Every business likes to make a healthy profit and sail off into the sunset. But in reality, the sea can be choppy and companies can end up making a loss for all sorts of reasons.
Sometimes losses happen simply because the business is very new, or because costs have unexpectedly risen. But COVID-19 has thrown another dimension into the mix, seeing thousands of companies fail to turn a profit when in ‘normal’ times this wouldn’t have been an issue.
Under general rules businesses can carry back trading losses from one year, and put them against profits in the previous year. This basically reduces the amount of profit for the previous year, and less profit means a lower tax bill.
But because the business has already paid its tax bill for the previous year, it can then claim a reimbursement of the Corporation Tax or Income Tax it paid in that previous year (yippee – everyone likes a tax rebate).
The loss carry back period is usually 12 months, meaning that the trading loss can be carried back and offset against the previous 12 months.
A limited company offsets the losses against any profits in the same accounting period, and can then claim to offset the remaining loss against its total profits from the previous 12 months.
To carry back losses against income tax, a person can offset their trading losses against their net income from the current year, the previous year, or both.
An example of carry back losses
This is how it normally works. Imagine your limited company made:
A loss of £7,000 in the accounting period 1st January 2018 to 31st December 2018, and;
A profit of £19,000 in the previous 12 months.
Under the carry back rules, the company’s £7,000 loss can be offset against the profits for the previous accounting year.
It reduces the previous year’s profit from £19,000 to £12,000. Lower profit means less tax, but because you’ve already paid tax on the full £19,000, you’ll get a rebate for the difference.
Our video below explains how Corporation Tax works in more detail, but the same principle applies for unincorporated businesses (such as partnerships and sole traders).
Spring Budget 2021: An extension to the carry back rules
During the Spring Budget announcement, Chancellor Rishi Sunak revealed key changes to the carry back rules.
This means that losses (up to a maximum of £2 million) can be carried back against the previous three years, starting with the later years first. It’s a temporary measure, set to last two years.
The loss carry back period has been temporarily extended from one year to three.
The changes offer welcome cashflow relief to hard-hit incorporated and unincorporated UK businesses who have suffered trading losses due to the COVID-19 crisis. Extending the relief period for those losses helps those businesses reclaim tax paid for two extra years.
Which accounting periods do the extended carry back rules apply to?
This depends on whether you’re claiming to carry back losses for a limited company, or an unincorporated business (such as a sole trader or partnership).
For limited companies: The three-year extension applies to trading losses occurring in accounting periods which end between 1 April 2020 and 31 March 2022.
For unincorporated businesses: The extension applies to trading losses occurring in the 2020-21 and 2021-22 tax years.
The relief is capped at £2 million of unused losses per year. Companies forming part of an umbrella group that are carrying back losses of more than a de minimis of £200,000 will need to apportion the £2 million cap.
So, for groups, the maximum cashflow benefit is £760,000 (£2 million at 19% for two years) – clearly well worth claiming for the majority of companies.
Again, this is a tricky subject so an example might be useful.
Say a company has made a loss in the year ending 31st December 2020. Normally, it would only have been allowed to carry back the loss against profits in the twelve months up to the 31st December 2019.
However, under the new rules, once 2019’s profits have been offset in full, up to £2 million of losses can be carried back against profits made in the year ending the 31st December 2018 (and then on to 2017 if necessary).
Again, any extended relief available will be applied to the profits of the most recent years first. Any 2020 loss would be carried back to 2019, then 2018 then 2017.
How do I claim under the carry back rules?
You will need to carry back any trading losses within two years of the end of the accounting period that the losses occur in.
The claim is typically submitted as part of your company tax return or an amended tax return. Where a standalone claim is being made separately, you’ll need to include:
The name of the business.
The amount of the loss.
The tax period during which the loss has taken place.
How the loss is to be utilised.
It is possible to make a claim, even after everything has been submitted. Any tax that you’ve already paid out during the carry back period will generate a refund. If owe corporation tax then this will be deducted from your bill.
Can I claim early?
Yes, but let us explain.
A claim under carry back rules usually happens at the point when the business’s tax return is submitted. This is a bit of a pain, as tax return time may still be many months away.
Therefore, some go down the route of submitting an early loss carry back claim to secure a reimbursement of tax as soon as possible. Sounds good – but (yes, there’s a but)…
The downside of claiming early
Unfortunately, the process of claiming early is slightly laborious as there is no statutory provision allowing businesses to claim relief before submitting their tax return.
This means anyone that wishes to make an early claim must approach HMRC and ask to amend their tax return for the earlier period of profit.
Anyone asking HMRC to expedite their carrying back of losses will need plenty of evidence that losses will be included for the loss-making period when their tax return is eventually completed.
This makes it really important to know what HMRC considers acceptable evidence, and how to make sure early payment is a success. Again, this is where our team can help.
Who might benefit from a carry back claim submitted early?
Companies all over the UK may find making a carry back claim early to be a smart move. This is particularly the case during the COVID-19 pandemic, and during the next couple of years when they may still be trying to get back on their feet.
A company may choose to claim early if they:
Recently concluded an accounting period where they can demonstrate a loss, or they are currently in the middle of an accounting period where it’s already very clear a loss will be made, and;
They also made a profit in the accounting period prior to the current one.
What is carry ‘forward’ relief then?
Carrying a trading loss forward kind of works like carrying it back, but… forwards. Basically, the loss will be deducted from future profits the business makes in subsequent accounting periods, rather than previous ones.
Again, this may not be super appealing to businesses as it involves waiting for future profits to have occurred before a claim can be made.
It also only allows the loss to be set against profits the business has made – it doesn’t give any relief against capital gains or any other income sources.
Those looking to go down this route will need to declare their intention to use this loss relief within 4 years from the end of the tax year during which the loss occurred.
What are ‘terminal loss’ rules and how do they relate to carry back?
As we know, losses can be carried back or forward to another accounting period for the purposes of tax relief – but the terminal loss rules go a little bit further than this.
Basically, if a company has stopped trading, and during its last 12 months in operation it made a loss, it can carry back its trading losses and offset them against profits made at any point up to three years before the year in which the loss was made.
Important points to note here
As before, for each period, losses can only be offset against that year’s profits if the company or organisation was continuing on with the same trade during the accounting period (or periods) that fall in that year.
If the end date of the accounting period has changed, or any of the previous accounting periods in the three years prior are less than 12 months, then the profit will need to be apportioned.
The similarity with carry back continues where any loss should be offset against the most recent year’s profits first. Only then can earlier years be considered.
It’s also important to remember that losses must start with the earliest, and be accounted for in the order they’re made. Terminal relief cannot be used for losses carried forward to offset profits apportioned outside the specific three-year period.
We’ve tried to keep this all as simple as possible but it can certainly be a bit of a headache! If you’re not quite sure how (or indeed if) terminal loss rules apply to your company, you’re welcome to get in touch with us to discuss.
Watch out for any COVID-19 support grants too
One more thing to remember here is that if you’ve received any kind of government-backed coronavirus grants relating to your business (for example CJRS receipts as an employer, SEISS or business support grants) it should be included as part of your trading income.
Tax liability for the grants exists in the tax year during which the money was received, which will affect the calculation of trading losses for the two tax years 2020/21 and 2021/22.
Not sure where to turn when it comes to your business tax? If you need expert guidance on tax reliefs, losses and more then we’re here to help.