What you need to know when claiming tax relief for self-employed losses in 2020/21

If you make a loss from self-employment, you will usually be entitled to tax relief for it which often results in a tax refund. There are several different ways that tax relief can be given, and this will sometimes depend on whether you prepare your accounts on a cash basis or accruals basis. We have guidance on the different options available, with detailed examples, in our main website guidance.

This article considers areas where losses affect other parts of the tax return. We will look at

1. Losses and SEISS grants
2. Capital allowances and losses
3. Class 4 National Insurance and losses
4. Losses and tax credits/universal credit

Losses and SEISS grants

SEISS grants are taxable. We explain in our coronavirus guidance section which SEISS grants you must include on your 2020/21 Self Assessment tax return, and where you must enter the relevant figures in the self -employment section of the tax return. The profit or loss from your self-employment and the total of the first, second and third SEISS grants must both be entered separately on the 2020/21 tax return. But they are then combined together to give a figure for total taxable profits from self-employment. This means that where you have a loss, adding it to the grants may mean the loss is lower than you expected or it could even turn the loss into a profit. This can be seen in the example Marco below.

Marco the baker

Marco is a self-employed baker in Southend-on-Sea and has been supplying his local café with cakes and pastries on a daily basis for the past 5 years. Marco makes up his accounts to 31 December each year.

During the year ended 31 December 2020 the café was closed for several months due to the lockdown restrictions so Marco’s sales income reduced dramatically. The only government support he claimed during the pandemic were grants under the Self-Employment Income Support Scheme and he received the following payments:

• First grant: £4,800 received 25 June 2020
• Second grant: £4,200 received 30 September 2020
• Third grant: £4,800 received 12 January 2021

Marco’s self-employed accounts for the year ended 31 December 2020 showed a loss of £3,310. He has no other income.

Marco’s 2020/21 tax return will show the following entries in the self-employed section:

As Marco has no other income, his taxable profits above of £10,490 are less than his tax-free personal allowance of £12,500 so there is no income tax due (although there will be Class 4 National Insurance to pay).

If Marco had not claimed any SEISS grants, he may have been able to get tax relief for the self-employment loss of £3,310 in a different way, for example by allocating it back to a previous year. But this is not allowed when there are SEISS grants, even if this means there would be a bigger tax saving. The SEISS grants must be taken into account first to see if there is an overall taxable profit or loss from self-employment. As Marco’s total taxable profits from self-employment show a profit he has no loss which can be used to generate any tax relief.

Marco’s Class 4 National Insurance contributions (NICs) are calculated based on the profits figure of £10,490 above. This means the loss of £3,310 is also reducing the amount of profits on which Class 4 NIC would otherwise be payable.

Capital allowances and losses

If you have bought some equipment or machinery for your self-employment and you prepare your accounts on an accruals basis you are likely to be entitled to capital allowances known as the annual investment allowance (AIA). You can find out about capital allowances generally and also annual investment allowance on our website. In some circumstances it might be beneficial for you not to claim capital allowances in 2020/21 but to claim them in a later year. We explain why this might be the case by looking at the example of Jane below.

Jane the football coach

Jane is a self-employed football coach. Her income is usually around £20,000 per year, and her annual taxable profit is usually in the region of £12,000-£15,000. In the year to 31 March 2021 her income was only £4,000, due to the pandemic restrictions. Her allowable business expenses in the year to 31 March 2021 were £6,485, and she spent £1,500 on new equipment.

Jane’s loss from her self-employment, after claiming the annual investment allowance (AIA) in respect of the equipment is £3,985:

Table 1

Jane is also employed part time as a PE teacher, and in 2020/21 her salary was £14,800 (tax paid of £460). Jane was unable to claim any SEISS grants because of her part-time employment.

Jane claims to offset the loss from her self-employment against her other income (from teaching) for the 2020/21 tax year. Her tax calculation for 2020/21 is as follows:

Table 2

As the taxable income is below the tax free personal allowance of £12,500, Jane does not owe any tax for 2020/21 so the tax deducted from Jane’s PAYE income of £460 will be repaid to her.

However, if Jane does not claim AIA for her new equipment costs (and claims writing down capital allowances in respect of the expenditure in the 2021/22 tax year instead), her loss for 2020/21 becomes £2,485, as shown in table 1 above.

If she offsets this against her PAYE income in a similar way to table 2, the 2020/21 calculation becomes:

Table 3

The taxable income is still below the amount of the tax free personal allowance of £12,500, so the tax deducted from Jane’s PAYE income of £460 will still be repaid. However, in this scenario Jane makes better use of her personal allowance as she uses £1,500 more of the allowance and can also claim capital allowances in future tax years in respect of the new equipment costs of £1,500.

Class 4 National Insurance and losses

Due to the way that the rules work when claiming for a loss, sometimes you will get a reduction in your income tax and Class 4 NIC (as for Marco above) but other times you will only get a reduction in your income tax. We look at this in the example Hameed below.

Hameed the window cleaner

Hameed, who lives in England, was employed until March 2019, when he decided to set up his own window cleaning business. Hameed’s only income since March 2019 has been from his self-employment as a window cleaner. In the 2019/20 tax year he made a profit of £10,000 but his accounts for the year to 31 March 2021 show a loss of £4,000. He was unable to claim the first three self-employment income support scheme (SEISS) grants as he only started his business in 2019/20.

He has prepared his accounts on an accruals basis and he decides to make a claim to carry back the loss of £4,000 to the 2017/18 tax year under the ‘opening year losses’ rules and offset it against his employment income in that year of £20,000. This will generate a tax refund to claim on his 2020/21 tax return of £800 (£4,000 x 20%).

However, this claim does not save Hameed any Class 4 NIC as this is not charged on employment income. Therefore, Hameed has not had the full relief he is entitled to for the loss of £4,000.

In these circumstances, Hameed is allowed to reduce his profits on which he will pay Class 4 NIC in the next tax year by the amount of £4,000. He is predicting that his profits for the year ended 31 March 2022 will be in the region of £14,000. Therefore, Hameed will only pay Class 4 NIC on profits of £10,000 (£14,000- £4,000) for the 2021/22 tax year.

Although Hameed will not need to pay Class 2 National Insurance contributions for 2020/21 as the loss means he is below the small profits threshold, he may decide to pay the contributions voluntarily to maintain his National Insurance contributions record and so protect his entitlement to state benefits such as state pension. He can elect to do this on his 2020/21 tax return.

⚠️ NOTE: If Hameed lived in Scotland, then the figures may be different due to the Scottish income tax bands.

Losses and tax credits/universal credit

There are different rules for dealing with trading losses for both tax credits and universal credit purposes. There is more information on the in our main guidance section.