HMRC enquiries into loss relief claims

Q: What other restrictions will HMRC check?

Tax generated losses. Section 74ZA blocks sideways relief for losses arising from arrangements whose main purpose, or one of whose main purposes, is to obtain a tax reduction by sideways loss relief (BIM85762). The reliefs cap. Under section 24A, sideways loss relief counts towards the general cap of the greater of £50,000 and 25% of adjusted total income, although the cap does not apply to losses set against profits of the same trade (BIM85703). Farming. Repeated farming losses face a separate test; see the farming losses five year rule. Cash basis. BIM85005 notes that losses for 2013 to 2014 up to 2023 to 2024 computed on the cash basis cannot be set against other income. The mechanics of a valid claim are covered in using a trading loss against other income.

Q: What does this look like in practice?

Illustration only. Tom is employed and also runs a photography business in the evenings, averaging about 6 hours a week. His accounts show a £30,000 loss, which he sets against his salary. HMRC opens an enquiry into the return. If it accepts the trade is commercial, Tom is non active because he works fewer than 10 hours a week, so his relief against salary is capped at £25,000 and £5,000 stays available to carry forward against future profits of the same trade. If HMRC shows there is no realistic prospect of profit, section 66 removes the whole claim against salary, the closure notice amends the return, and the extra tax is due 30 days later with interest.

HMRC challenges a claim to set a trading loss against other income by opening an enquiry into the return or into a standalone claim, then testing whether there is a real trade, whether it was run on a commercial basis with a view to profit, and whether limits such as the 10 hours a week test for non active traders apply. If the claim fails, the closure notice reduces or removes the relief, the extra tax becomes payable with interest, and a penalty can follow if the claim was careless or deliberate.

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How does HMRC open an enquiry into a loss claim?

Loss relief always needs a formal claim, and the way HMRC challenges it depends on where the claim was made. The Enquiry Manual at EM1907 explains that a claim made in a Self Assessment return is enquired into as part of the return under section 9A of the Taxes Management Act 1970, while a claim made outside a return is enquired into under paragraph 5 of Schedule 1A. Claims affecting more than one year, such as carrying a loss back, follow Schedule 1B. HMRC stresses that opening the enquiry under the right provision is what allows it to amend the claim and recover tax at the end.

For a standalone claim, paragraph 5(2) of Schedule 1A sets the enquiry window as the latest of the quarter day after the first anniversary of the claim, and, for a claim relating to a tax year, the first anniversary of 31 January after that year. The quarter days are 31 January, 30 April, 31 July and 31 October. Loss relief is also one of the issues HMRC’s Wealthy and Mid sized Business Compliance directorate tracks: its annual report technical note showed about £102 million of tax under consideration on loss relief at 31 March 2026.

Is the activity really a trade?

The Business Income Manual at BIM85701 says the first question is whether the activities amount to trading at all. If they do not, the losses are not trade losses and no relief is available. HMRC officers are told to examine critically any claim that a trade exists where the claim may have been made to obtain relief only available to businesses. The factors are discussed in the badges of trade.

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How does HMRC test whether the trade is commercial?

Section 66 of the Income Tax Act 2007 denies relief against general income unless the trade is carried on throughout the basis period on a commercial basis and with a view to the realisation of profits. BIM85705 describes this as a two legged test.

On the first leg, HMRC relies on Wannell v Rothwell, where the judge distinguished the serious trader, “whatever his shortcomings in skill, experience or capital”, from the amateur or dilettante. Uncommercial terms, such as prices that do not reflect costs, or an uncommercial way of operating, such as opening hours that suit only the owner, point towards a hobby. HMRC also accepts that “commercial” is not the same as “profitable”.

On the second leg, section 66(3) says a trade carried on so as to afford a reasonable expectation of profit is carried on with a view to profit. BIM85710 explains that no time limit applies, so a distant but realistic prospect of profit is enough, and that “profit” here means commercial profit in the accounts before capital allowances but after depreciation and interest. Officers are told they may look closely at business plans and projections and point to past results, or argue there is another reason for the trade, such as personal enjoyment, offsetting private spending or increasing the value of an asset.

Section 66(5) helps a business that changes. If the way the trade is carried on changes during the basis period, it is treated as having been carried on all year in the way it is run by the end of the period.

Why are claims in the first years of a trade tested more strictly?

Early trade losses relief under section 72 lets a loss in the first four tax years be carried back against income of the previous three years. Section 74 restricts it unless the trade was run 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. BIM85735 calls this a tougher test than section 66 and says HMRC generally expects a reasonable time to be fairly short, “say a year or so”.

The same page lists situations that give cause for enquiry: recurring production costs that clearly cannot be recovered from sales, and overheads (often largely the private car and household costs) that are clearly out of proportion to expected income. See early trade losses relief.

How does the 10 hours a week test work?

Under section 74C, an individual trades in a non active capacity unless, in the relevant period, they spend an average of at least 10 hours a week personally engaged in the trade’s activities, carried on commercially and with a view to profit. The relevant period is normally the tax year, but it becomes six months from the start of trading or six months to the date of cessation where the trade starts or stops part way through the year.

For a non active trader, section 74A caps sideways relief at £25,000 a year. BIM85765 explains that the cap does not apply to professions or vocations, that it is applied after the other restrictions, and that Self Assessment taxpayers are expected to restrict their own claims. It also says relief given on the assumption that the active test would be met can be recovered by assessment if it is failed. Because the test turns on hours, HMRC will ask for evidence of time spent, so a diary or time log kept as the year goes on is far stronger than a reconstruction made during the enquiry. More detail is in non active trader loss restrictions.

What other restrictions will HMRC check?

Tax generated losses. Section 74ZA blocks sideways relief for losses arising from arrangements whose main purpose, or one of whose main purposes, is to obtain a tax reduction by sideways loss relief (BIM85762).
The reliefs cap. Under section 24A, sideways loss relief counts towards the general cap of the greater of £50,000 and 25% of adjusted total income, although the cap does not apply to losses set against profits of the same trade (BIM85703).
Farming. Repeated farming losses face a separate test; see the farming losses five year rule.
Cash basis. BIM85005 notes that losses for 2013 to 2014 up to 2023 to 2024 computed on the cash basis cannot be set against other income.

The mechanics of a valid claim are covered in using a trading loss against other income.

How is the claim withdrawn or reduced after an enquiry?

BIM85085 says that once made, a loss claim can only be changed by the taxpayer amending it within the amendment window, by an officer correcting an obvious error or amending it as part of an enquiry settlement, by a discovery assessment after the enquiry window has closed, or by a supplementary claim under section 42(9) of the 1970 Act.

Where the claim was in a return, the officer’s closure notice under section 28A amends the return, and any extra tax is payable 30 days after the notice is given under paragraph 5 of Schedule 3ZA. A partial closure notice can settle the loss issue while other questions stay open. Where the claim was standalone, paragraph 7 of Schedule 1A requires the closure notice to amend the claim to eliminate any excess, HMRC must give effect within 30 days by assessment or repayment, and an appeal must be made in writing within 30 days. See HMRC closure notices.

A withdrawn loss can also bring a penalty. Schedule 24 to the Finance Act 2007 covers inaccuracies in returns and in statements made in connection with a claim for relief, including a false or inflated statement of a loss, where the inaccuracy was careless or deliberate. The penalty ranges are explained in HMRC penalties for tax return errors.

What does this look like in practice?

Illustration only. Tom is employed and also runs a photography business in the evenings, averaging about 6 hours a week. His accounts show a £30,000 loss, which he sets against his salary. HMRC opens an enquiry into the return. If it accepts the trade is commercial, Tom is non active because he works fewer than 10 hours a week, so his relief against salary is capped at £25,000 and £5,000 stays available to carry forward against future profits of the same trade. If HMRC shows there is no realistic prospect of profit, section 66 removes the whole claim against salary, the closure notice amends the return, and the extra tax is due 30 days later with interest.

What mistakes weaken a loss claim?

Having no business plan or projections that show how profit will be made.
Claiming household and car costs that dwarf the income.
Keeping no record of hours worked.
Ignoring the £25,000 cap on the assumption HMRC will apply it.
Running the same loss making pattern for years without any change in how the trade operates.

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Sources

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 24 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.