A trading loss is a loss taken in a period where a company’s allowable tax deductions amount to being greater than its taxable income. The company’s trading loss can generally be used to recover past tax payments or be used to reduce future tax payments by making a company unprofitable for tax purposes. Here is an example to put things into perspective:
Company X has a taxable income of £1,000,000 and tax deductions of £1,300,000. This means its trading loss is £1,000,000 - £1,300,000 = - £300,000. Since there was no income to tax, Company X won’t pay any taxes that year.
But what happens if Company X makes a lot of money the next year? If £250,000 of taxable income is made and the company’s tax rate is 40%, then £100,000 would need to be paid in taxes (£250,000 x 40% = £100,000). The trading loss incurred last year can be applied to this year’s taxes, which will reduce it significantly, maybe even to zero.
It would also be possible for Company X to carry the trading loss back and use it for previous years, rather than future years.
The great thing about trading losses is that they provide relief to your company if needed. If your company isn’t doing well, the trading loss is there to indicate that your business is unprofitable for tax purposes. Some companies are actually bought only because of their trading losses.