Loss relief: is your business being carried out on a commercial basis?

The recent case of Judith Thorne v HMRC has again raised the issue of whether a business is trading commercially and the impact this can have on the availability of income tax loss relief. Relief for trading losses is only available where a trade is carried on during the accounting period on a commercial basis with a view to the realisation of profits. If it is established that there is a reasonable expectation of profit at some point, the trade is considered to be carried on with a view to the realisation of profits.

For a number of years Mrs Thorne ran an equestrian breeding business and from 2007/08 began to farm asparagus too. In 2008/09 Mrs Thorne submitted a claim for the combined losses of both businesses to be offset against her other income received in the tax year.

HMRC argued that because the equestrian business and the asparagus business were not legally separate they were to be treated as one trade. The equestrian business had generated losses in the first five years and HMRC found that it had no realistic possibility of generating a profit in future. On that basis, HMRC concluded the trade was not being carried out on a commercial basis and the loss relief claim was refused.

Mrs Thorne appealed against HMRC’s decision, arguing that the losses from the asparagus farming related to start-up costs, the crops would be profitable in future years and the two businesses should be treated separately.

The First Tier Tribunal found that although the asparagus farming was carried out on a commercial basis, the equestrian breeding was not and agreed with HMRC that the two businesses were to be combined as one trade. The Tribunal also agreed with HMRC that, overall, the trade was not carried out on a commercial basis because it included the uncommercial equestrian element. The loss relief claim was disallowed.

This case highlights the need for businesses to consider whether they are trading on a commercial basis. Businesses undertaking different activities should ensure that all the activities are considered to be carried out on a commercial basis to enable any losses within the business as a whole to be used efficiently.

Traders should also consider whether a loss-making business is being carried on for reasons other than to make a profit, for example, as their hobby or for their personal enjoyment.

It may also be the case that a business consistently makes losses, and this can also lead to loss relief claims being refused by HMRC. In Kitching v HMRC, an accountant ran a sport goods retail business which made consistent losses. Mr Kitching sought to offset the losses generated in the retail business against his employment income. The Tribunal concluded that the way in which the retail business was operated meant that it would never make a profit without significant changes to the way in which it was run and until that happened the trade could not be considered to be carried out on a commercial basis. Relief for the trading losses was again refused.

The importance of a good business plan, demonstrating how the business intends to become profitable, over what timescale, cannot be overstated. We can assist in preparing a business plan for your business which should be reviewed and updated regularly. Cashflow forecasts and projections are also good evidence should HMRC challenge the viability of your business in loss making periods.

If you would like any further information please contact your local tax advisor.

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