Trading Losses and How to Claim Relief

Introduction

If your self-employed business makes a loss rather than a profit, you can use that loss to reduce your tax bill. There are several ways to claim relief for trading losses, including setting them against other income, carrying them back to previous years, or forward to future profits. Choosing the right option depends on your circumstances and can make a significant difference to your tax position.

What counts as a trading loss

A trading loss occurs when your allowable business expenses exceed your trading income in a tax year. This is the loss you calculate on your Self Assessment tax return after deducting all your business costs from your business income.

You can only claim relief for losses from actual trades. If HMRC considers your activity a hobby rather than a business, you cannot claim loss relief. You must be carrying on a trade on a commercial basis with a reasonable expectation of profit.

Ways to claim relief for trading losses

You have several options for using your trading losses. The reliefs available depend on whether the loss arose in the early years of your trade or during the normal course of business.

Offset against other income

You can set your trading loss against your other income in the same tax year and/or the previous tax year. "Other income" includes employment income, rental income, pension income, and savings or investment income.

This type of relief is claimed under section 64 of the Income Tax Act 2007. You make the claim in your Self Assessment tax return for the year the loss arose.

If your loss exceeds your other income, you can extend the claim to set the remaining loss against capital gains in the same year. This can be valuable if you have made capital gains that would otherwise be taxable.

Carry losses forward

If you do not use all of your loss through other relief claims, or if you choose not to claim other reliefs, you can carry the loss forward. Losses carried forward can only be set against future profits from the same trade.

There is no time limit on carrying losses forward – they remain available until you use them or cease trading. You must use carried-forward losses as soon as profits become available; you cannot choose to keep losses back for later years.

When you carry losses forward, they are automatically set against the first available profits from the same trade in future years.

Carry losses back

You can carry a trading loss back to set it against trading profits (from the same trade only) in the previous tax year. This is in addition to any claim to set the loss against other income in the current or previous year.

To carry a loss back, you must first make a claim to set it against other income in the year the loss arose. Any loss remaining after that claim can then be carried back against trading profits of the previous year.

This relief is useful if you paid tax on trading profits in the previous year, as carrying the loss back generates a tax refund.

Early years loss relief

Special rules apply to losses made in the first four tax years of your trade. You can carry these losses back for up to three years against your total income (not just trading income) from earlier years. The loss is set against the earliest year first, then the next year, and so on.

This relief is particularly valuable if you had substantial employment or other income in the years before starting your business. It can generate significant tax refunds from those earlier years.

To qualify, the loss must arise in the first four tax years that you carry on the trade. The loss must be from actual trading, and the usual rules about carrying on a trade on a commercial basis still apply.

Losses in the final year of trading

When you cease trading, special rules apply to losses in the final 12 months. You can carry back terminal losses against trading profits from the same business in the three years before cessation, setting them against later years first.

Terminal loss relief applies to the loss made in the final tax year, plus any loss made in the period from the start of the previous tax year up to the date of cessation.

This relief is only available when you permanently cease trading. It does not apply if you simply close a business and start a new one, or if you incorporate your business.

Choosing the right relief

The best option depends on your tax position:

Offset against other income is most valuable when you have high-rate income that would otherwise be taxed at 40% or 45%. Using your loss against this income saves more tax than carrying it forward to set against profits that might be covered by your personal allowance or taxed at the basic rate.

Carrying losses forward preserves the loss if you have little other income and expect to make substantial profits in future years. However, you receive no immediate tax benefit.

Carrying losses back generates an immediate tax refund if you paid tax in the previous year. This improves your cash flow but may not be the most tax-efficient option if you expect to become a higher-rate taxpayer in future.

You need to balance immediate cash flow needs against long-term tax efficiency. Consider your marginal tax rates in different years – using losses against higher-rate income saves more tax than using them against basic-rate income.

How to make a claim

You claim trading loss relief through your Self Assessment tax return. Different reliefs are claimed in different boxes on the return, so you need to specify which relief you are claiming.

Time limits apply to loss relief claims. You generally have four years from the end of the tax year in which the loss arose to make your claim. Missing this deadline means you lose the right to claim that particular relief.

If you are carrying losses back and claiming a refund of tax paid in an earlier year, HMRC will process the refund after they receive your claim. Make sure you have already submitted the tax return for the earlier year, as HMRC needs to verify the income and tax paid.

Record keeping

Keep detailed records of your trading losses and how you have used them. You need records showing:

• How the loss was calculated
• Which reliefs you claimed
• How much loss was used in each year
• How much loss remains to carry forward

If you carry losses forward, you need to track them through subsequent years until they are fully used. Your accounting records should clearly show brought-forward losses and how they were applied against profits.

Sources

• Relief for trading losses (Self Assessment helpsheet HS227)

This article provides general guidance based on current HMRC rules. For advice specific to your situation, speak to your accountant.