What are the current rules for relieving trade losses?

Tax Question

What are the current rules for relieving trade losses?

Tax Answer

Relief for trade losses is given in a number of ways, the rules for which differ between unincorporated businesses and companies.

General Rules for Unincorporated Businesses

Relief against other income and gains

Current year trade losses can be used against other income and potential gains arising either in the same year, the previous year, or both. Relief can be claimed for the previous year, instead of or before the current year if that would be more tax-efficient, but the losses must initially be applied in full to income of the chosen year. If there is insufficient income to relieve the entire loss, what remains can be set against chargeable gains of that same year, followed by income and gains of the other year.

A few restrictions are imposed on this relief, full details of which are given in HMRC’s Helpsheet HS227.

Relief against profits of the same trade

Under the general rules, trade losses can be carried back and used against trade profits of the previous year.

In recognition of the impact COVID-19 had on trading activities, the carry-back rules have been temporarily extended to provide additional relief for losses made in the 2020/21 and 2021/22 tax years, by allowing them to be relieved against profits of the same trade arising in the previous three years. Relief must be given against the most recent year first and a cap of £2,000,000 applies to the amount of loss from each year that can be carried back and relieved during the first two years of the extended period.

Trade losses can also be carried-forward indefinitely to relieve profits of the same trade in later years. If a trade is incorporated and at the date of incorporation has unused trading losses, provided the trader received shares in the company in return for transferring the business, ‘pre-incorporation loss relief’ allows for the unused trade losses to be relieved against income that the trader receives from the company.

Relief against profits in the early years of trade

A specific relief is available for losses incurred during the first four years of trading. The losses can be set against other income arising in the previous three years, starting with the earliest year. If the losses available exceed the income for the earliest year, the balance can be applied against the income of the second year and then finally the third year.

Full details of the relief, restrictions, and how to claim are given in HMRC’s Helpsheet HS227

Relief against profits in the final years of trade

‘Terminal loss relief’ applies only to losses arising during the final 12 months of trading and is given against trade profits of the previous three years. Losses must be set against trade profits of the most recent year first.

Details of how to calculate terminal losses, the interaction with overlap relief, and the time limit for making a claim is given in HMRC’s Helpsheet HS227.

HS227 Losses (2022) – GOV.UK (www.gov.uk)

General Rules for Companies

As companies are charged to Corporation Tax on all sources of income and gains, relief for trading losses can be obtained by setting the losses against other profits or gains realised by the company.

Relief against other profits and gains

A trade loss incurred by a company can be used against income from other sources and capital gains crystalised during the same accounting period. Alternatively, provided the company was operating the same trade at some point during the accounting period(s) that fall into the previous 12 months, the loss can be carried back and relieved against total profits (which includes non-trading profits and capital gains) of that previous 12-month period.

As is the case for unincorporated businesses, due to COVID-19 a temporary extension to this relief has been put in place. The temporary rules provide for up to £2,000,000 of trade losses in accounting periods ended between 1 April 2020 and 31 March 2022, to be relieved against total profits of the previous three years, rather than just 12 months. Relief must be given in the most recent year first. The standard 12-month relief option is still available and, as there is no limit on the amount of loss that can be relieved under that rule, it may in some cases be the better option.

Provided the trade continues, any losses that have not been relieved against current or previous year profits can then be carried forward and used in future accounting periods. The relief available for carried-forward losses will be determined by the accounting period in which the loss is to be used.

Post-April 2017 Accounting Periods

When the carried-forward loss is going to be used against profits of an accounting period that began on or after 1 April 2017, the rules for a loss incurred pre-1 April 2017 are different from those for a loss incurred after 1 April 2017.

Pre-1 April 2017 losses can only be used to relieve profits from the same trade, whereas post-1 April 2017 losses can be used against the company’s total profits.

Pre-April 2017 Accounting Periods

If a carried-forward loss is to be relieved against profits of an accounting period that ended before 1 April 2017, relief will only be given against profits of the same trade.

Where a company makes a trading loss in accounting period that straddles 1 April 2017, before a carry-forward relief claim can be made the loss will need to be apportioned between the pre-and post-1 April periods. A simple time apportionment is acceptable, but if that does not give a just and reasonable result, any alternative method can be used as long as the method itself is ‘just and reasonable.’

Further details can be found in HMRC’s guidance.

Extended Loss Carry Back for Businesses – GOV.UK (www.gov.uk)

Work out and claim relief from Corporation Tax trading losses – GOV.UK (www.gov.uk)

Carry forward Corporation Tax losses – GOV.UK (www.gov.uk)