restriction of relief: uncommercial losses made in early years of trade
S74 Income Tax Act 2007 (ITA 2007)
S74 ITA 2007 recognises that losses may be made in the opening year(s) of a new trade (including a profession or vocation), but excludes from relief losses made in the first four tax years in circumstances akin to those in S66 ITA 2007 (uncommercial trades - BIM85705 onwards).
The first consideration is whether the activity amounts to a trade, then consider whether the trade is uncommercial. Losses are not available for relief under S72 ITA 2007 unless the trade was carried on, throughout the basis period for the tax year:
- on a commercial basis and
- in such a way that profits could reasonably be expected in the basis period or within a reasonable time afterwards.
For information on commercial basis, see BIM85705.
The use of the words ‘reasonably’ and ‘reasonable’ in the second part of the test make this a tougher test than in S66 ITA 2007, see BIM85710. ‘Reasonable time’ should be interpreted by reference to the particular circumstances, especially the nature of the trade. In general, we expect it would be a fairly short period of say a year or so.
We take the view that the test should be considered for each year for which relief is claimed and that it is necessary to look at the year of loss and whatever, on the facts, is a reasonable time thereafter. Where there are losses relating to a part of the basis period during which the test is satisfied, relief may be allowed for them, even if the test is failed for the remainder of the basis period.
Where you are satisfied that the activity has the character of a sideline or hobby which is not being carried on on a commercial basis and the prospect of a profit within a reasonable time is remote, you should challenge the claim to the relief. Situations which would give cause for enquiry include:
- recurring costs of production are clearly not recoverable from sales,
- overhead expenses claimed (often largely the private car and part of the household expenses) are clearly out of proportion to the anticipated revenue.
In general, if the challenge under S74(2) ITA 2007 is successful you should contend that S66 ITA 2007 also applies, but it should not be overlooked that there are differences in the two tests.
Where the trade was previously carried on by the individual’s spouse or civil partner living with him (her), the four-year period comprises the tax year in which the spouse or civil partner first carried on the trade, and the next three years (S74(5) ITA 2007).