If a sole trader or partner incurs a loss rather than earning profit, they may be able to deduct a trading loss from their personal tax.
As a sole trader, if you make a trading loss in a tax year, you may be able to deduct the loss from your personal income for tax purposes. This can help to reduce your overall tax liability, as the loss is offset against your other income.
To deduct a trading loss from your personal income for tax purposes, you must follow these steps:
- Calculate your trading loss for the tax year: This involves subtracting your total trading expenses from your total trading income for the year. If the result is a negative figure, you have made a trading loss.
- Deduct the trading loss from your personal income: You can deduct the trading loss from your total income for the tax year. This includes any employment income, rental income, investment income, and other sources of income. You can deduct the trading loss up to the total amount of your income for the year.
- Claim the loss on your tax return: You must report the trading loss on your self-assessment tax return for the tax year in which the loss occurred. You should include the loss as a deduction on the ‘adjustments’ section of the tax return.
- Carry forward or back the loss: If the trading loss exceeds your total income for the year, you can carry forward the excess loss to offset against future trading profits. Alternatively, if you had trading profits in the previous year, you may be able to carry back the loss to offset against those profits and claim a refund of tax paid in that year.
It is important to note that there are certain rules and limitations around claiming trading losses as a sole trader. For example, losses can only be offset against income in the same tax year or carried back or forward to offset against future or past trading profits. Additionally, losses cannot be offset against other sources of income, such as employment income or rental income. Therefore, it is recommended to seek advice from a tax professional to ensure you are claiming the trading loss correctly and taking full advantage of any available tax reliefs.
Other relief is also available:
Start up loss relief means that ifa taxpayer suffers a loss in any of the first four years of a new business, that loss can be carried back and set against the total income in the three tax years immediately prior to the tax year of the loss.
tart-up loss relief is a type of tax relief available to new UK companies in their first four years of trading. The relief allows companies to deduct their trading losses from their taxable profits, up to a maximum amount. Here are a few examples of how start-up loss relief might be applied to a company’s profit calculation in the UK:
Example 1: ABC Ltd. is a new company that started trading in the current tax year. The company made a trading loss of £50,000 in its first year of trading. As a new company, ABC Ltd. is eligible for start-up loss relief. The company can claim relief for the entire amount of its trading loss (£50,000), which can be offset against its other taxable profits for the year.
Example 2: XYZ Ltd. is a new company that started trading two years ago. The company made a trading loss of £70,000 in its second year of trading. As a new company, XYZ Ltd. is eligible for start-up loss relief. The company can claim relief for the maximum amount of its trading loss in the second year, which is £50,000. The remaining £20,000 can be carried forward to offset against future taxable profits.
Example 3: PQR Ltd. is a new company that started trading four years ago. The company made a trading loss of £100,000 in its fourth year of trading. As a new company, PQR Ltd. is eligible for start-up loss relief. However, the maximum amount of relief that can be claimed is limited to the company’s qualifying trading losses in the first three years of trading. Assuming the company made qualifying trading losses of £20,000 in each of its first three years of trading, it can claim relief for the total amount of its trading loss in the fourth year, which is £60,000. The remaining £40,000 cannot be claimed as start-up loss relief.
In each of these examples, start-up loss relief is used to reduce the company’s taxable profits, which in turn reduces the company’s tax liability. By claiming start-up loss relief, companies can reduce their tax bills and reinvest the savings back into their businesses. It is important to note that there are certain rules and limitations around claiming start-up loss relief, such as the maximum amount that can be claimed and the time limits for making a claim. Therefore, it is recommended to seek advice from a tax professional to ensure you are claiming the relief correctly and taking full advantage of any available tax reliefs.
Carry across or one year carry back relief
In the UK, carry across and carry back relief refer to the ability of a company to use losses in one tax year to offset profits in another tax year. Here are some examples of how carry across and carry back relief may be applied to a company’s profit calculation in the UK:
Carry across relief:
- ABC Ltd. makes a trading loss of £30,000 in the current tax year. The company has taxable profits of £100,000 in the previous tax year. The loss can be carried across to the previous tax year, and the company can claim a reduction in its taxable profits for that year. The company can carry forward the remaining £10,000 loss to offset against future profits.
- XYZ Ltd. has taxable profits of £150,000 in the current tax year. The company incurred a loss of £20,000 in the previous tax year. The loss can be carried across to the current tax year, and the company can claim a reduction in its taxable profits for this year. The company can carry forward the remaining £10,000 loss to offset against future profits.
One year carry back relief:
- PQR Ltd. makes a trading loss of £40,000 in the current tax year. The company had taxable profits of £80,000 in the previous tax year. The company can claim one year carry back relief, which means that the loss can be offset against the taxable profits in the previous year. This would reduce the taxable profits in the previous year to £40,000, and the company would receive a tax refund for the difference.
- LMN Ltd. has taxable profits of £200,000 in the current tax year. The company incurred a loss of £50,000 in the previous tax year. The company can claim one year carry back relief, which means that the loss can be offset against the taxable profits in the previous year. This would reduce the taxable profits in the previous year to £150,000, and the company would receive a tax refund for the difference.
In each of these examples, the carry across or carry back relief is used to reduce the company’s taxable profits, which in turn reduces the company’s tax liability. By claiming these reliefs, companies can reduce their tax bills and improve their cash flow. It is important to note that there are certain rules and limitations around claiming these reliefs, such as the time limits for making a claim and the maximum amount that can be claimed.
Loss-making taxpayers can also to set trading losses against chargeable capital gains in the same tax year. This applies when a taxpayer has claimed carry across relief but all of the loss has been absorbed.
In the UK, individuals who are tax payers and have made trading losses in a given tax year can set those losses against their chargeable capital gains for that year. Here are some examples of how loss-making taxpayers can set trading losses against chargeable capital gains:
- John is a self-employed electrician and incurred a trading loss of £15,000 in the tax year 2021/2022. However, he sold some shares for a gain of £10,000 in the same tax year. He can set the £15,000 loss against his chargeable capital gain of £10,000, which means he will not have to pay any tax on the capital gain. The remaining £5,000 loss can be carried forward and set against future capital gains or against future trading profits.
- Sarah is a freelancer and incurred a trading loss of £25,000 in the tax year 2021/2022. However, she sold a rental property for a gain of £20,000 in the same tax year. She can set the £20,000 gain against the £25,000 loss, which means she will not have to pay any tax on the capital gain. The remaining £5,000 loss can be carried forward and set against future capital gains or against future trading profits.
In each of these examples, the individuals can reduce their tax liability by setting the trading losses against the chargeable capital gains. This is a valuable tax planning opportunity for individuals who have incurred trading losses in a given tax year and have chargeable capital gains to offset them against. It is important to note that there are certain rules and limitations around setting trading losses against chargeable capital gains, such as the time limits for making a claim and the maximum amount that can be claimed.
A taxpayer may also carry forward a trading loss for a tax year and set it against profit earned in subsequent years, taking earlier years first. Losses can be carried forward indefinitely until the loss is exhausted.
Any loss incurred by the taxpayer in the final 12 months of trading can be carried back and set against previous trading profits year by year for three years or until the loss is fully absorbed.
A tax payer who incorporates their business, transferring it to a company in return for shares (at least 80 percent of the consideration transferred), any unrelieved trading losses can be carried forward and set against income such as such as a salary or dividends that they receive from the company in question.
All these forms of relief are subject to a cap of £50,000 or 25 percent of the taxpayer’s income in the relevant tax year.