Tax Planning, Credit Ratings and Year End Accounts: Basic tax planning for loss making businesses 

I have often said that there is a seesaw with tax planning on one side and access to finance on the other. The more you want to achieve in tax planning the less likely your financial results will show a bank you are a safe bet for a loan. And on the reverse, the better the performance looks for the purpose of getting funding, the less tax planning options are generally available for you.

But what do you do when profits are falling? It’s all about balance and planning.

The information given here is, of course, given in general terms, but provides some food for thought about tax planning and the importance of your annual accounts. It is always best to get specific advice to make sure you find the right solutions for you.

Is my business making a loss?

As all accountants will say the starting point is having accurate and up to date bookkeeping. This is the backbone of all planning. And often it is the simple bit. The picture your figures paint can lead to many avenues of planning and decisions to be made.

But your end of year accounts may be different to those presented by your bookkeeping. Part of the work we do preparing the year end, is to adjust the accounts for items such as Work in Progress, accruals, prepayments and deprecation.

And you are not taxed on the same profit as the accounts but one calculated after various tax adjustments we have to make on your tax return. Whether you are a sole trader, partnership or limited company, the principals are broadly the same.

Example: High profits, lower taxable profit

You might be showing a profit of £10,000 in your profit and loss report, but if you bought a bit of kit for £5,000 in the year and this is shown as an asset then your accounts might only show £1,000 of the cost of this asset in the year through the depreciation figure.

In the tax adjustments we add back to the £1,000 of depreciation, as it is “disallowed for tax purposes”. This makes the profit rise to £11,000 and then, if we can, we utilise the Annual Investment Allowance. This allows us to reduce the taxable profit by the full value of the asset (the £5,000 it actually cost in the year) and your taxable profit then drops to £6,000.

The result is that the full accounts show a £10,000 profit. This is what the bank would see. But your HMRC taxable profit is reporting £6,000. This is the perfect tax planning. Your full accounts show a high profit while the taxable profit is low. The bank will be happy with your performance and you are happy because you have made a bit of a tax saving.

Example: Low profits, higher taxable profit

Sometimes the opposite can happen. The tax adjustment means you end up paying more tax than you would think from the face of the profit and loss.

You might be showing a loss of £2,000 in your profit and loss report.  Leading you to think you have no tax to pay. But this loss might include £1,000 of depreciation for an asset you bought a few years ago (and got the Annual Investment Allowance back in that year) and you may have spent £2,500 on client entertaining.

As in our first example, depreciation is added back for tax purposes and it reduces the loss to £1,000. There is no asset purchased this year, so no further adjustment is made to the taxable profit because of capital expenditure.

But HMRC do not allow a business to get tax relief on entertaining. If your business is a limited company, then there is still some tax benefit to this because at least you don’t have to pay personal tax for this type of cost.

For this example, HMRC add back the £2,500 of entertainment costs in the year and now the £1,000 loss after adjusting for the depreciation has now increased to a £1,500 profit, and there is now tax to pay even though you didn’t make money this year.

This is the worst position to be in because now you have accounts that the bank won’t like so much and you are paying tax! Gah!

We usually trawl the entertainment expenses to make sure that staff entertainment is reported separately or at least adjusted for – because this type of entertainment is allowable to tax. Let’s hope we can all still have Christmas party’s this year!

How do grants and loans affect tax?

One last item to factor in is that with the raft of coronavirus measures brought in, you may for the first time be in receipt of a grant.

Grants are taxable income. 

If you are a sole trader or in a partnership, then the self-employed support grant that you may have received is taxable and although it may have been paid to a personal account needs to be declared in your accounts as taxable income.

We recommend putting this to “other income” in your bookkeeping records so that it doesn’t confuse the key figures in your accounts.

For partnerships, this could get very complicated as each partner may have received different amounts and receive different profit shares each year.

It is important to record who received this income and make us aware when we start your accounts preparation so that we can ensure these are dealt with correctly.

The furlough grant is another example.

The cost of the wages paid to furloughed staff remains as a cost on your profit and loss. The income from the grant should also be reported as income on your profit and loss report. The two should, in theory, net off in total for the period 1 March to 31 July. But it is important to recognise the furlough grant as other income so it can be clearly seen that you have treated the grant properly.

If you have received a loan under the bounce back loans, business interruption loan or similar, then this cash injection into the business DOES NOT go on the profit and loss.

This needs to be shown as money in from a loan, which gets reported on your balance sheet. With the grants you don’t have to pay them back, so it is your income. Loans you do have to pay back so they go on the balance sheet so you can track how much you owe back to the bank.

Once you have ensured these items are correctly recorded in your bookkeeping then you can assess: “Have we made a loss this year?”

Tax planning with losses

If your business makes a loss at the next year-end, there are various options open to you.

For most businesses if your business reports a loss overall, after considering all streams of income (trading income, investments, bank / deposit interest etc.) then you have 2 basic options:

  1. Carry back the loss to offset against the previous year’s profits (if there were any)
  2. Carry forward against future year profits

(There are some other options in various situations but let’s stick with these for now)

Carrying forward profits is the default position. The downside is that these losses will reduce future tax bills, rather than getting you a cash injection now. If you don’t make a profit for many years, then it will take long time to turn those losses into saved tax.

Carrying losses back can be very useful as it can get a cash refund from HMRC relatively quickly. In some cases where you might shorten a year end you could even carry back losses before the previous year’s corporation tax was due – although this only fits some very specific situations.

If you are looking to close your business, then another option is open to you: Terminal Loss Relief.

Where you cease to trade business clearly you can’t carry forward losses because there is no business to carry them forward to. So HMRC give a greater loss relief which enable you to carry the loss back 3 years (based on each year being a 12-month period).  This can release cash to aid the winding up process.

If you operate a partnership or sole trade, then you have another useful factor to consider.

Losses in a year can be offset against other income (capped at £50,000 per year). So if you have made losses but you have employment or rental income, the losses can offset income from these sources and reduce your tax liability or get you a refund if you have paid tax at source, as you would have paid via employment. This is, in normal times, a very useful rule for start-up businesses.

Limited Companies that operate in a group (where a holding company owns other companies each trading in their own right), have another option: Group Relief.

You can move a loss from one limited company, on the company tax return, to offset the current year trading profits in another company in the group.  This can be a vital item of planning where you have a number of projects in a holding company structure as we discussed a few months ago in our Is your business structure in the right way article.

Research and Development (R&D) tax credits

If you make an R&D claim through a limited company in a year that you are already loss-making then you have some further options.

You can either carry the loss back as above and get a tax refund from the previous year (assuming that year you had paid tax), carry forward the loss to a future profitable year or surrender the loss for a tax credit.

The downside is that the tax credit is at a lower value, 14.5%, rather than the full rate of tax (currently 19%) but it gets you the cash much faster than waiting for the profitable years ahead.

R&D is one of the golden items for tax planning because it reduces taxable profit but not accounting profit. Find out if you may have an R&D claim by clicking the button below.

Could you make an R&D claim?

We can help

These are some of the fundamental elements and considerations that we make when preparing your year end accounts. There are often more complex planning and options open to you.

Contact us on 01474 853 856 or discovery@a4g-llp.co.uk to get specific tax planning advice for you and your business. Having good management information and an early start on your year end accounts can help make sure this planning is all done to help you in the best way we can.

Contact me today!

Josh Curties

BA (Hons) ACA

Partner & Principal Adviser

01474 853856

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