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What If Your Business Makes a Net Operating Loss?

Nigel Graber
Woman staring at a red downward arrow

When you're self-employed, you run the risk of your business not being profitable. But making a net operating loss needn't be the end of the world. In fact, there are certain advantages, such as tax write-offs.

What's a trading loss?

What qualifies as a net operating loss? This is when you're self-employed or a partner in a business and your expenses are higher than your income in any one accounting period.

A loss isn't any reason to throw a party, but you can use it to cut your taxable income and reduce your tax bill. Here's how:

  • Set the loss against any other income you have, including from savings. This cuts the tax bill payable on this other income.
  • Set the loss against income from the previous tax year. This will usually generate a repayment.
  • In your first four years of trading, you can set your loss against income from all three previous years.
  • Set your loss against future profits.
  • Wind up your business. If the loss occurs in your final year, set it against the previous three years' profits.

Note that from April 2013, income tax relief is capped at the greater of £50,000 or 25% of annual income.

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What about time limits on claiming losses?

There are strict time limits for making loss claims. For losses you want to use in this or the previous tax year, you've got one year beginning on the 31 January after the loss-making year. So, if your tax year 2015/16 was a loss-maker, you'd have until 31 January 2018 to make a claim.

In the case of losses carried forward to later years, you'll have to claim no more than four years after the end of the loss-making year. So, if your loss was for the tax year 2017/18, you'll need to claim by 5 April 2022.

New-business losses must be claimed no more than one year from 31 January after the loss-making year. If your loss-making year was 2016/17, you need to lodge your claim by 31 January 2019.

For businesses in start-up mode, you can claim up to four years from the end of the tax year when your business finishes. If your final year is 2017/18, you'll need to claim by 5 April 2022.

What about tax credits?

There's some good news elsewhere, too. Thousands of loss-making companies can get tax credits and cashback for their research-and-development projects. This could be a lifeline for a loss-making business.

If your business R&D project shows that you're seeking 'a scientific or technological advance', you could offset losses against project expenditure. For example, loss-making SMEs can surrender R&D-losses activity for cash - to the tune of £33.35 for every £100 of R&D spent.

HMRC scrutiny of net operating losses

But eligibility for tax relief on trading is coming under greater scrutiny from HMRC, which is keen to clamp down on businesses claiming a net operating loss just to get tax write-offs. HMRC now wants to see evidence of growing businesses turning a profit in their first five years and to illustrate plans showing a projected profit.

Under the Income Tax Act 2007, businesses must trade with the intention of making a profit. If a business posts losses, HMRC will presume that the business isn't operating on a commercial basis or to make a profit.

To get around this scrutiny, it's vital to have a well-researched business plan from the start. Then, if HMRC reviews your case, you'll have evidence that you planned to make a profit. Review and edit your business plan regularly in line with actual performance.

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