Losses For The Self-Employed

March 9, 2010 - Author: Tony

If you have made a loss in your business, what can you do with it to cut your tax bills? Your two main options are to:

? deduct the loss from other income or a capital gain
? carry the loss forward and deduct it from future trading profits from your business.

DEDUCTING THE LOSS FROM OTHER INCOME AND CAPITAL GAIN

You can either deduct your trading loss from any other income or capital gains which you have in the tax year in which your loss-making accounting year ends, or you can carry the loss back and set it against other income or gains for the previous tax year. Other income could be, for example, dividends from shares or earnings from a job.

You must claim this relief within 12 months of the 31 January following the end of the tax year to which the loss relates. For example, suppose you have been in business for some time, your accounting year ends on 31 July and you made a loss in your 2001-2 accounting year. These accounts form the basis of your tax bill for the 2002-3 tax year. Your tax return and final tax settlement for 2002-3 are due on 31 January 2004. You then have a further 12 months – in other words, until 31 January 2005 – to elect to deduct your losses from other income and gains either for 2002-3 or for 2001-2002.

If you have other deductions which will reduce the tax bill on your other income and gains to nil in one of the tax years, opt to deduct the loss in the other year. If after setting the loss against income and gains for one or both years, there is still some loss left over, you can carry the excess forward to set against future profits.

DEDUCTING THE LOSS FROM FUTURE TRADING PROFITS

If you make this choice, you carry forward the loss and set it against the next future profits from the same trade. If you have any losses left over, you carry them forward against future profits ad infinitum, until they are used up. If you are going to use your loss in this way, you have to use the whole of the loss before you can use any other deductions, such as outgoing or allowances, which you may have. The main disadvantage of making this choice to use up your loss relief is that it takes a while to turn it into cash.

To use this option, you must tell your tax office within five years of 31 January following the tax year to which the loss relates. For example, if the loss was made in the accounts being assessed for the 2002-3 tax year, you have until 31 January 2009 to make your claim. For losses made from 1998-99 onwards (and for losses made in earlier years, if you started up on or after 6 April 1994), relief is given automatically as you make subsequent profits. If your business started before 6 April 1994, for any losses you are carrying forward from 1996-97 or earlier years, you will have to make a claim when you want to use the relief and set the loss against your profits for a given tax year.

IF YOU ARE STARTING A NEW BUSINESS

If you spend money before your business actually starts, it may count as pre-trading expenditure. It will be set against the earnings of your business in its first year and, if it creates a loss, you can get loss relief. You can get tax relief on expenditure going back seven years.

There is special tax treatment for a loss you make in the first four tax years of a new business (as long as your inspector believes it was reasonable to plan for profits during that period). You can get a tax refund by setting the loss against any other income (for example, wages from a job) which you had in the three years before the loss. Set the loss off against the earliest year of income first, then the next earlier and so on.

If you want to set off your loss in this way, you need to tell your tax office in writing within 12 months of 31 January following the end of the tax year in which the loss relates.