Tax Doctor:
Mark McLaughlin
ATII ATT TEP

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May 2004

Q:

I am a 40% taxpayer in my ‘full time' job and have also set up a small PC repair business. I have registered for Class 2 National Insurance contributions and have registered as self- employed with the tax office.

My self-employed business is going to lose money this year. Can I claim this as a loss on my tax return and offset it against the tax I have paid in my full time job?

A:

On the face of it, it should be possible to claim tax relief for your trading losses. The types of potential loss relief in the circumstances are as follows:

• Loss relief is given against income from other sources (i.e. including employment income) of the year in which the loss is incurred, and/or the immediately preceding year.
  
  
• Your query does not indicate how long you have been operating the PC repair business. This is relevant because there is an alternative form of loss relief, which applies in the early years of a trade. The relief is available for losses incurred in the tax year in which the trade commenced, or in any of the next three tax years. The loss can be carried back against total income of the three years preceding the year of loss, taking income of the earliest year first.

A claim for loss relief must be made within 12 months of 31 January after the tax year in which the loss is incurred (i.e. 22 months following the end of the tax year), or possibly longer if the Inland Revenue allow. For example, a loss for 2003/04 must be claimed by 31 January 2006.

There is a potential restriction in loss relief, which can prevent losses from non-commercial (or ‘hobby') businesses being claimed against total income. The loss relief mentioned in the first bullet point is not available unless the taxpayer can show that the trade was conducted on a commercial basis and with a view to realising profits for the year in which the loss was incurred. This rule is aimed at distinguishing between individuals claiming loss relief on hobbies or activities giving them personal enjoyment, and those who are seriously intent on operating profitable businesses.

With regard to loss relief in the early years of a trade (see the second bullet point above), there is a separate but similar potential loss relief restriction. For the loss-making period in question, it is necessary to show that the trade was conducted on a commercial basis and in such a way that a profit could be expected during the period, or within a reasonable time after the end of that period. What is a ‘reasonable' timescale will depend on the nature of the trade and the particular circumstances. The Inland Revenue's own guidance indicates that ‘in general, it would be a fairly short period of say a year or so', but in practice loss relief can often be claimed for a number of years.

Self-employed individuals are liable to pay both Class 2 and Class 4 National Insurance contributions. You mention being registered to pay Class 2 contributions in respect of your self-employment (payable at a weekly rate of £2.05 for 2004/05). It is possible to claim exception from liability to pay Class 2 contributions, if earnings (or net profits) from self-employment are less than the ‘small earnings exception' limit (£4,215 for 2004/05). A claim should be considered if your business is expected to make a loss. Further information on making a small earnings exception claim is contained in Inland Revenue leaflet CA02 ‘National Insurance contributions for self-employed people with small earnings', which is available for downloading from the Inland Revenue website (http://www.inlandrevenue.gov.uk/leaflets/ca02.pdf). This leaflet contains an application for exception for liability for Class 2 contributions (form CF10). It may also be possible to claim a refund of Class 2 contributions already paid, and leaflet CA02 explains the procedure and time limits for doing so. However, you should bear in mind that Class 2 contributions give entitlement to a range of contributory benefits. You may wish to consider whether it would be worthwhile paying Class 2 NICs in order to maintain your contributions record for this reason.

Mark McLaughlin

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