If you’re self-employed or a partner in a partnership, there may come a time when your business expenses and capital allowances outweigh your income or turnover. This is considered a trading loss. Understanding the options for tax relief on such losses can be a significant financial advantage.
In this article, we’ll explore various ways to claim tax relief, along with practical examples to help you decide what works best for your circumstances.
How Are Trading Losses Calculated?
You work out your losses the same way as your profits for the year. You can use either use:
- Accruals basis: Recognising income and expenses when they are incurred, regardless of payment dates.
- Cash basis: Recognising income and expenses only when money is received or paid.
Example
Suppose you’re a freelance graphic designer and prepare your accounts using the accruals basis. Your turnover for the year is £25,000, but your allowable expenses and capital allowances total £30,000. This means you’ve made a trading loss of £5,000 (£25,000 - £30,000).
Now, the key question is: what can you do with this loss?
Engaging with the Trading Allowance
If your trading income is below £1,000 annually, you can benefit from the trading allowance, which simplifies reporting by allowing you to deduct £1,000 from your income instead of claiming actual expenses. However, if you’ve made a trading loss, this might not always be the most beneficial route.
By not claiming the trading allowance and instead claiming actual expenses, you could also qualify for tax relief on your trading loss.
Example: To Claim or Not to Claim the Trading Allowance
Let’s look at Zelda, a yoga instructor, to illustrate this:
- Zelda prepares her accounts using a cash basis.
- Her trading income for the year ended 31 March 2024 is £2,100.
- She typically claims the trading allowance (£1,000), which would leave her with a taxable profit of £1,100 (£2,100 - £1,000).
However, in this year, Zelda’s expenses include a £1,500 specialist yoga course, bringing her total business expenses to £2,345. If Zelda chooses to claim her actual expenses instead of the trading allowance, her taxable profits for the year would be nil (£2,100 - £2,345). Additionally, she can claim tax relief on the resulting trading loss of £245 (£2,100 - £2,345).
This example demonstrates why opting out of the trading allowance might be better when expenses exceed income.
How Tax Relief for Losses Works?
For the UK tax year ending on 5 April, the process to claim relief for a trading loss is structured to minimise your taxable income or capital gains. Relief can often be claimed:
- Against other income (same or previous tax year).
- Against capital gains (same or previous tax year).
- Carried forward to offset against future trading profits.
- Carried back against prior years for new businesses.
- When a business ceases to offset past profits.
For losses arising in the 2024/25 tax year onwards, it no longer matters whether you use the accruals basis or cash basis to prepare your accounts. Reliefs can be claimed under any accounting method. This means there is no restriction that you could only carry forward losses against future profits of the same trade rather, you can settle the loss against other income as well. Let’s dive into each type of relief:
Set Loss Off Against Other Income
You can use a trading loss to reduce taxable income from other sources (e.g., employment income, rental income) in the same tax year or the previous tax year. This approach, often called sideways loss relief, reduces the overall tax liability.
For losses arising in the 2023/24 tax year or earlier, the accruals basis must be used to calculate the loss. From 2024/25 onwards, you can use either the accruals or cash basis.
Note
You cannot partially apply this relief. The entire loss must be used against other income until it is either fully utilised or there is no taxable income left.
Example:
Sarah, a sole trader, incurs a £15,000 trading loss in 2023/24 and has £20,000 employment income.
£20,000 (income) - £15,000 (loss) = £5,000 taxable income
Her £12,570 personal allowance fully covers this, so no tax is due
Sarah cannot choose to offset only part of the loss to maximise her personal allowance—the entire £15,000 loss must be used first.
Means, Sarah cannot choose to only use £7,430 of the loss so that she still has £12,570 taxable income (matching her personal allowance) and carry forward the rest. The full £15,000 loss must be used before any balance can be carried forward or back.
What If Her Income Was Lower?
If Sarah had only £12,000 income, the loss would bring her taxable income to £0, and the remaining £3,000 loss could be carried back or forward.
Set Loss Off Against Capital Gains
You can set the loss from your self-employment against capital gains in the same tax year in which you made the loss and/or the tax year prior to that in which you made the loss. However, you must offset the loss against any other income in the tax year first (before setting it off against capital gains). So, you can only set a self-employment loss against a capital gain to the extent the amount of the loss exceeds the other income in the tax year.
This method of loss relief is only likely to be beneficial if there is no other income in the tax year in which the loss is used, so the loss can just be offset against any capital.
Example:
John has a £4,000 trading loss in 2023/24, along with:
- £1,500 in other taxable income (e.g., employment, rental, or interest income)
- £5,000 in capital gains from selling shares
Step 1: Offset against other income first i.e. £1,500 - £4,000 = £2,500 remaining loss
Step 2: Apply remaining £2,500 loss to capital gains i.e. £5,000 - £2,500 = £2,500 taxable capital gains
Step 1:
Offset against other income first i.e. £1,500 - £4,000 = £2,500 remaining loss
Step 2:
Apply remaining £2,500 loss to capital gains i.e. £5,000 - £2,500 = £2,500 taxable capital gains
Losses must first offset other income before reducing capital gains, making this method most useful when other income is low or zero.
Carry Forward Losses
If you can’t use the loss immediately, you can carry it forward and offset it against future profits from the same self-employment. This reduces future taxable profits and is often the default position if no other relief is claimed.
- Losses must be used in the first tax year after the loss where profits are made.
- Unused losses can be carried forward indefinitely.
Example:
Tom, a freelance photographer, incurs a £2,000 loss in 2023/24. In 2024/25, he makes a £5,000 profit. By carrying forward the loss, Tom reduces his taxable profit to £3,000 (£5,000 - £2,000).
Carry Back Losses for New Businesses
For a new self-employment business, if the loss occurs in any of the first four tax years of trading, you can set it against your total taxable income of the three tax years immediately before the loss year, starting with the income of the earliest year first. This reduces the tax due on this income, and a repayment of tax is usually generated.
Example:
Emma started a bakery in April 2023 and incurred a £6,000 trading loss in her first year (2023/24). Since this is within her first four years of trading, she can carry back the loss against her total taxable income from the previous three tax years (2020/21, 2021/22, and 2022/23), starting with the earliest year.
Emma’s taxable income from employment in those years was:
- 2020/21: £3,000
- 2021/22: £2,000
- 2022/23: £4,000
Step 1:
Offset against 2020/21 income (£3,000 - £3,000 = £0), £3,000 loss remaining
Step 2:
Offset against 2021/22 income (£2,000 - £2,000 = £0), £1,000 loss remaining
Step 3:
Offset £1,000 loss against 2022/23 income (£4,000 - £1,000 = £3,000 taxable income left in 2022/23)
Final Taxable Income After Applying the Loss:
- 2020/21: £0 (fully offset)
- 2021/22: £0 (fully offset)
- 2022/23: £3,000 (partially offset)
Since Emma originally paid tax on her employment income in these years, she will now receive a tax refund for the overpaid tax on the £6,000 loss carried back.
Offsetting Losses When a Business Ends
If your business ceases operations and you incur a loss in the final 12 months, you can set this loss against trading profits from the previous three tax years, starting with the most recent.
Example:
Mark closes his consulting business in March 2025 with a loss of £5,000 in the final year. He offsets this against trading profits of £3,000 from 2024/25 and £2,000 from 2023/24, resulting in reduced tax liabilities for those years.
Interaction with Capital Allowances
Capital allowances, which provide tax relief on certain business assets, can sometimes increase or create a trading loss.
However, you may choose not to claim capital allowances in a loss-making year if it doesn’t yield additional tax savings. Instead, deferring the claim to a future year when profits are higher might be more beneficial.
Example:
Anna, a carpenter, purchases tools eligible for a £1,200 capital allowance. She’s already made a £1,000 trading loss. Claiming the allowance now would increase her total loss to £2,200.
Since she has no taxable profits in the current year, this does not reduce her tax liability.
By deferring the capital allowance to the next tax year, Anna strategically uses the £1,200 allowance to offset against her profits in next year. This reduces her taxable income by £1,200, effectively lowering the tax she owes for the next year.
Deferring the allowance allows her to maximise the benefit by ensuring it is applied when she has taxable profits, avoiding a situation where the allowance provides no immediate tax advantage.
Conclusion
Whether you’re just starting, running a growing business, or winding down operations, evaluating your loss relief strategies can help you make informed decisions and potentially save thousands in taxes. Remember, most claims are made through your self-assessment tax return, and strict time limits apply, so seek advice from a tax professional if you’re unsure.
By taking the time to understand these rules, you can turn trading losses into opportunities to improve your financial position, which is an essential skill for any self-employed individual.
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