Act (ICTA 1988) have been re-written as sections in the Income Tax Act 2007:

61 Non-partners

62 Partners

64 Trade loss relief

66 Restriction unless trade is commercial

67 Restriction hobby forming and market gardening

71 Treating trade losses as CGT losses

72 Losses in early years of trade

75 Restrictions on leasing

80 Restrictions on sideways relief

83 Carry forward

86 Trade transferred to a company

89 Terminal losses

102 Restriction on trade loss relief for limited partners

HMRC manuals have good examples of losses in practice - see Business Income Manual BIM7500

Recent updates to this guide:
Parts re-written and update on restrictions section with added links