Income tax - Main reliefs and exemptions

Learning Outcomes

This article outlines core income tax reliefs and exemptions for individuals and unincorporated businesses, including:

• Principal trading loss reliefs available to individuals and partners (start-up/early trade loss relief, relief against general income including carry-back, carry-forward relief, and terminal loss relief).
• Optimisation of relief claims across tax years (set-off order, interaction with personal allowance, and relief against capital gains where permitted).
• Annual Investment Allowance (AIA): qualifying expenditure and exclusions, and its effect on trading losses (creation or increase).
• Statutory time limits and claim mechanics for each relief (including claims within Self Assessment for sole traders and partnerships).
• Restrictions on sideways loss relief (commerciality test and the cap on income tax reliefs) and their impact on claim strategy.
• Coordination of reliefs in realistic scenarios (including partnerships and multi-trade situations) and the trade-off between immediate cashflow benefits and long-term efficiency.

SQE1 Syllabus

For SQE1, you are required to understand the principal reliefs and allowances relevant to trading losses and capital expenditure for individuals and partnerships, with a focus on the following syllabus points:

• The reliefs available for trading losses, including start-up loss relief, carry-back, and carry-forward relief
• Terminal loss relief when a trade permanently ceases
• Set-off against general income (sideways relief) and, where conditions are met, against capital gains
• The Annual Investment Allowance (AIA) and its application to capital expenditure
• The process for claiming reliefs and the statutory requirements for each (including time limits)
• Restrictions on loss relief: trades not carried on commercially and the cap on income tax reliefs
• The interaction between reliefs and the practical considerations for choosing between them, including in partnerships

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What are the main ways a sole trader can obtain relief for trading losses?
2. How does the Annual Investment Allowance affect the calculation of taxable profits?
3. When can trading losses be set against prior year income, and what are the time limits?
4. What is the difference between carry-back and carry-forward relief for trading losses?

Introduction

Income tax reliefs and exemptions are essential for reducing tax liabilities and supporting business growth. For SQE1, you must be able to identify the main reliefs available to individuals and unincorporated businesses, understand the statutory requirements for each, and apply them to practical scenarios. This article covers the principal trading loss reliefs and the Annual Investment Allowance, with worked examples and key definitions.

Trading loss reliefs can provide an immediate repayment of tax (improving cash flow) or preserve relief for future profits. The choice involves weighing rates and allowances across years, claim restrictions, and time limits. The Annual Investment Allowance can accelerate relief for capital expenditure, often transforming a small profit into a loss that can then be relieved strategically.

Key Term: trading loss
A negative amount arising when allowable business expenses and capital allowances exceed trading income in a tax year.

Trading Loss Reliefs

Trading losses can arise when allowable business expenses and capital allowances exceed trading income in a tax year. The law provides several reliefs to mitigate the impact of these losses.

Start-Up Loss Relief (Early Trade Loss Relief)

A new sole trader or partner can claim to set off trading losses incurred in any of the first four tax years of trade against their total income for the current and/or previous three tax years. This is known as start-up loss relief or early trade loss relief.

Key Term: start-up loss relief
A relief allowing trading losses in the first four tax years to be set against total income of the current and previous three tax years, with carry-back using later years first.

Conditions for Start-Up Loss Relief

• The loss must arise in one of the first four tax years of the trade.
• The loss can be set against total income of the current tax year and then carried back to earlier years, using later years first (e.g. 2022/23 loss to 2021/22 before 2020/21).
• Claim is generally made in the Self Assessment return; the claim time limit is normally by 31 January, two years after the end of the tax year of the loss.
• Subject to the general cap on income tax reliefs and the commerciality requirement (see restrictions below).

Worked Example 1.1

Aisha starts a bakery business in 2022/23 and makes a trading loss of £15,000. She had employment income of £30,000 in 2021/22, £28,000 in 2020/21, and £25,000 in 2019/20. How can she relieve her loss?

Answer:
Aisha can set the £15,000 loss against her 2022/23 income first. If not fully relieved, she can carry back the balance to 2021/22, then 2020/21, then 2019/20, using later years first.

Carry-Back Relief (Trade Loss Relief Against General Income)

Trading losses can be set against total income of the current tax year and/or the previous tax year. This is known as carry-back relief or trade loss relief against general income, often referred to as “sideways relief.”

Key Term: carry-back relief
A relief allowing trading losses to be set against total income of the current and/or previous tax year.

Key Term: sideways relief
A claim to set trading losses against the claimant’s general income (and, if that income is fully covered, potentially against capital gains—see below) of the same year and/or the previous year.

Conditions for Carry-Back Relief

• The loss must arise from a trade carried on in the relevant tax year.
• The loss may be set against total income of the same year and/or the previous year; claims can be for all or part of the loss.
• If income is fully covered, any remaining loss may be claimed (by election) against capital gains of that year and/or the previous year, after exhausting income in those years (see relief against capital gains below).
• Claim time limit is normally by 31 January two years after the end of the tax year of the loss.

Carry-Forward Relief

If trading losses cannot be fully relieved using the above methods, they can be carried forward indefinitely and set against future profits of the same trade.

Key Term: carry-forward relief
A relief allowing unrelieved trading losses to be set against future profits of the same trade.

Conditions for Carry-Forward Relief

• The loss must be carried forward to be set only against profits of the same trade.
• The trade must continue.
• Relief is given against the first available profits; it is generally automatic (claimed through the return).

Worked Example 1.2

Ben runs a consulting business. In 2021/22, he makes a trading loss of £10,000. He has no other income that year. In 2022/23, he makes a trading profit of £20,000. What can he do?

Answer:
Ben can carry forward the £10,000 loss and set it against his 2022/23 trading profit, reducing his taxable profit to £10,000.

Terminal Loss Relief (Cessation)

When an unincorporated trade permanently ceases, a “terminal loss” incurred in the final 12 months can be carried back and set solely against profits of the same trade. This relief may produce repayments from earlier years.

Key Term: terminal loss relief
A relief allowing the loss of the final 12 months of trading to be set against profits of the same trade in the final tax year and then carried back against profits of the same trade in the three preceding tax years, using later years first.

Key points:

• Terminal loss = loss of last 12 months before cessation (computed on the usual tax year basis).
• Set-off order: final tax year first, then carry back up to three earlier years, later years first.
• Claim time limit: normally within four years after the end of the tax year to which the claim relates.

Worked Example 1.3

Priya ceases trading on 31 December 2023. Her final 12-month loss is £24,000. Trade profits were: 2023/24 (to cessation) £5,000; 2022/23 £12,000; 2021/22 £9,000; 2020/21 £8,000. How is terminal loss relief applied?

Answer:
The £24,000 terminal loss is set (1) against 2023/24 trade profit £5,000, leaving £19,000; then (2) carried back to 2022/23 profit £12,000 (balance £7,000); then (3) to 2021/22 profit £9,000 (only £7,000 needed; £0 remains). Tax for those years is recalculated and repaid accordingly.

Relief Against Capital Gains (after Income is Exhausted)

If a loss is claimed against general income (same or previous year) and that income is insufficient, the unrelieved amount can, by separate claim, be set against capital gains of the same year and/or the previous year. This is available only after income of those years has been fully covered by the loss claim.

Key points:

• Only the unrelieved portion (after set-off against income for the relevant year(s)) can be used against capital gains of the same and/or previous year.
• This is an election and must follow the statutory ordering (income first, then gains).

Worked Example 1.4

Omar has a 2022/23 trading loss of £40,000 and total income in 2022/23 of £10,000. He also realised chargeable gains of £18,000 (no other gains; annual exemption available). In 2021/22 he had income of £8,000 and gains of £5,000. How might relief work?

Answer:
Omar can claim sideways relief in 2022/23 against income £10,000 (leaving £30,000). He can carry back to 2021/22 income of £8,000 (leaving £22,000). He may then elect to use the remaining £22,000 against capital gains: first 2022/23 gains (£18,000) and (if any balance remains) 2021/22 gains (£5,000). The annual exempt amount should be considered in optimising the claim, as using losses against gains wastes the annual exemption for that year.

Restrictions and Strategic Considerations

Two key statutory restrictions often affect sideways relief (including early trade and carry-back claims):

• The trade must be carried on a commercial basis and with a view to the realisation of profits. If not, sideways relief may be restricted. Certain specific rules (e.g. farming losses over consecutive years) can further restrict sideways relief.
• A cap applies to certain income tax reliefs, limiting sideways loss relief to the greater of £50,000 or 25% of adjusted total income for the year to which the claim relates.

Key Term: not commercial with a view to profit
A restriction that denies sideways loss relief if the trade is not carried on a commercial basis and with a view to the realisation of profits.

Key Term: cap on income tax reliefs
A limit that restricts certain reliefs (including sideways loss relief) to the greater of £50,000 or 25% of the claimant’s adjusted total income for the relevant tax year.

Other practical factors:

• Partial claims are permitted; claims can be tailored to preserve allowances or avoid wasting the annual exemption for capital gains.
• Sideways relief reduces net income and can restore personal allowance where income exceeds £100,000.
• Carry-forward relief is against the same trade’s future profits and is typically automatic, but offers no immediate cash benefit.

Worked Example 1.5

Sophie, a sole trader, makes a £120,000 loss in 2022/23. Her only other income that year is £40,000 employment income. She is fully commercial. How might the cap affect a sideways relief claim for 2022/23?

Answer:
Sideways relief is capped at the greater of £50,000 or 25% of adjusted total income. Adjusted total income (before relief) is £40,000; 25% is £10,000. The cap is therefore £50,000. Sophie can set only £50,000 of her loss sideways in 2022/23. The balance can be carried back (subject to claim and time limits), carried forward against future profits of the same trade, or considered for set-off against capital gains where conditions allow.

Partnerships

For partnerships, the trading loss is computed at the firm level, then allocated to partners in accordance with profit-sharing ratios. Each partner claims relief individually. The same suite of reliefs (early trade, sideways relief, carry-forward, terminal) and restrictions (commerciality and cap) apply to partners for their share of the loss. Special rules may restrict sideways relief for certain limited or non-active partners; otherwise, the general framework above applies.

Claim Mechanics and Time Limits (overview)

• Sideways relief (current and/or previous year) and early trade relief: claim by 31 January two years after the end of the tax year of the loss (via Self Assessment).
• Terminal loss relief: normally within four years after the end of the tax year to which the claim relates.
• Carry-forward relief: generally automatic via the return; ensure losses are tracked and set against first available profits of the same trade.
• Relief against capital gains: by election and only after income of the relevant year(s) is fully covered.

Exam Warning

For SQE1, be careful to distinguish between carry-back and carry-forward relief. Carry-back relief can reduce tax paid in the previous year, but only within strict time limits. Carry-forward relief is only against future profits of the same trade. Also consider the commerciality test and the cap on income tax reliefs when evaluating sideways relief.

Annual Investment Allowance (AIA)

The Annual Investment Allowance provides immediate relief for qualifying capital expenditure on plant and machinery, up to a specified annual limit.

Key Term: Annual Investment Allowance (AIA)
A capital allowance allowing 100% deduction for qualifying expenditure on plant and machinery, up to an annual limit.

Conditions

• The AIA limit is currently £1 million per year (as a permanent limit set in legislation).
• Most plant and machinery (except cars) qualifies. Certain features and fixtures in business premises typically qualify; expenditure on land and buildings does not.
• AIA is generally available to individuals, partnerships (without corporate members), and companies; if an individual controls multiple businesses, AIA may need to be shared.
• The allowance is claimed in the year of purchase (date the obligation to pay arises and the asset is brought into use). The AIA limit is time-apportioned for accounting periods shorter or longer than 12 months.
• Any excess expenditure above the limit is eligible for writing down allowance at the standard rate.
• Private use: where an asset is used partly for private purposes by a sole trader or partner, capital allowances (including AIA) are restricted to the business-use proportion.

Worked Example 1.6

Clara buys new equipment for her business in 2022/23 costing £120,000. What is her AIA claim?

Answer:
Clara can claim the full £120,000 as AIA, reducing her taxable profits for 2022/23 by that amount.

AIA: Practical Points

• AIA is optional: it can be disclaimed in whole or in part to smooth taxable profits or avoid wasting personal allowances.
• For partnerships and individuals with more than one qualifying business under common control, the AIA may be shared; careful allocation maximises overall relief.
• Cars do not qualify for AIA; instead, use writing down allowances (with possible first-year allowances for certain low-emission cars subject to current rules).
• AIA can create or increase a trading loss, enabling more extensive loss relief claims (e.g. sideways relief or carry-back).

Worked Example 1.7

Noah’s sole trade expects a small 2023/24 profit of £5,000 before capital allowances. He is considering claiming £30,000 AIA on equipment purchased in March 2024. He has £35,000 employment income in 2023/24. What are the considerations?

Answer:
Claiming AIA would create a £25,000 trading loss (£5,000 − £30,000), enabling sideways relief against Noah’s employment income (subject to the cap and commerciality). Alternatively, he could disclaim some or all AIA to prevent wasting personal allowance or to defer relief to a year with higher marginal rates. The optimal approach depends on his broader profile (e.g. expected profits, rate bands, and whether a carry-back claim is advantageous).

Interaction of Reliefs and Practical Considerations

The choice of relief depends on the taxpayer’s circumstances. Early trade loss relief and carry-back relief can generate immediate tax repayments, which may be important for cash flow. Carry-forward relief is useful if there is no other income to relieve in the current or previous years. The AIA can increase a trading loss, making more relief available.

When integrating reliefs:

• Sideways relief reduces net income, which can restore personal allowance for those with income just above £100,000.
• Consider the personal savings allowance and dividend allowance; preserving some taxable income in lower bands may be beneficial depending on the profile.
• Weigh using losses against capital gains against losing the annual exemption; often it is preferable to preserve the exemption and use losses against income instead.
• For terminal loss relief, follow the mandated set-off sequence (final year then the prior three years, later years first); for early trade relief, use later years first when carrying back.
• For partnerships, each partner optimises their own claim, potentially making different choices based on their wider income.

Worked Example 1.8

Derek starts a business in 2022/23, incurring a trading loss of £30,000 after claiming AIA on equipment. He had employment income of £25,000 in 2021/22. What is the best use of his loss?

Answer:
Derek can claim early trade loss relief, setting the £30,000 loss against his 2021/22 income, generating a tax repayment. He should check the cap on reliefs and consider whether any 2022/23 income should first be covered to utilise personal allowances optimally.

Process and Claims (practical steps)

• Sole trader: claim via the Self Assessment (SA100 with SA103) for the loss year; specify sideways relief (current/prior year), early trade, terminal loss, and (if relevant) capital gains set-off in the additional information boxes/white space.
• Partnerships: the firm files SA800; each partner claims relief for their share through their SA100 based on the partnership statement.
• Keep detailed records of capital allowances, AIA allocations, and unrelieved losses carried forward; ensure consistency year to year.
• Monitor deadlines: generally, 31 January two years after the end of the loss tax year for sideways/early trade claims; four years for terminal relief claims.

Revision Tip

Always check the time limits for making claims and the order in which losses must be set against income. Be able to explain the practical steps for each relief and the impact of the cap on income tax reliefs.

Key Point Checklist

This article has covered the following key knowledge points:

• The main income tax reliefs for trading losses: start-up loss relief, carry-back, carry-forward relief, and terminal loss relief
• Sideways relief against general income, and when losses can be set against capital gains after income is exhausted
• The Annual Investment Allowance: qualifying assets, exclusions, apportionment, and planning opportunities
• Statutory restrictions: commerciality test and the cap on income tax reliefs (greater of £50,000 or 25% of adjusted total income)
• Time limits and claim mechanics for each relief, including Self Assessment process for individuals and partnerships
• Interaction between AIA and loss reliefs, and practical considerations to optimise claims, preserve allowances, and improve cash flow
• The importance of accurate record-keeping and timely claims

Key Terms and Concepts

• trading loss
• start-up loss relief
• carry-back relief
• carry-forward relief
• Annual Investment Allowance (AIA)
• terminal loss relief
• sideways relief
• not commercial with a view to profit
• cap on income tax reliefs