How much tax relief for losses can a trader claim?

The cap

Since 2013 there’s been a ceiling on some income tax reliefs, and using trading losses against other income is on the list. The restriction (referred to as the cap) depends on how the trader uses the losses. If traders use them to reduce tax on other income it’s restricted to the greater of 25%  adjusted total income, and £50,000.

Using the loss

Relief for a trading loss from an unincorporated business can be used to reduce tax paid or payable on, e.g. income from employment, property and savings. It can be used for the same year or the tax year before the loss occurred and is called sideways loss relief. Note that this is not available to businesses that prepare their accounts on a cash basis - they have to carry the loss forward to offset future trading profits instead. 

A trader can set a trading loss against tax payable on a capital gain but only if it can’t be used against their income.

Danger zone

Traders can’t choose how much of the loss to use for sideways relief, it’s all or nothing, so careful planning on how to use it effectively is vital. There’s a danger of wasting personal allowances or the annual capital gains tax exemption if they use the loss poorly.

Example. Z has employment income as well as from self-employment. In 2020/21 he earned £15,000 as an employee and his self-employed business makes a £6,000 loss. If he sets the loss against his employment income, he loses out by taking his income below the £12,500 personal allowance.

If sideways relief  isn't claimed the loss is instead used against future profits from the same trade; there’s no limit, so the cap might be avoided that way.

An alternative to sideways loss relief

The government made a temporary pandemic concession on carrying claims back for a longer period than usual. These rules allow traders to use the losses made in 2020/21 and 2021/22 against income of the three previous tax years rather than just the same or previous year. What’s more, they can choose to claim only against the current year or the previous year, rather than both. The special coronavirus loss rules mean that relief is against trading income only for years two and three, so if the traders has other income in these years, they can avoid losing the tax-free personal allowance. If they can’t claim sideways loss relief because they haven’t any other income, they can still claim the new coronavirus carry back relief.

Remember the time limits for claiming this relief: 31 January 2023 for trading losses in the tax year 2020/21 and 31 January 2024 for trading losses in 2021/22. 

To make use of the coronavirus carry back loss relief the trader will need to elect out of the cash basis.