If the summer of 2007 was the high point of UK prosperity then financial results for the tax year 2007/08 may not have been too bad. But the following year may tell a different tale and this article explains what can be done with a 2008/09 tax loss.
This article does not cover the nuances of loss relief or explain how a trading period is tagged to a tax year. The emphasis is on examining which tax years can be adjusted with a 2008/09 loss.
The 4 year start up rule
A trade loss is common in the early years and this relief enables losses arising in the first four tax years to be offset against total income in the earlier three years. For example a loss in 2008/09 can be offset against total income in 2005/06 and if the loss is not fully utilised then the remainder of the loss is set against income in 2006/07 and then 2007/08.
Taking this example into the second year a tax loss in 2009/2010 can be offset against income in 2006/07, 2007/08 and then 2008/09. But note just how quickly the loss in the second year of trading catches up with the tax year of commencement of trade. It is therefore important to maximise offsets against the earliest and highest income years – and this requires tax planning.
The above relief is especially useful for offsetting losses against earlier year’s employment income or savings and investment income. In the early years there are a number of reliefs and care is required to ensure that losses return the highest tax recovery without wasting personal allowances.
The 3 year terminal rule
A trade may cease for any number of reasons with the terminal years making losses. To this extent the final 12 month loss may be carried back against the profits of the same trade in the previous three years. For example a loss in 2008/09 can be offset against profits in 2007/08, 2006/07 and then 2005/06.
There are a number of allowances and relief’s which coincide in the final trading period and I have found on occasions that the 12 month loss can exceed the available profit in the last three years. Good tax planning can help but one issue that is easy to spot is over extended trading – where a sole trader “gives it a couple of more years” resulting in annually reducing profits.
The down side of a couple of less profitable final years is that any earlier periods of high taxation fall outside of the three year limit.
Past, present or future choices
In any year of loss a trader has to initially decide whether to carry forward the loss without claiming immediate relief. By doing so the aim would be to allow the loss to reduce the profits of the same trade in the following year.
In most situations this may not sensible and what remains then is to decide whether to claim loss relief against total income of one or both of the past and/or current years – and in what order to make these claims. For example a loss in 2008/09 can be offset against total income in 2008/09 or 2007/08 or both (2008/09 and then 2007/08 or 2007/08 and then 2008/09).
Also, should there be any capital gains in either 2008/09 or 2007/08 then further calculations may be required to assess the benefit of offsetting the trade loss against capital gains.
The Chancellor’s relief for 2008/09
On 22 April 2009 the Chancellor introduced a new relief for the 2008/09 tax year only. With the aim of allowing a 2008/09 trade loss to be offset against the previously ‘blocked’ years of 2006/07 and 2005/06.
To begin with a trader must make a ‘past’ or ‘present’ claim against total income for either or both the years 2008/09 and 2007/08. Only then can an offset of up to £50,000 be made against profits of the same trade in 2006/07 and 2005/06 (in that order). In the interests of providing greater detail I attach the link to the Revenue’s guidance (click).
Loss interaction with the Annual Investment Allowance
Without going into the detail, I should mention that 2008/09 is also the first year under the new annual investment allowance regime and this could have a massive impact on the tax position of traders who purchased plant and machinery in the year to 5 April 2009. Including a trader’s payments on account and tax credit position.
In fact never before has it been so easy to claim 100% relief on qualifying expenditure and this alone could result in a tax loss. The only problem with losses is that often they are themselves wasted and therefore care and planning is required – particularly on the date of purchase of new assets.
If you are planning on ceasing or retiring in the next three years then this is the year to outline your closing tax years and at the very least ask yourself whether there are tax benefits in changing your existing accounting end date.
This article is for discussion purposes only and does not represent advice on which you should act without consulting a professional as tax legislation is complex and changes frequently.