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 the maximum capital allowances were claimed.

Secondly, we reviewed the tax losses rules allowing a new business in its first four years of trade to carry 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 revisited the basic trading loss offset rules which allow all sole traders to offset losses against the prior year's income.

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.

Above and beyond?

In addition, 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 Class 4 national insurance of 9% against later profits potentially saving a further £2,700 (£30,000 @ 9%).

Conclusion

In total, nearly £15,000 of tax has been saved, funding half the initial set up costs.