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Instant relief! The best use of trading losses. By Rebecca Benneyworth

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14th Nov 2008
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Rebecca Benneyworth kicks-off the first in her a series of articles examining relief for losses.

The next couple of years is going to be a difficult time for everyone, and in business, thoughts turn to the best use of losses, obtaining the maximum and swiftest relief for our clients, securing a tax repayment as soon as possible to help with the cashflow.

The legislation governing loss relief in income tax was rewritten into Income Tax Act 2007, but it is fair to say that no material amendments were made to the relief provided for by ICTA Ss 380, 381, 385 and 387. In this first in a series of loss relief articles, I shall examine some of the practicalities associated with claiming loss relief in an ongoing business, under what was previously Section 380. I shall deal with opening and terminal losses in another article, and non trading and corporation tax provisions separately.

The priority claims for loss relief will be made against the other income of the year and the total income of the preceding year under Section 64 ITA 2007. This permits relief against total income of the year and the preceding tax year, or both if the taxpayer so chooses. Where the taxpayer chooses to claim in respect of both years, the order of claim must be specified. It is normal to assume that previous year relief will be preferable in the first year of losses, as there are profits available against which to set the loss. It may be that the non trading income of the taxpayer is small, and thus it would be preferable to avoid a claim in the year of the loss, leaving other income to be covered by personal allowances.

Where the loss is substantial, it may exceed the profits of the preceding period. However, the claim cannot be restricted to leave other income in charge to tax and covered by personal allowances – the relief is given for the whole of the loss or the whole of the income – whichever is the greater. However, it is normal in these situations to revisit the capital allowance claims and to consider restricting the amounts claimed to ensure that where possible personal allowances are not wasted. The new Annual Investment Allowance permits a partial claim, so this leaves it open to the taxpayer to make a claim of an appropriate amount to ensure that he comes out with the best result.

The time limit for the claim is 31 January following the due filing date for the return (ignoring the new 31 October deadline). Where the taxpayer incurs a loss in the following period (a second loss) the way in which the claims interact is specified by Section 65(2) ensuring that earlier losses are given priority – this is logical given that the later loss can be set against the income of the year of the loss if not relieved by carry back.

There is, of course the normal restriction for trades not carried on on a commercial basis with a view to the realisation of profit. This is now dealt with by Section 66, which includes a number of points to note. The meaning of “with a view to realisation of profit” is given as “so as to afford a reasonable expectation of profit” by Section 66(3). However, if during a basis period there is a change in the way that a trade is carried on, the way in which it is carried on at the end of the period determines the question for this point. There is a separate test for hobby farming, which is given in Ss 67 – 70.

Relief under Section 64 is also subject to the new limitations imposed on partners by Section 103C ITA (introduced by Sch 4 FA 2007) and similar restrictions in new Section 74C (introduced by Sch 20 FA 2008). Both impose an upper limit on the relief available in any fiscal year of £25,000, being the total relief against other (non trading) income available to a claimant who is “non active” in the trade. For partnership losses the restriction also applies to limited partners.

An individual carries on a trade in a non active capacity in a tax year if the individual carries on the trade at any time during the tax year and does not devote a significant amount of his time to the trade in the relevant period for the tax year. Significant amount is defined as 10 hours per week on average personally engaged in the activities of the trade, and those activities are carried on on a commercial basis with a view to the realisation of profits as a result of those activities. The relevant period is the basis period for the tax year, unless this is shorter than 6 months, in which case it means the six months starting at the date trade commenced, or the six months ending on the date trade ceased.

Where clients have limited involvement in the business it is wise to address this issue at the first by advising that they keep records of the amount of time they spend in the business on a weekly basis. This would include administrative time as well as what might be termed “chargeable” time. Thus they will have the evidence with which to argue their case, should the need arise.

Claiming relief for losses against other income also raises the issue of relief for Class 4 National Insurance purposes. A trading loss which has been set against other income has received no relief for Class 4 NIC, and when trading profits once more come on stream, the trader would be able to make a claim to reduce the profits chargeable to Class 4 (but not tax) in respect of the losses. It is important that this claim is not overlooked, and that there is a process in the practice by which you ensure that relief is claimed.

Other issues to consider include relief for pension contributions. When businesses become less profitable, or make a loss, the amounts contributed in previous years may become excessive, particularly when the pension provider increases the contributions automatically on an annual basis. Post A day it is up to the contributor to ensure that the amount paid into the scheme does not exceed the limit of relief (the total income for the year). Overpaid contributions are no longer refunded to the contributor, but the contributor is responsible for advising the pension provider that the contributions paid exceed the taxable income – unless the contributions in the year are no more than £3,600. As a result the scheme provider will suffer a clawback of the basic rate tax relief given at source, and the contributors payments attract no tax relief at all.. Clients should be encouraged to review the amount of their pension contributions in the economic downturn, and you should ensure that pension providers are notified as soon as possible once it is established that the income no longer covers the gross amount payments made. Clients contributing less than £3,600 per annum can safely ignore this responsibility.

In the next article on this topic, I shall examine the effect on tax payments of claiming a loss against the preceding year’s profits and some of the more intricate practical aspects of this relief.

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By User deleted
20th Nov 2008 13:44

timescale
what date does this commence from?

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By david5541
10th Aug 2009 10:36

rebbecca bennyworths losses article dated14/11/08 11.19
I AM UNABLE TO FINDTHE ARTICLE WHICH FOLLOWS THIS ONE REFERING TO TERMINAL LOSSES
HOW DO i DO THIS?

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