Insights

For many unincorporated businesses, the last tax year will have been a very tough period to have been trading. There may be self-employed losses in the 2020/21 tax year for which tax relief can be claimed. Securing income tax relief for losses can be achieved using the new temporary carry back relief for 2020/21 and 2021/22, which was introduced by Finance Act 2021. Accessing this relief can be complicated as this article explains and there are multiple ways to do it - some more beneficial than others in the long term.

Using the cash basis for self-employed accounts

If self-employed accounts are prepared on a cash basis under the Income Tax (Trading and Other Income) Act 2005 Chapter 3A Part 2, losses must be carried forward and set against future profits of the same trade. In situations where trading ceases, terminal loss relief may be claimed.

Some self-employed businesses using the cash basis of accounting may benefit from changing to accruals accounting if they make a loss to maximise their options for obtaining income tax relief for the loss.

There may also be a capital allowances consideration and a need to balance the cash flow advantage of obtaining a tax refund with wasting the personal allowance. The following example explains how:

Worked example

Pete is a self-employed personal trainer turning over around £20,000 per year, with annual taxable profits of £15,000. In the year to 31 March 2021, Pete’s gross income dropped to £4,000 due to the pandemic. He bought some new equipment and allowable business expenses in the year to 31 March 2021 were £7,985, including £1,500 on kit.

Pete therefore incurred losses from self-employment of £3,985 and he was able to claim the annual investment allowance (AIA) for the £1,500 of equipment. Pete also works part time as an employed PE teacher in a school and in 2020/21 his salary was £14,800 (tax paid of £460). The self-employment losses can be offset against his other salaried income for the 2020/21 tax year.

Pete’s tax calculation for 2020/21 is as follows:

Employment income £14,800

Less: self-employed loss (£2,485)

Less: AIA (£1,500)

Taxable income £10,815

Pete’s taxable income is below the personal allowance of £12,500 and he will receive a £460 rebate.

Alternative approach to claiming loss relief

There is an alternative approach. If Pete decides not to claim AIA for the new equipment and claims writing down allowances instead, the loss becomes £2,485 but less of his personal allowance is wasted, as the example below shows.

Alternative tax return calculation

Employment income £14,800

Less: self employed loss (£2,485)

Taxable income £12,315

The taxable income is still below the personal allowance of £12,500, and so the tax deducted from Pete’s PAYE income of £460 will be repaid. However, £1,500 less of his personal allowance is wasted and capital allowances can be claimed in future tax years in respect of the new equipment. As Pete’s business picks up this may be more advantageous in the long term.

Dealing with Class 4 National Insurance and losses

There are separate rules for relieving trading losses for national insurance contributions (NIC) purposes. Depending on the circumstances, the relevant amount of the loss can be carried forward and set off against the first available profits in a subsequent tax year. This reduces the Class 4 NIC liability in the later tax year.

Worked example

For example, Clare was employed in a gym until March 2019 and then decided to set up a cleaning business. Her only income since March 2019 has been from self-employment as a domestic cleaner. In the 2019/20 tax year, her profits were £10,000 but her accounts for the year to 31 March 2021 show a loss of £4,000.

Clare was not eligible for the first three self-employment income support scheme (SEISS) grants because of the dates when her business started. She can claim to carry back the loss of £4,000 to the 2017/18 tax year as ‘opening year losses’ and offset this against her employment income in that year of £20,000. This will generate a tax refund on her 2020/21 tax return of £800 (£4,000 x 20%). The loss of £4,000 remains unrelieved for Class 4 NIC purposes. Clare expects her profits for the year ending 31 March 2022 will be £14,000 so her Class 4 NIC liability for the 2021/22 tax year will be based on profits of £10,000 (£14,000 - £4,000).

Clare is not liable for Class 2 NICs for 2020/21 because her losses mean she is below the small profit threshold. However, she may pay contributions voluntarily to maintain her national insurance record and protect her state pension entitlement.

How do coronavirus support payments affect claims for losses?

The 2020/21 tax return requires coronavirus support payments such as local authority grants, Job Retention Scheme grants and Eat Out to Help Out payments to be included in ‘other business income’ in the self-employed section of the 2020/21 tax return, rather than in turnover.

This may mean grant payments need to be stripped out of the accounts to enter in the relevant box of the tax return and will be declared on the same basis as the accounts figures, i.e. according to the accounts basis period. However, SEISS grants are treated differently.

SEISS payments should be excluded from the turnover figure in the tax return but in accordance with Finance Act 2020, SEISS grant payments are liable to tax and self-employment national insurance in the 2020/21 tax year. This means they should be treated as revenue received. (SEISS grants paid into a partnership and then distributed to all partners are exempt from this requirement).

In practice, this means SEISS grant payments are automatically added to a self-employed profit or offset against a self-employed loss in the 2020/21 tax year. The way this is calculated is illustrated in the example below:

Worked example

Daisy is a self-employed pastry chef and has supplied cafés on a daily basis for the past five years. Her accounting year end is 31 December each year. During the year ended 31 December 2020, Daisy’s income shrank because cafes were closed due to Covid-19. She claimed the SEISS and received the following payments:

First grant: £4,800 (received 25 June 2020)

Second grant: £4,200 (received 30 September 2020)

Third grant: £4,800 (received 12 January 2021).

Daisy’s self-employed accounts for the year ended 31 December 2020 showed a loss of £3,310. Her 2020/21 tax return will show the following entries in the self-employed section:

Net loss from self-employment (£3,310)

SEISS grants £13,800

Total taxable profits from self-employment £10,490

Without offsetting the loss there would have been a small taxable profit after personal allowances of £1,300 (£13,800 - £12,500). By offsetting the loss automatically, tax of £260 is saved (£1,300 x 20%).

It is not possible to make a separate loss relief claim in respect of the loss of £3,310 in isolation; for example, claiming carry-back relief to obtain full tax relief for the loss and then saving tax of £662 (£3,310 x 20%). The tax cost of the automatic offset is £402 if basic rate relief might have been obtainable from an earlier year.

Class 4 NIC is calculated based on profits of £10,490, as the loss of £3,310 is offset against the SEISS grant income which is chargeable to Class 4 NIC. Automatically offsetting the loss against the SEISS grant wastes £2,010 of the 2020/21 personal allowance of £12,500.

Note: if you are expecting a tax refund following a loss relief claim but already owe HMRC outstanding tax for a previous period, it is unlikely HMRC will issue your refund, which will be offset against any arears.

As this article highlights although loss relief is available there are many considerations, and it may be helpful to consult an expert. If you need help with your self-employed accounts, please contact partners@rjp.co.uk.