Calculation of trading losses

How is a loss calculated?

A trading loss is calculated under the same rules as trading profits generally. However, only losses from a UK trade are eligible for the various reliefs detailed in this focus, as there are no similar provisions for losses in foreign trades. Losses from trades carried on overseas can only be carried forward and used against future profits of the same trade.

Additionally, if the company was not within the charge to corporation tax when the loss arose, the loss will not be eligible for relief in later periods once the company comes within the charge.

Capital allowances are given as a deduction from trading income, and therefore the allowances claimed become part of the loss available.

 

Can charitable donations create or increase a loss?

Where a company makes payments which are eligible for charitable donations relief, those are accounted for separately and do not form part of the trading loss.

 

Relief for losses

What are the options for using a company trading loss?

There are several ways in which a company can use a trading loss arising in an accounting period, as shown in the following table:

Method of relief	Conditions
Set against other profits and gains of the same period	The trade must be carried on wholly within the UK
Carried back and set against profits and gains arising in the previous 12 months*
Carried forward and set against future profits	Includes overseas trades
Surrendered to other companies in the same group or consortium	The trade must be carried on wholly within the UK
Carried back and set against profits and gains arising in the previous 36 months	Only applies to a loss incurred in the 12 months ending with the cessation of the trade or carried forward losses after 1 April 2017

 

* there is currently a temporary extension to this period – see below for a full discussion.

 

How is relief given in the same period?

The company can make a claim to set the loss against other profits and gains arising in the same accounting period.

This is an all-or-nothing election, as the company cannot choose against which sources or to what extent the losses will be relieved. If, for example, there are foreign profits with a foreign tax credit available, the company cannot single out this source and exclude it from the loss claim.

Example

C Ltd suffers a trading loss of £30,000 in an accounting period. In the same period, it also has property business profits of £30,000 and a non-trading loan relationship profit of £10,000. C Ltd makes a claim to offset the losses arising.

	£
UK property business profits	30,000
Profits from non-trading loan relationships	10,000
	40,000
Current year loss claim	(30,000)
Taxable total profits	10,000

 

Example

D Ltd made a trading loss of £100,000 in an accounting period. In the same period, it realised chargeable gains of £30,000 and profits from an overseas operation of £40,000, with a foreign tax credit of £10,000. The company has a choice to make. It can either:

·         claim relief for the trading loss and pay no corporation tax, but forego any credit for the foreign tax suffered; or

·         pay tax on the chargeable gain, whilst using the foreign tax credit against the corporation tax due on the overseas profit.

It is not possible for D Ltd to offset only £30,000 of the loss and extinguish the gain.

A claim must be made within the normal time limit, i.e. no later than 2 years after the end of the loss-making period.

 

How is relief given for earlier years’ profits?

A loss can be carried back and relieved against profits and gains of an earlier period, provided that:

• the company has made a claim against profits and gains (if any) of the current period; and
• there are surplus losses still unrelieved.

The carry back is limited to profits arising in the twelve months immediately prior to the loss-making period – but see below regarding the temporary extension. The same trade must have been carried on during the period in which the loss is offset, although not necessarily for the entire period: it is sufficient for it to have been carried on at some point during that time. The mechanics of relief depends on whether the prior accounting period is twelve months long or not.

The simplest situation is that in which the company has a chargeable accounting period of twelve months ending immediately before the start of the loss-making period.

Example

E Ltd makes a trading loss of £100,000 in the year ended 31 December 2021. In the same year it makes chargeable gains of £30,000. In the year ended 31 December 2020 it had trading profits of £85,000. The effect of a loss relief claim would be as follows:

	Loss memorandum
Year ended 31 December 2021	£	£
Trading loss		100,000
Chargeable gains	30,000
Less: Current year trading losses	(30,000)	(30,000)
Taxable total profits	Nil
Trading losses unrelieved		70,000
Year ended 31 December 2020
Trading profits	85,000
Less: Loss carried back from year ended 31 December 2021	(70,000)	(70,000)
Taxable total profits	15,000
Trading loss unrelieved		Nil

 

 

What if the prior accounting period is not twelve months?

If the previous accounting period is not twelve months in length, the losses can be relieved against profits which arise within the twelve months ending immediately before the start of the loss-making period. Where necessary, an apportionment of the profits must be made.

The loss will be relieved against the later period first.

Example

F Ltd has the following trading results during the periods detailed.

Year ended 31 March 2020	Profit £100,000
9 months ended 31 December 2020	Profit £75,000
Year ended 31 December 2021	Loss £150,000

F Ltd has no other profits or gains during these periods. The effect of making a claim to carry back the loss is as follows:
 

	£	Loss memorandum
9 months ended 31 December 2020
Trading profit	75,000	150,000
Less: Losses carried back	(75,000)	(75,000)
Taxable total profits	Nil
Trading loss unrelieved		75,000
Year ended 31 March 2020
Period within the 12 months ending on 31 December 2020: 1 January 2020 - 31 March 2020
Trading profit for year	100,000
Available for loss offset (3/12 × 100,000)	(25,000)	(25,000)
Taxable total profits	75,000
Trading loss unrelieved		50,000

 

The remaining loss will be carried forward.

 

What if there are losses from more than one accounting period?

Where it is possible to offset losses from two periods against the same profits, the loss from the earlier period is relieved first.

Example

E Ltd makes up accounts for 6 month periods to 30 June and 31 December. Its results are as follows.
 

6 months ended 30 June 2020	Profit £50,000
6 months ended 31 December 2020	Profit £30,000
6 months ended 30 June 2021	Loss £45,000
6 months ended 31 December 2021	Loss £20,000

The loss from the period ended 30 June 2021 will be utilised first.
 

Loss from 6 months ended 30 June 2021	£
Against profits of 6 months ended 31 December 2020	30,000
Against profits of 6 months ended 30 June 2020	15,000

The losses from the later period (the 6 months to 31 December 2021) could be carried back to cover both the 6 months ended 30 June 2021and the 6 months to 31 December 2020. However, there are no profits remaining in these periods for relief. The loss will therefore be carried forward to later periods.

 

What if there are also brought forward losses?

If the company makes a claim to carry back a loss to a period for which there are also losses brought forward, the losses brought forward take precedence.

Example

H Ltd has the following trading results during the periods detailed.
 

Year ended 31 March 2020	Loss £30,000
Year ended 31 March 2021	Profit £75,000

The company has unused losses arising in the year ended 31 March 2022 of £60,000.
The losses will be utilised as follows:
 

Year ended 31 March 2021	£
Profit	75,000
Less: Losses brought forward from 2020	(30,000)
	45,000
Less: Losses carried back from 2022	(45,000)
Taxable total profits	Nil
Loss memorandum
Year ended 31 March 2020
Loss for the year	30,000
Used against the profits from year ended 31 March 2021	(30,000)
Losses remaining	Nil
Year ended 31 March 2022
Loss for the year	60,000
Used against the profits from year ended 31 March 2021	(45,000)
Losses remaining	15,000

 

What are the temporary rules following the coronavirus pandemic?

Broadly, under s.37 Corporation Tax Act 2010 if a company makes a trading loss in an accounting period, it may claim to deduct the trading loss from the company’s total profits, firstly in the same accounting period, then any unrelieved losses can be offset against the total profits in the preceding twelve-month period. This was discussed above.

Under the Finance Act 2021, a company can extend the trading loss carry back period from one year to three years, with loss relief given in priority to later years first. This extension applies to trading losses arising in accounting periods ending between 1 April 2020 and 31 March 2022. Using the extension is not the only choice, all other options, e.g. carry forward relief and group relief remain available.

 

Is the relief under the extension capped?

There is no cap on the amount of trading losses that may be carried back to offset total profits of the previous twelve months. However, there is a cap on the amount of loss relief that may be claimed against profits in years two and three of the carry back claim. A £2 million cap applies to trading losses incurred in relevant accounting periods ending between 1 April 2020 and 31 March 2021, with a separate £2 million cap in place for trading losses incurred in relevant accounting periods ending between 1 April 2021 and 31 March 2022.

Example

A Ltd prepares its accounts to 31 December each year. It has the following results:

Year ended	Profit/loss
31 December 2017	£2.225M
31 December 2018	£1.75M
31 December 2019	£2.5M
31 December 2020	(£5.5M)

 

Under the new extension provisions, Acom can utilise the 2020 loss by first offsetting the £2.5 million profits in 2019. This is not subject to the £2 million cap. It can then offset the £1,750,000 profits from 2018, and finally £250,000 of the profits from 2017. The offset in 2018 and 2017 is subject to the cap, so £1 million of the loss will carry forward.

 

What about groups of companies?

Generally, the £2 million cap for each relevant period is applied at group level. However, there are instances where this group-level cap does not apply. In addition, groups may be subject to additional requirements, such as submitting an allocation statement to HMRC. HMRC’s guidance provides further information on how the loss extension rules affect companies within a group.

 

Will using the extension always be the best option?

While there is a strong cash-flow incentive for loss-making companies to embrace the new provisions, they should at least consider the alternative position if they carry forward losses instead.

Larger companies in particular should be mindful of the upcoming increase to the main rate of corporation tax to 25% from April 2023, and whether losses arising now will be better used relieving the increased tax burden that lays ahead.

 

How do losses carry forward?

New rules were introduced for accounting periods beginning on or after 1 April 2017 with the aim of simplifying the use of losses arising from a trade. Where an accounting period straddles this date it is split into two notional periods for the purposes of applying the loss relief rules. It is still important to understand the old rules, as there may be losses arising before 1 April 2017.

Losses arising before 1 April 2017

Where a loss is not fully utilised in any other manner and arises in a period during which the company is within the charge to corporation tax, it will be carried forward automatically for use in later periods. The loss will then be set against the first profits arising from the same trade. The set-off is automatic and no claim needs to be made.

For losses arising before 1 April 2017 it is possible for periods on or after 1 April 2017 for the automatic application of the losses to be restricted by way of making a claim. This allows companies more flexibility in which losses to use first.

Example

In Year 1 A Ltd makes a loss in a trade of £30,000. It makes no claim for relief, and the loss is carried forward. In Year 2 the same trade shows a profit of £50,000. The loss carried forward is automatically set off against the profit, leaving £20,000 chargeable to corporation tax (50,000 -30,000).

It is necessary to identify when a trade is the same, and when it has changed so that losses brought forward can no longer be relieved. Whether or not the same trade is being carried on is a question of fact, to be decided on the circumstances of each particular case. As such, it is the tribunal that will decide, should there be a dispute.

HMRC guidance acknowledges there is a presumption that a company carries on only one trade unless:

• one activity is so different in nature from the other that it can be seen as quite separate; and
• the activities are separately organised and managed right up to board level.

Losses arising after 1 April 2017

For losses arising on or after 1 April 2017 new rules apply. These rules distinguish between qualifying and non-qualifying losses, with different rules applying to the use of each type.

What are qualifying losses?

Where losses are considered to be qualifying they can be carried forward to a later period and be used as if they arose in that later year. In order for a loss to be qualifying:

• the trade giving rise to the loss must not have become small or negligible in the period the loss arose;
• the trade must be carried out on a commercial basis with a view to profit in the period in which the loss is to be used; and
• the loss, when it arose, must have been capable of being set off against other profits in that period.

Where a loss qualifies it can then be set against the taxable total profits of later periods. In order to use a brought forward loss a claim must be made within two years of the end of the accounting period in which it is to be used.

 

And non-qualifying losses?

Where the losses do not qualify a more restricted relief is available. In this case the loss is still carried forward but can only be used against profits of the same trade. This happens automatically although it is possible for a company to claim so that the losses are not offset but carried forward. This claim must be made within two years of the end of the period in which the loss would automatically be used.

 

Restrictions on loss relief

When is relief restricted?

Relief for trading losses is potentially restricted in the following circumstances:

• the trade is not carried on in a commercial way with a view to realising profit;
• a government investment in the company’s written off;
• the loss arises from a trade carried on by a limited partnership;
• there is tax avoidance involving losses carried forward;
• there is a change in ownership of the company.

 

Does a company need to prove its losses?

Whilst it will usually be the case that accounts have been prepared and a corporation tax computation drawn up, there may be occasions when neither of these tasks has been completed. This typically happens when a company fails.

HMRC guidance states that the lack of such documents does not make it impossible to claim relief. Where it is clear that the trading losses significantly outweigh the claim for relief, the relief will not be denied. In looking at this, regard is to be had to the Statement of Affairs prepared by the company's liquidators, management accounts, or any other documentation which would assist in quantifying the position.

However, if the whole of the loss shown in unaudited or management accounts is claimed, HMRC may resist the claim.

 

What does trading commercially mean?

Losses which arise from a trade that is not carried in a commercial way with a view to realising profit cannot be relieved against other profits. In this case profit is simply defined to mean an accounting profit, and so includes deductions such as depreciation (as opposed to capital allowances).

For relief to be restricted, it is not sufficient for HMRC to show that a number of years have shown accounting losses. If the trade is carried on in such a manner as to give a reasonable expectation of making a profit, this will be sufficient to allow relief. However, the onus of proof is on the company to show that the trade was carried on in such a manner. If the way in which a trade is carried on changes during the period from a non-commercial basis to a fully commercial one, it is the situation at the end of the period which is important. Provided that the trade is run on a commercial basis at that time, there will be no restriction on the loss for the entire period.

HMRC states that this provision is not intended to catch anything other than extreme situations, in which expenditure greatly exceeds any possible income which the trade could generate over any period.

 

What about government investment write-offs?

If a government investment in a company (either by way of shares or loan) is written off, any losses available to the company are reduced by an amount equal to the amount written off. The reduction of the losses is made at the end of the last accounting period prior to the write-off.

If the amount written off is greater than the losses currently available, the excess must be carried forward and deducted from future trading losses until the whole of the write-off has been accounted for.

Example

The Government makes a loan of £500,000 to A Ltd to allow it to pursue a project. The loan was advanced in March 2017, which fell in A Ltd's year ending 31 December 2017. In the year ended 31 December 2021, A Ltd incurred losses of £100,000. The loan is written off in March 2022.

The write-off is deducted from the loss arising in the year ended 31 December 2021, thus eliminating it completely. The balance of the written-off loan (£400,000) is carried forward and will be deducted from any future losses made by A Ltd.

 

What is the restriction for limited partners?

A company may join a partnership as a limited partner. This means that:

• the company is not entitled to take part in the management of the partnership; and
• its exposure to risk is capped at the amount which it has contributed to the partnership (so if the partnership's losses extend beyond that, someone else is liable for the excess).

In this case, there is a restriction on the relief which can be claimed by the company for losses arising from the partnership trade either:

• against other profits or gains in the loss-making period or earlier periods; or
• by way of group relief.

The restriction covers all losses arising from that trade on a cumulative basis, so the total loss relieved cannot exceed the amount of the cap.

The cap is the amount of capital the company has contributed to the partnership, measured at the end of the loss-making period (or, if earlier, at the date the company leaves the partnership).

Capital contributed is defined as that which the company has provided to the partnership and:

• has not withdrawn;
• is not entitled to withdraw whilst it is a limited partner; and
• is not entitled to have someone else repay to it.

This includes any profit share to which the company is entitled, and which it has not withdrawn. If this has already been added to the company's capital account, it will not be counted twice.

Example

B Ltd is a limited partner in a partnership carrying on a trade. It made an initial contribution to the partnership of £20,000. In Year 1, B Ltd's share of the loss arising was £15,000. It used this against other profits of the same year and the previous year. In Year 2, its share of the loss was £8,000. However, it will only be able to utilise £5,000 of the loss against other profits, bringing its total losses used in that way to £20,000.

The remaining loss of £3,000 can only be carried forward against future profits. Any loss arising after that will only be available for carry forward, unless a further contribution is made to the partnership.

 

What about the tax avoidance restriction?

For accounting periods beginning on or after 18 March 2015, a restriction applies to limit the use of brought forward losses in certain circumstances. These rules only apply when four conditions are satisfied, as follows:

• there are profits arising in the current period due to tax arrangements which are designed to allow the brought forward losses to be used;
• the company (or a connected company) brings a deduction into account which would not have arisen except for the arrangements;
• the main purpose (or one of the main purposes) of the arrangements was to secure a tax deduction for the company (or a connected company); and
• when the arrangements were entered into, it was reasonable to assume that the tax value of the arrangements would be more significant than the other advantages.

Where these conditions are all met, any losses brought forward cannot be used against the profits which arise as a result of the arrangements.

Where an accounting period straddles 18 March 2015, an apportionment will be required to limit the use of brought forward losses. The restriction on the use of brought forward losses will apply to the part of the accounting period which begins on 18 March 2015, and the apportionment will be made on a time basis, unless this would give an unjust or unreasonable result.

This restriction also applies to non-trading deficits on loan relationships, and to excess management expenses brought forward.

These rules will only apply to banking companies when other, more targeted, anti-avoidance rules do not cover the situation. These more specific rules apply to losses, non-trading deficits on loan relationships, and excess management expenses which have accrued by 1 April 2015, and seek to restrict the amount of such deductions which can be used by banking companies against subsequent profits to a maximum of 50% of the profits. The rules also contain provisions to ensure that certain arrangements made at any time on or after 3 December 2014 are caught. The purpose of these rules is to ensure that an amount of tax is paid by banking companies which are profitable for an accounting period, even where there are substantial brought forward losses or other deductions.

 

Why might losses be restricted on a change of ownership?

Where a company changes ownership, the use of trading losses brought forward will be restricted where either:

• in the period from 3 years before to 5 years after the change of ownership, there has been a major change in the nature or conduct of a trade; or
• the scale of a company's activities has become small or negligible, and following a change of ownership, there is a considerable revival of the trade.

Where these provisions apply, the accounting period in which the change of ownership occurs is split into two notional periods at the date of the change. Profits and losses are apportioned between the two notional periods on a just and reasonable basis. In practice, time apportionment will apply unless another method is considered more appropriate.
Trading losses arising:

• before the change of ownership cannot be carried forward against profits after that date; and
• after the change of ownership cannot be carried back to a period before that date.

Subject to the exclusions outlined below, a change in ownership of a company occurs if either:

• a single person acquires a holding of more than half the ordinary share capital;
• two or more persons each acquire a holding of at least 5% (and jointly more than half of the ordinary share capital); or
• two or more persons each increase their holdings such that they each hold at least 5% (and jointly more than half of the ordinary share capital).

Further, from 1 April 2017, there will also be a change in ownership if a company acquires an interest in another company, so that the group condition for group relief for carried forward losses is met.

There is no change in ownership of a company where it remains a 75% subsidiary  of one company, regardless of changes to intermediate direct shareholdings. This is to allow the situation where a company is a member of a group, and its direct ownership is passed between members of the group whilst still being a subsidiary of the ultimate group holding company. Further, where a change of ownership occurs on or after 1 April 2014, it is disregarded where a new company (N) (usually a holding company) acquires all the issued share capital of another company (C), and certain other conditions are met.

The conditions to be satisfied by the acquisition must result in N:

• possessing all the voting power in C; and
• being beneficially entitled to 100% of the profits available for distribution to equity holders in C (including in the event of a winding up of C).

Broadly this means that the shares in N, after the acquisition, must be of the same class(es) and be owned in the same proportions by the same shareholders, as the shares of C were prior to the acquisition.