What to do if the business is making a loss? This is a guidance on how to use business losses to offset other taxable income to save tax. There are slightly different rules between incurring losses as a sole trader and as a company. And there are rule changes for corporation tax loss which was brought forward from April 2017.

Business Losses as a Sole Trader

If you are in transition from being employed to a business owner, you might have a salary job to make sure you have the sufficient financial support as well as building your business on the side at the same time. If your side business is making a loss but you have a full-time/part-time job and tax is being deducted before you get paid, you can use your business loss to offset your salaried income. This enables you to get some tax back.

You can even decide how much loss you want to offset for the current year and carry back some to the previous year so that your personal allowance (currently £11,000) will not be wasted. For example, if you currently earn £10,000 which is under the tax-free threshold for personal tax, then you have a business that is making £2,000 loss, if you are offsetting the current year there is no benefit to you, as your first £11,000 income is tax-free anyway. However, if your previous year’s income is £30,000 and you paid tax on it then you can use that £2,000 to offset previous years which allows you to get some tax back. If you do not have anything to offset to the previous or current year then you can carry forward and if it becomes profitable in the second year you are able to offset the second year’s profit. Either way, you can always get some tax relief from your losses.

The income related to a sole trader includes capital gain. If you do have capital gain, there is an allowance of roughly £11,000 per year. When you use the allowance to offset capital gain, you need to make sure you do not waste the annual allowance. For you as a person, you have a tax-free allowance for both income tax as well as your capital gain.

Business Losses as a Ltd Company

A limited company is a separate person than you. If the company is making a loss, the loss cannot be used to offset your personal income. This is one of the reasons why people find it beneficial to first set up their business as a sole trader.

A limited company does not have any allowance. If you do incur loss but at the same time the company is running two different kinds of business activities where one is profitable and one is making a loss. You are able to use the current year loss to offset other income; this includes the interest from your business savings.

If there is nothing else left for you to offset, you need to consider carrying it back to the previous year. If you do have a trading history and you were making some profits before then you can carry it back to the previous year to offset that. Once you make a declaration on the corporation tax, you will get a tax refund from the government. The remaining unused losses will be brought forward for the future years.

If you are in your final year of trading and have some losses, you can use that loss to offset your previous 3 years profits then you will get some tax back that you have paid.

Corporation Tax Losses Rule Change Post April 2017

  • If the losses are incurred before April 2017, you can only use it to offset the future profit of the same trade.
  • If the losses are incurred after April 2017, you can use it to offset any profits. But the trade-off is that for carry forward losses, companies will be able only to use the losses to offset against up to 50% of the profit. Each company will be entitled to £5 million annual allowance. That means most small businesses will not be affected.

The Best Order to Consider Loss Relief to Get the Tax Relief Quicker

  1. Offset current year first – so that you get immediate tax relief from current year
  2. Carry back to previous years – so that you get tax refund from previous year’s taxed that you’ve already paid
  3. Bring forward to the future years – so you get tax relief if your business is profitable the next year

For sole traders, always remember to consider your tax-free allowances when utilising the losses, so that you can make sure your tax-free allowance won’t be wasted and you can maximise the tax relief you are entitled.

If you find this content useful, we do provide tailored professional advice on your personal or business tax matters. If you are interested, please direct message the author of this article so we can arrange a chat.

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