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Markel Tax

22 Jun 2020

Maximising relief for trade losses incurred by unincorporated businesses

To benefit from this relief, a claim must be submitted to HMRC by the first anniversary of 31 January following the end of the tax year of the loss. So for losses made in 2020/21, a claim must be made by 31 January 2023.

Capital gains

Only once a s 64 claim has been made, a claim can be made to offset any remaining losses against the lower of:

  • the remaining loss after the s 64 claim; and

  • the “relevant maximum” i.e. the net gains in the tax year, less capital losses brought forward.

As with a s 64 claim, a s 71 must be claimed by the first anniversary of 31 January following the end of the tax year of the loss.

Carry forward

Under s 83 losses may be carried forward and set against future profits of the same trade.

While the losses are carried forward automatically, a claim must be made to establish the amount of loss to be carried forward.

This claim must be made within four years from the end of the tax year in which the loss arose. For example, for losses made in 2020/21, a claim must be submitted by 5 April 2025.

New businesses

In addition to the above loss relief options, new businesses have more flexibility on their opening year losses.

Any losses arising in the first four tax years of trading can be carried back against net income of the three preceding tax years, on a first in first out basis.

As with s 64, there is a restriction against the amount of loss which can be offset against non-trading income.

To be entitled to this loss relief, a claim must be made by the first anniversary of 31 January following the end of the tax year of the loss.

Terminal loss relief

A trader is entitled to terminal loss relief under s 89 when they permanently cease trading. Terminal loss relief allows any loss, occurring in the final 12 months of trading, to be offset against the trading profits in the tax year of cessation and then carried back to the three preceding tax years, most recent year first.

To calculate the loss, the final 12 months of trade is split either side of 6 April. For example, if a trader permanently ceases to trade on 31 July 2020, the loss is calculated as follows:

  1. Loss arising between 6 April 2020 and 31 July 2020

    plus;

  2. Any losses between 1 August 2019 and 5 April 2020.

Covid-19 impact – During these difficult times, many businesses may have been forced to close their doors to business and some may not open again so the question of when the trade actually ceases may come down to when that final decision is made by the business owner. HMRC are only likely to allow a terminal loss claim once they are satisfied the trade has permanently ceased. HMRC are likely to challenge claims for terminal loss relief in respect of businesses supposedly closed but which then reopen later in the year. Each case would need to be reviewed on its own facts. 

Loss relief restrictions on non-active partners and Covid-19 impact

A non-active partner is defined as one who does not spend, on average, at least 10 hours per week working in the partnership.

If a partner falls into the above category, the restrictions below will apply to their amount of s 64, s 71 and s 72 relief:

  • Annual limit of £25,000

  • First four tax years of trade only: the lower of £25,000 and their ‘unrelieved contribution’, which is the capital a partner has introduced into the partnership plus any undrawn profits.

During the Covid-19 lockdown period, many partners may now find themselves spending less time, if any, on the business and could technically fall within these restrictions. It is hoped that HMRC will take into consideration the reduced activity due to government restrictions when deciding which partners are considered non-active.

Limited liability partnership (LLP)

While an LLP is similar to a partnership, from a loss relief perspective, the options available to active partners and non-active partners of an LLP are more restrictive than those available to partners in a general partnership.

Where a loss is being offset against non-trading income, active partners of a LLP are only entitled to a loss relief claim equal to their ‘contribution’ to the LLP. In this context, ‘contribution’ is the capital introduced into the LLP by the partner plus any further amount the partner has agreed to pay in the event of the LLP being wound up.

The following example illustrates the difference in loss relief between active partners in a general partnership and active partners in an LLP:

Assume the facts of the illustration above remain the same, except now John and Adam have been trading as a LLP.

John’s maximum relief under s 64 is:

  • His contribution of £20,000; plus

  • The amount he has agreed to pay in the event of the LLP being wound up of £10,000

The maximum relief for John under s 64 in 2020/21 is £30,000, leaving John with net taxable income of £220,000 and his share of the remaining loss of £38,750 which could be carried back and set against other income in 2019/20 (subject to the cap for that year) or carried forward and set against future trading profits.

For non-active partners in an LLP, the restriction is always the lower of £25,000 and their ‘unrelieved contribution’, however, the definition of unrelieved contribution differs for the first four tax years of trade:

  • First four tax years of trade only: the capital introduced into the LLP by the partner plus any amount actually contributed on a winding up of the LLP by the non-active member

  • Fifth tax year of trade and onwards: the capital introduced into the LLP by the partner plus any further amount the partner has agreed to pay in the event of the LLP being wound up

Maximising loss claims will be crucial for many business owners and we are on hand to review claims and work alongside advisers to maximise the benefit of the losses.


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Tagged Tax for entrepreneurs and corporates
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