A refresher from ACCA on how farmers and market gardeners in the UK may obtain relief by averaging the profits of consecutive years.
Farm subsidies
The Direct Payments to Farmers (Legislative Continuity) (DPLC) Bill provides governments across the UK powers to administer direct payments to farmers for 2020. The Chancellor has confirmed the same level of funding for 2020 as for 2019.
The averaging relief is available to individuals in the following trades, professions and vocations such as:
- farming or market gardening
- intensive rearing in the UK of livestock or fish on a commercial basis for the production of food for human consumption, and
- creative artists (two-year averaging only).
The rules relating to the averaging profits are in Income Tax (Trading and Other Income) Act 2005 (ITOIA 2005), Part 2 Chapter 16 s221 to s225.
These averaging rules were originally introduced because it was felt that farmers were suffering from a high effective rate of income taxation, mainly because of fluctuations in profits caused by the weather and increasing influence of world market prices. Averaging may help farmers who pay tax at the basic rate one year and higher rate the next, or farmers who are liable to tax in one year but are not liable in the next year.
Farming is defined in Income Tax Act 2007 s996 as being the occupation of land wholly or mainly for the purposes of husbandry but excluding any market gardening.
Full averaging relief can be claimed where the profits of one tax year are 75% or less of the profits of an adjacent year
Averaging options
Finance Act 2016 extended the ability for profit averaging to five years and removed the marginal relief.
- two year averaging
- five year averaging (not available for creative artists)
- no averaging at all.
The following conditions have to be met for averaging provisions to apply:
- For two year averaging, the current year and prior year’s profits must not be within 75% of one another, ie the difference between the profits for the two years must be more than 25% of the profits of the year with the better result.
- For five year averaging, the average of the previous four years’ profits and the fifth year’s profits must not be within 75% of one another, ie the difference between the profits for 2018 to 2019 and the average of the profits for the four previous tax years must be more than 25% of the profits of the higher figure. This condition is also satisfied if any one of these years has nil profits or a loss. Those losses will then receive tax relief under the normal loss relief rules. The last year subject to the five-year averaging claim cannot already be subject to an averaging claim from a future tax year. As with a two-year claim, averaging claims must effectively be made in a consecutive order.
Averaging is NOT permitted:
- in the year of commencement or cessation of trade
- for other streams of income for the farmers such as letting of property, income from leisure activities or income generated from renewable energy etc
- for farming on a contract basis
- when using cash accounting
- for partners who joined or left during the averaging period
- no marginal relief is available after 1 April 2016
- for companies, including corporate partners
- for other bodies which are subject to corporation tax.
Example ― illustrating averaging options for 2018/19 losses (taken from Tolley)
Henry has been farming his land for many years. His recent results are listed below, together with the overview of the impact of the averaging claims between 2014/15 and 2018/19.
| Tax year | Original profits | Averaged profits | ||
| Profit / (Loss) | Tax and Class 4 liability on original profits | Averaging adjustment on Tax Return | Revised tax and Class 4 liability on profits (as shown on the Tax Return) | |
| £ | £ | £ | £ | |
| 2014/15 | 43,000 | 9,901.51 | 2,250 | 9,101.46 |
| 2015/16 | 31,500 | 6,289.60 | 2,250 | 6,942.10 |
| 2016/17 | 25,000 | 4,324.60 | 4,375 | 4,324.60 |
| 2017/18 | 24,000 | 3,925.24 | 3,925.24 | |
| 2018/19 | (20,000) | Nil | 12,000 | (3,128.16) |
| Total | 24,440.95 | 21,165.24 | ||
The overall effect of the averaging claims over the period 2014/15 to 2018/19 is a reduction in income tax and Class 4 national insurance contributions (NIC) of £3,275.71.
The five-year period straddles the rule changes which apply from 2016/17 onwards, illustrating averaging under both the old rules and the new rules.
Henry made a loss in 2018/19 of £20,000, which may be carried back, offset against other taxable income or carried forward to offset against future trading profits. For averaging purposes, the profit for 2018/19 is nil. The rules changed with effect from 6 April 2016 and, as Henry is a farmer, he has the choice of:
- a claim for two-year averaging
- a claim for five-year averaging ― as the profits for 2018/19 are nil, the volatility condition in ITTOIA 2005, s222A(2)(b) is met and five years’ worth of profits can be averaged.
To decide which is more beneficial, it is necessary to run calculations under both.
In analysing the effect of two-year and five-year averaging, it is assumed that the trading loss for 2018/19 is offset against Henry’s other taxable income for 2018/19 (ie not affecting the trading income reported in 2018/19 (following the averaging claim) or 2017/18).
Two-year averaging
The two-year averaging claim would be half of the aggregate of £24,000 and nil: £12,000. This would lead to a reduction in income tax and NIC for 2017/18 of £3,480 (£3,925.24 – £445.24). The income tax and NIC due on trading profits of £12,000 for 2018/19 would be £351.84.
The adjustment for the difference in the 2017/18 liability would leave an income tax and Class 4 NIC refund of £3,128.16 (£351.84 less £3,480) on the 2018/19 Tax Return before taking into account tax on other income.
Five-year averaging
The profits for the tax years 2014/15 to 2018/19 total £123,500 and this is same whether you consider the original profits (£43,000 + £31,500 +£25,000 + £24,000 + nil) or the revised profits following the averaging claims (£40,750 + £29,375 + £29,375 + £12,000 + £12,000). Therefore, the average over the five years is £24,700.
In order to decide whether the five-year averaging claim is more cost effective it is necessary to calculate the tax due for each of the five tax years as if the profits were £24,700 and compare the overall tax liability against the tax liabilities if the five-year averaging claim is not made:
| Tax year | Trading profits (based on averaging claims already made and assuming a two-year claim is made for 2017/18 and 2018/19) | Income tax and Class 4 liability on trading profits (based on averaging claims already made) * | Trading profits (under five-year averaging) | Income tax and Class 4 liability on trading profits (under five-year averaging) |
| £ | £ | £ | £ | |
| 2014/15 | 40,750 | 9,101.46 | 24,700 | 4,446.96 |
| 2015/16 | 29,375 | 5,673.35 | 24,700 | 4,317.60 |
| 2016/17 | 29,375 | 5,593.35 | 24,700 | 4,237.60 |
| 2017/18 | 12,000 | 445.24 | 24,700 | 4,128.24 |
| 2018/19 | 12,000 | 351.84 | 24,700 | 4,034.84 |
| Total | 21,165.24 | 21,165.24 |
* Rather than consider the income tax and Class 4 NIC on the trading profits reported on the tax return, this column looks at the position for the relevant tax year taking into account the reduction or increase in the liability as a result of the earlier averaging claims.
Conclusion
There is no difference between making the two-year averaging claim and the five-year averaging claim, but it is easier in terms of the tax return entries to make the two-year averaging claim.
Losses – sideways relief
Most losses can be claimed against other income, but there are special rules which restrict your ability to claim if your farm is not commercial or if you had a run of losses (worked out before capital allowances) of more than five tax years.
Time limit and how to claim
The time limit for making the claim is the first anniversary of 31 January following the latest tax year covered by the claim (eg where the claim relates to 2017/18 and 2018/19, the time limit is 31 January 2021).
They are claimed in the tax return for:
- sole traders in box 72 Self-employment
- partners in box 11 Partnership pages
You can see more on the return rules including worked examples and a look at the rules relating to the averaging profits of farmers on our technical advisory webpages
Useful links
HMRC Helpsheet 224 for Farmers and market gardeners
HMRC Helpsheet 234 for Creative artists
ACCA examples for prior to 2016 changes
Article from ACCA In Practice