If a company is operating at a loss, the difficult decision may need to be taken to close operations permanently. Still, even though the business will no longer be trading, it is important not to miss out on valuable tax relief that can often be overlooked.
When it comes to the complexities of tax relief rules, and utilising any tax losses as efficiently as possible, expert advice should be sought from a tax specialist. However, the following article provides a useful outline of the rules relating to terminal loss relief in respect of both corporate and unincorporated businesses. We also look briefly at the rules for offsetting losses against any liability to tax for those businesses that are continuing to trade.
By understanding the basic principles behind the rules on relief, and how these rules work in practice, this can help business owners to make the most of the tax relief that can be claimed.
What is terminal loss relief?
The tax legislation in the UK provides various forms of relief for business losses, both for corporation tax and income tax purposes, including a special relief for losses made in the final 12 months of trading as either a limited company, sole trader or partnership. This is known by HMRC as terminal loss relief where, as the name suggests, this is specifically designed to provide relief against terminal losses arising during the last year of trading prior to cessation.
Under the rules relating to terminal loss relief, this means that if a company has ceased to carry on a trade and made a terminal loss in that trade, relief can be sought against an earlier liability to corporation tax. Equally, where anyone liable to income tax has made a loss in the year before ceasing trading, they may carry back that loss on permanent cessation.
For those liable to income tax, relief is available for any terminal loss made in either a trade, profession or vocation that is permanently discontinued. However, a deduction can only be made from profits from the same business, where a loss cannot be set against any general income that the taxpayer may have. Similarly, for companies, relief is granted from trading losses on cessation, subject to the condition that the company must have been carrying on the same trade during the accounting period or periods falling within the relevant timeframe.
What are terminal losses?
For corporation tax purposes, terminal losses are defined as the whole of any loss made by a company in the trade in an accounting period that begins during the final 12 months, and the overlapping proportion of any loss made by the company in the trade in an accounting period that ends, but does not begin, during the final 12 months. For example, for a company whose year-end was 30 April, and which ceased trading on 30 June 2022, the terminal loss relief period for the last 12 months of trading will be made up of 61/61 days for the period 1 May 2022 to 30 June 2022, plus 304/365 days from 1 May 2021 to 30 April 2022.
For income tax purposes, terminal losses are defined as any trade loss made from the start of the final tax year to the date of closure of the business, plus any loss made in that part of the previous tax year falling within the 12 month period prior to cessation.
How does terminal loss relief work?
In the case of both corporate and unincorporated businesses, terminal losses may be carried back and set against any liability to tax over the course of the preceding 3 years. This can result in a deduction from any tax due or, alternatively, a welcome repayment of tax already paid. However, the rules are slightly different based on the relevant statutory provisions.
Under the terminal loss relief rules for companies, terminal losses incurred in an accounting period which falls wholly within the 12 months prior to closure, and a proportionate part of a loss incurred in an accounting period falling partly within that 12 months, can be carried back to accounting periods ending within a period of 3 years preceding the accounting period in which the loss is incurred. A terminal loss can therefore be carried back for 3 years preceding the beginning of the accounting period during which the loss arose, provided part of that accounting period falls within the 12 months prior to cessation. This means that it is possible for part of the loss to be carried back for more than 4 years. Under the scenario set out above, where a company with a 30 April year-end ceased trading on 30 June 2022, terminal losses can be carried back to the accounting periods between 1 May 2017 to 30 April 2021.
For sole traders and partnerships, when trading ceases, the claim is for the total amount of terminal trade losses made, known as the ‘relievable loss’, to be deducted in calculating the individual’s net income for their final tax year and the 3 previous tax years. This means that terminal losses can be set against trade profits for the year of cessation ‘and’ against trade profits for the 3 tax years prior to that. For example, if a business ceases trading in the 2021-22 tax year, terminal loss relief can be claimed for losses in the last 12 months, against profits during 2021 to 2022, as well as in the 3 previous years.
How should terminal losses be calculated?
How terminal losses are calculated will not only depend on how a business is registered and what type of tax it is liable to pay, for example, corporation tax or income tax, it will also depend on when the losses occurred and when the business stopped trading. However, in the case of both corporate and unincorporated businesses, the loss must be set against the profits of the most recent accounting period or tax year first, before it can be carried back further.
A detailed example of how the carry-back rules on cessation of trading work in the context of companies can be found online at GOV.UK (HMRC manual CTM04530). In the context of sole traders and partnerships, there is express statutory guidance on how terminal loss relief deductions are to be made. These are set out in the following 4 steps:
- Step 1: deduct the relievable loss from the trade profits in the final tax year
- Step 2: deduct any part of that loss not deducted at step 1 from the trade profits in the previous tax year
- Step 3: deduct any part of the relievable loss not deducted at steps 1 or 2 from the trade profits in the tax year before the previous one
- Step 4: deduct any part of the relievable loss not deducted at steps 1, 2 or 3 from the trade profits in the tax year before that one.
If all of the relievable loss has not been deducted at steps 1 to 4, an individual may then use the part not so deducted in giving effect to any other relevant relief that they may be entitled to claim. However, terminal losses will typically be fully deductible within these 4 steps. The following scenario helps to illustrate how terminal loss relief is calculated in practice:
Tom runs a barbers shop as a sole trader, where he prepares accounts to 5 April each year. His business ceased trading on 30 July 2022, making a total loss of £20,000 for the period from 6 April 2022 to the date of closure. However, a profit of £18,000 was made by the business in 2021/22, a profit of £17,000 in 2020/21 and a profit of £15,000 in 2019/20. The total terminal losses for the last 12 months of trading is therefore £20,000. Under the terminal loss relief rules for unincorporated businesses liable to income tax, this loss can be relieved as £18,000 against the full 2021/22 profits, and the remaining £2,000 against the £17,000 profits in 2020/21, in this way reducing the taxable profits that year to just £15,000.
Where there are overlap profits to be relieved — profits taken into account twice in the early years of the trade or if the accounting date was changed — these are deducted in calculating the terminal loss. For example, if Tom had unused overlap profits of £2,000, his total terminal losses would be £22,000, reducing his taxable profits for the 2020/21 tax year to £13,000.
Importantly, it is not possible to tailor a terminal loss relief claim to preserve the personal allowance. For example, if a trader ceased trading in 2021/22 with a terminal loss of £20,000 and profits of £25,000 for 2020/21, it is not possible to restrict the claim against the 2020/21 profits to the level of the personal allowance for that year (£12,500), carrying the rest back to 2019/20 (£7,500). Instead, the profits of 2020/21 are reduced by the full amount of the loss (£20,000), reducing profits to £5,000 and losing £7,500 of the personal allowance.
How can you claim terminal loss relief?
When claiming terminal loss relief, either as a company, sole trader or partnership, you must start with the latest accounting period or tax year. You must also tell HMRC that your claim is for terminal loss relief, the amount of loss used for each year and the decrease in tax due for earlier years. It is also important to bear in mind that there is a time limit for claims against profit of the same trade. For example, for unincorporated businesses that ceased trading in the 2021-22 tax year, the time limit for claims against profit of the same trade is 5 April 2026.
The rules for terminal loss relief can be complicated, but broadly enable a trade loss in the final period before closing to be carried back and offset against trading profits for the previous 3 years. However, to maximise any relief sought, it is always best to seek expert advice.
Equally, the rules can become even more complicated when it comes to loss relief for businesses that are continuing to trade, but operating at a loss, not least with the introduction of a temporary extension to the carry-back rules in the wake of the pandemic.
Can trading losses be carried back if still trading?
Even if a business continues to trade, relief from corporation tax or income tax can still be sought against losses arising from trading, although the rules here are not normally quite as favourable as those that can be applied when a business ceases to trade.
Under the normal loss relief rules, applicable to any corporate business that has made a trading loss while continuing to trade, tax relief is given by offsetting the loss against other gains or profits of a business in the same accounting period. The loss can also be carried backwards to the previous accounting period or forward to the following accounting period.
Similarly, under the usual rules for sole traders and partnerships, if the business is to continue despite operating at a loss, then a trading loss can be set off against general income or possibly capital gains arising in the same tax year or an earlier year, or against profits from the same trade. This is known as sideways’ loss relief, where the taxpayer can choose whether to offset the loss against income of the current tax year or the previous tax year. Unrelieved losses can also be carried forward to be offset against future profits arising from the same trade.
However, a temporary extension to the one-year carry back rule for trading losses of both corporate and unincorporated businesses was introduced under the Finance Act 2021. This provides businesses with additional relief, by allowing unrelieved losses to be carried back and set against trading profits for 3 years, despite the fact that they are still trading.
Terminal loss relief FAQs
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Legal disclaimer
The matters contained in this article are intended to be for general information purposes only. This article does not constitute legal or financial advice, nor is it a complete or authoritative statement of the law or tax rules and should not be treated as such.
Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission.
Before acting on any of the information contained herein, expert professional advice should be sought.
Author
Gill Laing is a qualified Legal Researcher & Analyst with niche specialisms in Law, Tax, Human Resources, Immigration & Employment Law.
Gill is a Multiple Business Owner and the Managing Director of Prof Services Limited - a Marketing & Content Agency for the Professional Services Sector.
