For those who are self-employed or in partnership, occasionally you may make a loss for tax purposes. This could be simply as a result of a downturn in business, the write-off of a bad debt or the purchase of a large item of equipment suddenly increasing your claims for capital allowances, or more dramatic such as the effects of the pandemic.
There are various loss reliefs available to you when you are in this position. For income tax relief you are able to:
Carry forward the loss against future profits of the same trade;
Offset the loss against other income received in the same or previous tax year (this claim may also be extended to offset the income tax loss against capital gains of the same or previous tax year);
For a new trade, you can carry back the loss against your general income of the previous three years, earliest first. (This claim is available for the first four tax years of a new trade); or
When ceasing to trade, you can carry the loss back against your trading income (of the same trade if you have more than one) of the previous three years, latest year before earlier ones.
Choosing a particular loss claim can be quite complicated in order to both maximise your income tax recovery and to ensure that personal allowances are not wasted unnecessarily (as loss claims are all-or-nothing and are taken into account before your personal allowances are used). You can make more than one claim for a tax year until your losses are utilized and loss claims may then give rise to further reliefs such as the Transferable Married Allowance.
But the above only relate to income tax relief.
When you suffer a trading loss as a self-employed individual or as a partner, you also generate a loss for Class 4 National Insurance Contribution purposes. Class 4 NIC loss relief will generally follow the claim for income tax. However, when you offset the loss against your general income or capital gains, there is no source against which to offset the Class 4 NIC loss (for example, as employment income is subject to Class 1 NIC, you are unable to offset the Class 4 NIC loss). In this instance, the Class 4 NIC loss is carried forward to be used against future trading income. As Class 4 NIC is effectively a tax (as it has no connection with the level of current or future benefits you may claim), ensuring that you keep a record of it from one year to the next and making a claim for relief against your next trading profit. HMRC will not voluntarily keep a record of any Class 4 NIC losses for you but by doing so yourself, you could save up to 9% off your next self-assessment liability.