When claiming relief for business losses income tax is not the only consideration. The effect of losses on NI contributions is easily and often overlooked. What steps should you take to ensure you maximise the relief?
Trading loss relief
If you’re a sole trader or a member of a partnership which makes a loss, the tax system allows you to use it to reduce your tax bill for the current, past or future years. It can be quite tricky to decide which produces the greatest tax saving and in practice there’s sometimes no clear answer.
Example. Annie was an employee earning £20,000 per year before she became a sole trader on 1 April 2022. She has no other income. Her accounts for the year to 31 March 2023 show a loss of £10,000, largely because she bought a vehicle and other equipment. She expects to make a profit of around £50,000 for the year to 31 March 2024. She can claim relief for the loss against the tax she paid on her salary in an earlier year or against the tax on later years’ profits.
If she claims relief for an earlier year some will be wasted as it will be knocked off income (salary) on which she paid no tax: in 2021/22 her salary was £20,000 but only £7,430 was taxed as the remainder was covered by her personal tax-free allowance (£12,570 for 2021/22). Loss relief will only save tax on the £7,430, but the rules say she must either claim relief for all the losses (£10,000) or none.
Therefore, £2,570 (£10,000 – £7,430) of the losses don’t result in any tax saving. She could claim the relief against later years’ profits and not waste any but she’s happy to forego the relatively small extra saving as she needs the tax refund now.
National Insurance
While Annie used her £10,000 of loss relief to reduce the tax on her salary, the rules prevented her from using it to reduce the Class 1 NI she paid on it. Instead, £10,000 Class 4 loss relief is carried forward for use in later years.
Trap. Class 4 NI loss relief is easily overlooked. Where losses are set against tax on income to which Class 4 NI (NI on trading profits) doesn’t apply, e.g. salary and savings income, the relief is unused and can be carried forward to reduce Class 4 NI bills for later years.
Tip. Keep a record of how business losses are used, not just for tax but for NI too. Record tax and NI relief separately to ensure neither is overlooked.
What are NI losses worth?
It would be easy for Annie not to consider the effects of loss relief on NI. It’s often overlooked as being a minor issue. In reality, it’s far from that. Class 4 NI is payable at 9% of profits between the lower and upper profits limits; £12,570 and £50,270 respectively. Ignoring Class 4 NI loss relief would cost Annie £900 (£10,000 x 9%).
Trap. Class 4 NI loss relief is not always a factor when deciding the best option for claiming loss relief. It must be applied to the first available profits whether or not Class 4 NI is payable on them.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.