What to do with losses?
Losses incurred in trading or investment activities are, for tax purposes, calculated per tax year. Depending on the size and type of loss incurred, tax reliefs are available.
In this Insight we discuss some of the key losses our customers are currently facing and how they can be used to reduce income or capital gains. While our article provides an overview, this area of taxation can be complicated and varies according to individual circumstances. We therefore recommend you take advice to clarify your personal position.
When you sell chargeable assets such as shares or a second property, you will make either capital gains or losses, depending on whether you receive proceeds amounting to more or less than the original cost.
If you have made a capital gain, then you can deduct an annual exemption (currently £12,300) and the remaining gain is subject to capital gains tax.
In each tax year, the capital losses will automatically be offset against capital gains to give a net taxable-gains figure for the year.
If losses in a year exceed the gains, the excess loss is carried forward to be utilised in future years. It is worth noting that if this is the case, the capital gain for the year will be nil and the annual exemption detailed above is not used; this annual exemption cannot be transferred or carried forward, so it is lost for the year.
When losses are carried forward to future years, they do not have to be used in their entirety. They are used to reduce the gains in future years to the amount of the annual exemption.
The following table shows a simple example of how capital losses are utilised:
Offsetting capital losses against income
Although the normal rule is to offset capital losses against capital gains, there is one scenario where the loss can be offset against a taxpayer’s income instead. This relief is only available on losses on qualifying shares, i.e.:
- shares on which Enterprise Investment Scheme (EIS) income tax relief has been claimed; or
- unquoted shares in certain trading companies.
Rules around this can be more complicated and we recommend seeking specialist tax advice.
Negligible Value Claims
The final thing to consider when discussing losses is what happens when an asset becomes worthless or the value becomes negligible.
If a taxpayer owns an asset with negligible value such as shares where a company has gone into administration, a claim can be made to treat this asset as if it had been sold. The proceeds will be the current market value of the asset, which on many occasions will be zero.
If the asset is now completely worthless, this means the loss arising will be equal to the original cost of the asset.
This loss can be used as a current-year loss or, alternatively, if HMRC agrees the asset was of negligible value for the previous two years, the loss can be carried back and will be treated as if it had been made in either of the two tax years immediately preceding the claim.
If you hold an asset which you believe may be of negligible value, it is advisable to speak to a tax specialist about the asset and the possibility of making a claim.
If you let more than one residential or commercial property, the profits and losses must be aggregated. If you let properties both in the UK and abroad, you must keep aggregate figures for the UK and overseas properties separate. If you have an overall loss, for either UK or overseas properties, you are entitled to tax relief.
If your aggregate figures show a loss, usually the only way to obtain tax relief is for the loss to be carried forward against future years’ profits. This rule pertains except where all or part of the loss:
- results from capital allowances; and/or
- relates to the letting of agricultural land.
Losses in these categories can be used to reduce tax on other income for the:
- same tax year for which the loss occurs; or
- the following tax year.
Capital allowances are usually available only on furnished holiday lettings and on commercial lets, although houses of multiple occupation may also qualify. If you are unsure whether capital allowances are relevant to you, or if you would like further guidance on the loss rules, please do get in touch with our Tax team.
For anyone trading in a partnership or on a self-employed basis, several options are available for relief on trading losses. In order to obtain the maximum amount of tax relief, marginal rates of tax should be considered. Ideally, the loss should be relieved against the highest marginal rates available.
For businesses that will continue to trade, it is possible to relieve the loss in the following ways:
Carrying the loss forward
The loss can be carried forward indefinitely and will be used against the first available profits of the same trade.
Relief against other income in the same tax year of the loss (and/or the preceding tax year)
Although this will reduce the overall taxable income for the year (generally creating a tax refund if relieved against the preceding year), care should be taken to ensure the tax-free personal allowance for the year in which the loss is claimed is not wasted.
Where a business has been trading for less than four years, it is possible to offset the loss against the total income of the three tax years preceding the year of loss; in this case, the loss is set against income from the earliest year first.
Since 2013-14, HMRC has capped the amount of income tax relief available to an individual by offsetting loss against other income. The maximum amount of relief that can be claimed in this way is the greater of:
- £50,000; or
- 25% of the adjusted annual income.
However, there is no cap if the loss is relieved against business profits in the preceding year.
If an individual generates a loss from a non-trading activity, then the maximum offset that can be used against other income is £25,000. This will apply if the individual:
- worked, on average, less than 10 hours a week on commercial activities for the trade;
- is a limited partner or a member of a limited liability partnership;
- has a trade that is carried out wholly overseas;
- has claimed certain capital allowances; or
- has received income from oil-extraction activities or oil rights.
Claiming the loss against capital gains in the year of loss (and/or the preceding year)
If the loss cannot be fully utilised against income, then it is possible to claim the loss against capital gains. However, careful thought should be given to such a claim as the tax-free personal allowance will be wasted and part, or all, of the capital gains tax annual exemption may also be lost.
The above is true for those trading on an accruals basis, but if the accounts for the business are calculated on a cash basis, then the losses may only be carried forward. If you are currently trading on a cash basis, then it should be possible to change the accounting basis to the accruals basis. If you are currently trading at a loss on the cash basis, we recommend seeking specialist tax advice.
Time limits on making loss claims vary, so it is advisable to take advice as early as possible. Usually, loss claims are made in Self-Assessment tax returns.
It is important to think through all implications of claiming a loss in order to protect the tax-free personal allowance. If the loss is claimed in the year it is incurred, or in the preceding year, then it is advisable to protect the income tax relief that would have been claimed on EIS / Seed Enterprise Investment Scheme / Venture Capital Trust investments, as well as tax relief claimed on pension contributions and gift aid donations. Failure to consider these implications may result in unfavourable tax treatments.
Such claims are complex and are likely to differ according to personal circumstance.
If you have questions on any matter discussed within this Insight, please do not hesitate to contact one of the Tax team