Trading losses and NICs Ken Voller explains the interaction of trading losses and NICs
Trading losses This article is only concerned with trading losses for self-employed traders and professionals. I am not discussing here any other type of loss or considering the effect on people other than self-employed traders and professionals. Unfortunately, business being what it is, and aggravated by a general downturn in the economy, some businesses will make losses. The point is what can we do with those losses to lessen the pain and hopefully continue on into a brighter, more profitable, future? Because unsuccessful businesses do not generally last any particular length of time, either because of a sad demise or a turnaround in fortunes, it can sometimes be several years between having to consider the rules for losses and, for quite a number of advisors that I know, the rules were last looked at when they underwent their professional body entrance examinations! Clearly, the same can be true for HMRC staff who, in many instances, rely on the professional advisors to make appropriate entries onto Self-Assessment Tax Returns. The bit that seems to be most commonly forgotten by advisors and HMRC alike is that losses for NIC purposes are not necessarily the same as those for tax purposes. However, like most NIC matters, the basic rules are initially instigated from the tax rules. Accordingly, it is worth describing the tax rules first. Tax rules The rules for losses and Class 4 NICs have not changed since 1994 when the basic loss provisions (for Income Tax purposes) were revised (Finance Act 1994) to coincide with the change in basis of assessment of Schedule D Case I and II profits (ICTA 1988 s 18) for unincorporated businesses. Since then, we have lost contact with the scheduler system with the move to Income Tax (Trading and Other Income) Act 2005 (ITTOIA 2005) and the Income Tax Act 2007 (ITA 2007). Hence the tax loss rules are no longer found in ICTA 1988 but are now in Part 4 of ITA 2007: ITA 2007
ICTA 1988
s64
s380
Losses of a year of assessment available against income of that year or income of the proceeding year.
s72
s381
Relief for losses arising in early years of trade.
s83
s385
Carry-forward of losses not claimed under any other provision.
s86
s386
Carry-forward of losses where the trade has been incorporated.
s89
s388
Losses arising in the final year of trading.
NIC rules When we come to look at the rules for Class 4 NIC purposes the legislation is contained in Schedule 2 of the Social Security Contributions and Benefits Act (SSCBA) 1992. The NIC rules are neatly organised and paragraph 3 of the Schedule confirms the tax loss legislation that applies for NIC purposes. Interestingly, despite continuing promises of ‘harmonisation’, the original NIC legislation still refers to the ICTA 1988 rules! Although ITTOIA 2005 and ITA 2007 did insert amendments to SSCBA 1992, I feel that a complete rewrite would be useful. In many instances the tax and NIC rules will mirror each other but Schedule 2 confirms which parts of the tax legislation do not apply for NIC purposes. Perhaps it is not totally surprising how quickly the rules can produce differing calculations.
One point to be remembered is loss claims for NIC must follow those for income tax as far as possible. This means that, for example, it is not possible to make a claim for tax losses to be relieved in the year of the loss under ITA 2007 s64(2)(a) and for NIC losses to be relieved in the preceding year under s64(2)(b). Losses of a year of assessment The most straight-forward instance of losses arising would be for a sole trader, who has made profits in past years and expects to make them again in future years, realising a loss in a particular year. In this instance, the trader can offset that loss against income of the year in which the loss arises or the preceding year. Now, many such traders have no other sources of income and, therefore, opt for setting the loss back to the earlier year (s64(2)(b)) and receiving relief that way. This is normally good news for NIC purposes as the tax loss is also used against the profits for Class 4 NIC purposes for that year and a refund of NIC may arise depending on the level of profits and relievable losses. Example 1. Year to 5 April 2010 5 April 2011 5 April 2012
Profit
Loss
£ 20,000
£ (8000)
18,000
NICable profits after s64 £ 12,000 NIL 18,000
How to claim To make this claim on the 2011 Tax Return, it is a simple matter of completing the relevant box on the Self-Employment Pages with the Return. However, HMRC have confused the situation a little by allowing self-employment data to be included on a Return by one of three ways, being a ‘Full’ declaration (SA103F), a short declaration (SA103S) or a short declaration with all expenses grouped together into one entry. I tend to use the SA103F whenever losses are in point, as this enables the possible differences for tax and NIC purposes. Box 78 on page 4 of the 2011 form SA103F tells HMRC that the losses are to be carried back to an earlier year. We can see that an adjustment to the 2009/10 year needs to be made to relieve the losses both for tax and NIC purposes but it should be remembered that the loss still belongs to 2010/11. Accordingly, a letter claiming the losses will need to be submitted to HMRC who, in turn, will give the relief by way of a refund. That letter should clearly claim the losses for Class 4 NIC purposes as well and HMRC will usually repay the tax and NIC at the same time. Taking the example slightly further, if the trader has other sources of income in 2010/11, for example an employment, or income from property, he may chose to set the losses against that other income in the same year (s64(2)(a)). But where does this leave the loss for NIC purposes? The trading source has no profits for 2010/11 and the other sources of income do not carry any charge to Class 4 NIC. Therefore, the losses have not been relieved for NIC purposes. Lost losses? Despite a number of HMRC staff who may try to convince you otherwise, the loss is not lost but a claim is deferred to a future year as the only option is to carry forward the loss as if s83 ITA 2007 applies. Section 83 is the ‘catch all’ provision if relief is not available in any other way. You can see from this that we must now have two loss memoranda, one for tax and the other for NIC. If we extend example 1 to account for income from property of £25,000 in 2010/11 the position becomes:
Example 2 Year to 5 April 2010 5 April 2011 5 April 2012
Profit
Loss
£ 20,000
£ (8000)
18,000
NICable profits after s64/S83 £ 20,000 NIL 10,000
This is where it gets interesting! The tax loss claim on the 2011 Return is easy as it is simply including £8,000 at box 77 of the SA103F. However, there is nowhere on the self-employment pages to show the NIC loss to be carried forward. In these circumstances, I include a specific note in the ‘any other information’ field at box 102. That note usually includes something along the lines of ‘Losses incurred have been relieved for tax purposes under the provisions of ITA 2007 s 64 but carried forward for NIC purposes under ITA 2007 s 83 and will be relieved against future profits as they arise’. When it comes to complete the 2012 Return, an adjustment for the NIC losses brought forward is then entered into box 101 of that year’s SA103F. You can see that this type of scenario could also apply in instances where the loss of a year exceeds the profits of the preceding year so that they cannot be fully relieved, and also where claims are made for the tax loss to be relieved under s72 (losses in early years of trading). As you may now expect, loss relief available for tax purposes under s83 by carry-forward against subsequent profits is available for NIC purposes also, as is carry-back of terminal loss relief under s89. Partnerships I quickly want to mention that the tax and NIC rules covered apply equally to partners in a partnership subject to the following points:• • •
It is not permitted to have one partner in a partnership to have losses if another has taxable profits. They must all have losses, or nil profits. The rules for tax and NIC losses for trading/professional partners is the same as for sole traders/professionals. Anti–avoidance rules enacted to counter avoidance in, primarily, film partnerships can affect any partnership. These rules restrict losses incurred by partners who do not devote less than 10 hours a week to the business at any time during the tax year. Once the restricted loss relief (subject to a maximum of £25,000 per year) has been determined, this loss then becomes available for both tax and NIC purposes, and subject to the varying treatment referred to above.
Is your software up to the job? A final point to remember is that most Tax Return production software will probably not remind you to deal with the loss claim for NICs purposes, particularly if you are carrying forward losses unrelieved for NICs but which have been fully relieved for tax purposes. Be aware of the separate loss memorandum required and also be aware of the risk of an enquiry from HMRC. Ken Voller ATT(Fellow) is a tax and business adviser and can be contacted by telephone on 0845 130 6380 or by e-mail: ken@tax-business.co.uk