Case Study 4 - Start Up Tax Losses

Following redundancy from a high paid job, the client set up a new business as a sole trader, invested in equipment and had not yet made many sales. He therefore had incurred tax losses of £20,000 in the first year and £10,000 in the second year. He expected to make a profit in the third year.

How have we helped?

Firstly, we checked that the maximum capital allowances were claimed. We then reviewed the tax losses rules which allow a new business in its first four years of trade to carry the losses back for three years and receive a tax repayment. As the client had paid 40% income tax in previous years he could potentially receive a tax refund for 40% of £30,000 (£20,000 + £10,000) = £12,000. However, these rules require the earliest year to be used first and they are an all or nothing rule. For the earliest year the client had not paid 40% on that much income. We therefore revisited the basic trading loss offset rules which allow all sole traders to offset losses against the prior year's income which could be used for the first year losses.

The conclusion was to use one loss offset rule to reduce the last year of employment income by £20,000 and another loss offset rule to reduce an earlier year's employment income by £10,000.

This ensured the tax refund received was the full £12,000.

In addition, as the total £30,000 loss had not yet reduced any profits for Class 4 national insurance purposes, this loss should be noted on the tax return and used in a later period to reduce the Class 4 national insurance of 9% payable against the later profits.

This additional use for the losses could potentially save another £2,700 (£30,000 @ 9%).

In total nearly £15,000 of tax can be saved which funds half of the investment made in setting up the business or better still could be reinvested in the business to help it grow further.