Question about offsetting losses due to AIA against income

DJ_Mike

I became self-employed about 2 years ago, in addition to being full time employed under PAYE. Recently I submitted my tax return which, for the first time, was for a full year of self-employment, during which I'd invested a substantial amount in equipment, so I claimed for it under the Annual Investment Allowance.

While my self-employed income, minus expenses (mileage and stationary, basically), was very much in the black, the AIA took that very much into loss territory to the sum of approx. £1600. I decided to carry this loss forward into the next tax year.

What I'm now wondering is whether I should have simply offset the loss against my employed earnings' tax? If I've carried this loss forward, do I simply offset it in full against my self-employed earnings for this tax year? Is it worthwhile submitting an amendment to my last tax return to offset the loss against my employed earnings last year instead?

Advice appreciated!

pchelpman

As you know AIA can turn profits into allowable losses.

Tax relief for losses in the early years of a new self-employment can be claimed in a variety of ways.

The three main ways you can choose from are :

• carry the loss BACK, and set it against taxed income of previous year(s), or
• “sideways” , that is, against other taxed income of the same tax year of the loss, or
• forwards to set against profits of the same trade in future years.

A loss in the first four years of a new business can be carried back and set against general income for the three preceding years, earliest first. So if your loss is in 2010-11 you can carry that back to 2007-08.

One thing to consider is what was your highest rate of tax in those earlier years?

For example, if you were liable at 40% in 2007/08 but only at 20% in 2010/11 then it makes sense to claim the losses under option 1. rather then option 2. That has the potential to double the size of the refund at a stroke.

(NOTE >>> usually refunds of tax already paid in past years will carry extra “repayment supplement “ - a form of interest - but you won’t get any of that with refunds under option 1. I mention it just in case you were wondering if the Revenue pays interest on refunds)

You might find this guidance issued by H. M. Revenue & Customs helpful ….
http://www.hmrc.gov.uk/cgt/intro/losses.htm#3


Just be careful that you make all losses within their related timeframes, watch you meet deadlines and be careful if any loss claim looks like it will lower your taxable income to below the tax free personal allowance for any year. If so more consideration may be advisable as the the best way to claim.

Good luck.

DJ_Mike

Thanks for the very detailed reply! Two further questions:

If I've already submitted my tax return for the last tax year (2010-2011), is there any harm in going back and amending it to apply the loss against my income for that year? In the return I submitted, I carried it forward to this year. Would it just be easier to apply it to this year's tax return instead?

Also: I'm still building up my self-employed business, so naturally I'm spending a lot of money on equipment. But as I'm only earning money in it 'part time' as it were (as I still have full time employment on PAYE), my income from self-employment isn't as high as it might be were it my main source of employment. The last thing I want is to appear dodgy in the tax man's eyes because my self-employment income is quite low and I'm on a significant loss. Is there anything I should pay attention to here? Is it just a matter of good record keeping?

pchelpman

DJ_Mike wrote: »

If I've already submitted my tax return for the last tax year (2010-2011), is there any harm in going back and amending it to apply the loss against my income for that year?

There is no "harm" in doing this. I don't know what software you used to file but, if you did file online, you should be able to go back into the Return, amend it for your new claim then re-file.

DJ_Mike wrote: »

In the return I submitted, I carried it forward to this year. Would it just be easier to apply it to this year's tax return instead?

Not sure "easier" is the consideration I would have. My prime motivator is - would claiming in one year yield a higher tax refund than claiming in another year?

Like I said before - check which year had the higher tax rate and claim that one.

Could be that one of the three options, back, sideways or forward, would result in more money back.

You need to judge which would be best.

DJ_Mike wrote: »

Also: I'm still building up my self-employed business, so naturally I'm spending a lot of money on equipment. But as I'm only earning money in it 'part time' as it were (as I still have full time employment on PAYE), my income from self-employment isn't as high as it might be were it my main source of employment. The last thing I want is to appear dodgy in the tax man's eyes because my self-employment income is quite low and I'm on a significant loss. Is there anything I should pay attention to here? Is it just a matter of good record keeping?

Good record keeping is an absolute necessity. Just in case the Revenue ever ask questions of you.

We often have clients who start up self employment or a limited company and make losses in the first year or two as they spend money building up the new business.

It's not unusual and I doubt the Revenue would find it odd unless you are in some "higher risk" type of business activity when they might look closer under their "risk assessment" strategy.

You go for it.

Whichever of the three options results in the largest tax refund - you claim it.

One thing I didn't highlight is that each of the three options has a different procedure to get the desired result. Depending on which you option choose you will have to follow a particular route to lodge the claim.

All the best. Do let us know how you get on.

DJ_Mike

Thanks a lot for your patience and all your answers. I'm aware that to claim losses retrospectively over several years of income requires writing to HMRC to explain the situation and then wait for the refund. For carrying forward the loss into this tax year, I presume I just enter that on my tax return for 2011-2012 as a loss I wish to claim from a previous year (namely 2010-2011)?

pchelpman

Yes, you're correct about losses forward.

Losses brought forward from a past year are claimed in box 73, page SEF4, of the Return. At least, that WAS the box on the 2010/11 Return but I don't know yet if they have changed the box on the 2011/12 form.