In most cases, it is beneficial to offset trading losses against income – whether that means sideways loss relief against general income or carrying forward to offset future profits of the same trade. However, sometimes the trader’s circumstances mean that the loss is effectively wasted.
Sara starts a new business in 2021/22. In her first accounting period, she records a loss of £8,000. She expects to make a profit in 2022/23, of approximately £15,000. Assuming Sara has no other income in 2021/22 (or 2020/21) to offset the loss against, it will automatically offset the £15,000 profit from 2022/23. Unfortunately, £12,570 of this would be offset by her personal allowance. There is no scope to restrict the loss to preserve the allowance, so effectively she will only receive tax relief on £2,430, but the loss will be completely used up.
In these circumstances, further options should be considered. Firstly, as Sara’s business is new, she can claim early years’ loss relief. This effectively extends the window for sideways relief to the three previous tax years. If she were, for example, an employee in that time a tax refund could be secured.
If this is not possible, an often-overlooked option is to offset the loss against capital gains arising in the same, or previous, tax year as the trading loss. As such, it can be useful in situations where chargeable assets have been sold to fund the start up. Alternatively, if it is apparent that a trading loss will arise, the individual could look to trigger gains before the relevant tax year end to ensure the loss isn’t wasted. In the Sara example above, she would be able to trigger gains of up to £20,300 (including the CGT annual exemption) without paying any tax.
While this is very much a last resort, as the gains are likely to be subject to tax at just 10%, it is often better than doing nothing. One condition of offsetting losses in this way is that any available sideways relief must be claimed first, even if this is inefficient due to the personal allowance issue discussed above.
If this option is used, the loss should be noted and carried forward for Class 4 NI purposes in the same way as it is with a sideways relief claim.