Hidden Benefit of the New Extended Loss Relief

The new extended tax loss relief seems straightforward, but a closer look reveals an opportunity for sole traders and business partners to save more tax than first appeared.
Is this something you can take advantage of?

Tax Relief for Trading Losses:

Trading losses can be used to reduce tax payable on the income of the current year and previous year, or both. The trouble is this can mean losing at least some or all of your personal tax-free allowance.

Example 1 - Existing Rules:

In 2020/21 you made a loss of £30,000 and had other taxable income, a salary of £20,000 on which the tax payable is £1,500 ((£20,000-£12,500 personal allowances) x 20% £1,500). The rules say that losses are deducted from your income before personal allowances. Therefore, to get the £1,500 tax refund you must use £20,000 of the loss relief. This means the £12,500 personal allowance is wasted.

New Extended Loss Relief:

The new loss relief rules are different in that you can’t use them to reduce tax payable on your other income. Instead, the loss relief can only be used against profits from the same trade. Ironically, it’s this limitation that produces an opportunity for extra tax savings. The following example illustrates this. Bear in mind that to access the new loss relief you must either have no taxable income in the same and previous year as the loss or have reduced it to nil for at least one of them by making a claim for relief under the existing rules.

Example 2 - Existing Rules:

Jimmy’s sole-trader business shows the following results:

| Year | 2020/21 | 2019/20
|———-|:————-:| | Trading profit/(loss) | (£45,000) | £26,000 | Other income | £5,000 | £12,000 {: .table .table-striped .table-hover}
If he claims loss relief (under the existing rules) against his other income for both 2020/21 and 2019/20 he’ll have no taxable income in either year. He will have used all the loss but wasted his personal allowance for both years.

Example 3 - New Rules:

To access the new loss relief Jimmy must make a claim to use the loss in 2020/21 or 2019/20 under the existing rules. While the obvious choice is the year with the highest income, i.e., 2019/20, this would result in only £5,000 of the loss remaining to carry back to 2018/19 under the new extended loss relief rule. Tip. A better result is achieved if Jimmy instead claims loss relief against other income for the year of the loss (2020/21).

Using the Tip seems counterintuitive because Jimmy’s income for 2020/21 is only £5,000 meaning that the claim results in no tax saving for 2020/21 as his income is already covered by his personal allowances. However, by claiming the loss relief for 2020/21 Jimmy uses just £5,000 of it. This leaves £40,000 (£45,000 - £5,000) which can be carried back under the new rules, first against 2019/20 and then 2018/19. The relief can only be used against trade profits and so will cover those for 2019/20 but will leave his personal allowance intact to cover his other income for that year.

Another Angle

The limitation to trade profits rule can be used to increase loss relief carried forward. Say you made a loss in 2020/21 of £20,000 and had £1,000 in other income. In 2019/20 your profits were £10,000 and you had another income of £10,000. Using the existing rules, you could carry the £20,000 loss relief and so reduce your taxable income to nil. ut if instead, you claimed relief against the current year’s income, apparently wasting £1,000, you will limit the loss carried back under the new rules to £10,000 leaving £9,000 of it to carry forward.

**Because the new extended loss relief is only set against trading income it can, unlike the existing loss relief, avoid wasting all or part of your tax-free personal allowance. This is done by claiming relief under the existing rules for the tax year in which your other income is the lowest.__