Where a business is carried on as a sole trader or partnership, trading losses can be relieved against income, capital gains, or future profits. Once the business is operated through a limited company, trading losses are ring-fenced inside the company and are not the individual’s losses.
If an individual funds a limited company that ultimately fails, any personal tax relief is never trading loss relief. At best, the individual may obtain a capital loss (for example on shares or an irrecoverable loan), or capital loss relief against income in limited statutory cases (e.g. qualifying share loss relief).
The challenge is that there is more than one way to use a loss, and the most effective option depends on your wider tax position. This article explains, in practical terms, the three main ways trading losses can be used, and when each is likely to be appropriate.
Three ways to use a trading loss
At a high level, a trading loss can be relieved:
- Against income (s.64 ITA 2007)
- Against capital gains in the same year (s.71 ITA 2007 via TCGA 1992 s.261B)
- Against future profits of the same trade (s.83 ITA 2007)
Each option gives a different outcome in terms of timing, tax rates and cash flow.
1. Using a trading loss against income (s.64 ITA 2007)
This is often the most familiar form of loss relief.
A trading loss can be set against your total income, including:
- Employment income
- Rental (property) income
- Savings and dividends
- Pension income
Relief can be claimed in:
- The same tax year, and/or
- The previous tax year
Why this is attractive
Income is often taxed at higher rates than capital gains. If you are a higher or additional-rate taxpayer, using a loss against income can produce immediate and substantial tax savings, sometimes resulting in a repayment.
Points to be aware of
- Losses are set against income in a fixed order (non-savings first, then savings, then dividends)
- The trade must be run on a commercial basis
- Large claims may be restricted by the loss relief cap
In short: this route is usually best where you have significant income and want fast cash-flow relief.
2. Using a trading loss against capital gains (s.71 ITA 2007)
Less well known, but often very effective, is the ability to use a trading loss to reduce capital gains in the same tax year.
Where a valid claim is made, the trading loss is deducted from capital gains before capital gains tax (CGT) is calculated.
When this can be useful
This option can be particularly effective where:
- You have made a large disposal in the same year as the trading loss
- Your income is low, or already covered by allowances
- You want to reduce exposure to higher CGT rates
It can also prevent your annual CGT exemption from being wasted.
A simple example
If you make a £30,000 trading loss in the same year as a £40,000 capital gain, the loss can reduce the taxable gain to £10,000.
In short: this relief is valuable where gains exist and income-based relief would be inefficient.
3. Carrying the loss forward (s.83 ITA 2007)
If no claim is made to use a trading loss against income or gains, it is automatically carried forward.
The loss can then be set against future profits of the same trade, with:
- No time limit
- No monetary cap
Why carry forward?
Sometimes immediate relief is not optimal. If you expect future profits to fall into higher tax bands, it may be better to preserve the loss and use it later.
This approach is common where:
- Current income or gains are low
- The business is expected to become significantly more profitable
- Cash-flow relief is not essential in the short term
In short: carry-forward relief prioritises long-term efficiency over immediate savings.
Choosing the most effective option
There is no “default” answer. The most effective use of a trading loss depends on:
- The level and type of income and gains in the year of loss
- Current and future tax rates
- Whether cash-flow is a priority
- The scale of the loss and any applicable caps
In many cases, the optimal approach only becomes clear once multiple scenarios are modelled.
Why advice matters
Trading losses are valuable tax assets.
Used well, they can:
- Generate tax repayments
- Eliminate capital gains tax
- Reduce future tax bills
Used poorly, they can be delayed, restricted, or wasted altogether.
The interaction between income tax, capital gains tax and loss relief rules is complex — and small decisions can have large consequences.
