When any new business starts to trade as a sole trader or as a partnership and creates a tax loss, the individual involved has the ability to carry the tax loss back and offset this loss against total income for the previous three years.
Where the person claiming the relief is a higher rate taxpayer this will currently obtain relief at the 40% rate of tax to 5 April 2010 (with repayment supplement if appropriate). Alternatively, the tax loss to 5 April 2011 can be offset against total income to 5 April 2011 and there is the potential to achieve a rate of 50% tax relief on the tax loss claim.
Anticipation of Tax Loss
There is also the potential to claim to reduce the payments on account for 2011/12, i.e. the sums falling due on 31 January 2011 and 31 July 2011 in anticipation of the tax loss. This will have a distinctive cash flow advantage for the taxpayer.
For example, in an equine stud operation (e.g. the breeding of horses), it is accepted by HMRC that it can take a long time to establish bloodlines and sell stock at a profit and therefore, by concession, HMRC allow up to 11 years to make a profit. The first three trading years of, say, a stud or an organic farm can result in large tax losses which can be offset against total income.
The question that a high earner who also runs a stud has to consider is should they carry back the loss and achieve 40% tax relief or set it off against current earnings and achieve 50% tax relief?
Previously there was no such dilemma and it was normally good housekeeping or general acceptable policy to carry back the losses to the furthest point so that all tax paid subsequently was available for offset if needed.
New 50% Tax Rate
The new 50% rate of tax raises a fresh issue concerning tax loss utilisation – does the taxpayer capture 50% tax relief now (with possible payment on account advantages) or is the previous total income of earlier years used at the 40% tax rate (with possible interest) and the 50% tax relief on losses saved for a later claim?
The whole issue of opening year losses, for example stud and farming losses (especially those of an organic or bio-diverse nature) is an important area and it is key to keep a loss memorandum so that the ability to claim these losses against other income is protected.
Any tax claim for the losses must be able to show that the venture is fundamentally commercial. To be able to prove potential profitability ideally there should be a business plan. For example, there are many grants available for rural diversification and these often demand a business plan which therefore has a tax planning advantage. The tax planning dilemma between 40% and 50% utilisation is not restricted to rural businesses; it can apply to any start up situation and will involve distinct “tailor made” planning for each client. With 50% tax relief it will also be an incentive to avoid trapping tax losses in a corporate structure in the opening years.
The action plan is to look at the earnings for the past three years and to see how these can best be utilised against the current earnings. It is also essential to predict future losses to see that there will be enough income to offset if the 50% relief is taken in the current year.
By Julie Butler