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Guidance and examples for how farmers may obtain tax relief by averaging the profits of consecutive years.

The rules relating to the averaging of profits relating to farmers and creative artists are in Income Tax (Trading and Other Income) Act 2005 (ITOIA 2005), Part 2 Chapter 16 s.221 to s.225.

Farmers and market gardeners in the UK may obtain relief by averaging the profits of consecutive years. These 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 s 996 as being the occupation of land wholly or mainly for the purposes of husbandry but excluding any market gardening.

Companies, including corporate partners, may not claim farmers’ averaging nor may any other body which is chargeable to corporation tax. Averaging cannot be made in respect of a tax year in which a trade commences or is permanently discontinued.

Claims for the relief must be made within 22 months of the end of the second year of assessment concerned. This means that claims for 2012/13 and 2013/14 must be made by 31 January 2016.

The relief takes the form of averaging the profits of two consecutive years of assessment – if the lower of the two profit figures does not exceed 70% of the higher profit figure – or if one of the years has a loss (or nil profits). There is also a marginal relief which can be claimed when the difference between the profits of two years is not quite enough to qualify for full averaging.

Assessments are computed by averaging the adjusted trading profits and treating the average figure as the trading profit for each of the two years. Once a claim for averaging relief has been made in respect of any two years, then the averaged figure for the later year must be used in making the claim for averaging with the year next following, and so on. It is profits net of capital allowances (but before loss relief) which are averaged.

Averaging does not apply in calculating profits using the cash basis for small businesses.

View a worked example of normal averaging

1. Example –normal averaging

Mr Farmer has been farming for many years.

Mr Farmer’s adjusted taxable profits are as follows:

Year ended

31.12.2010 £50,000
31.12.2011 £20,000
31.12.2012 (£22,000) loss
31.12.2013 £17,000
31.12.2014 £40,000

The original assessment would be as follows:

2010/11 Original y/e 31.12.2010 £50,000  
  Original y/e 31.12.2011 £20,000  
        ÷2  
2010/11 Final       £35,000
  Average y/e 31.12.2011 £35,000  
  Original y/e 31.12.2012 Nil  
        ÷2  
2011/12 Final       £17,500
Loss relief s64 ITA 2007     (£17,500)
          Nil
2012/13 Averaged y/e 31.12.2012 £17,500  
  Original y/e 31.12.2013 £17,000  

No averaging since £17,000 is 97% of £17,500

2012/13 Final       £17,500
Less remaining loss Original   £4,400 (£22,000 – £17,500)   £4,500
2013/14         £13,000
           
2013/14 Unaveraged original y/e 31.12.2012   £17,000
  Original y/e 31.12.2014 (2014/2015)   £40,000
          ÷2
2013/14 Final       £28,500

The £22,000 loss is available under s.64 of Income Tax Act 2007 (ITA 2007) against income in 2011-12 with the balance carrying forward against farming profits in 2012/13.

Marginal relief

A form of marginal relief is given where the lower profits exceed 70% but do not exceed 75% of the higher profits. In these circumstances relief is given by reducing the higher profit and increasing the lower profit by an amount equal to three times the difference between them minus three quarters of the higher profit. Adjustment = 3x (0.75xH)-L. Where H is the higher profit and L is the lower profit.

Example – marginal relief

In two consecutive years Mr Farmer made profits of £40,000 and £29,200. The claim for full average relief is not possible as the lower profit exceeds 70% of the higher profit figure. However, Mr Farmer is entitled to marginal relief as the lower profit is less than 75% of the higher profit. The adjustment will be:

3x (0.75×40, 000-29,200) =2,400

The revised assessment will therefore be:

Year 1 £40,000-£2,400=£37,600

Year 2 £29,200+£2,400=£31,600

Giving effect of a farmer’s average profit

Averaging claims are made in the return of the later year by including an averaging claim tax adjustment (positive or negative) in that return. Relief is given by adjusting the tax due for the later of the pair of the years affected and it is not necessary to amend the return for the earlier years.

2013/14                                                                                                2014/15

Original assessed £40,000 Original assessed £22,000
Tax and NIC due £9,014 Tax and NIC due £3,482
Average profit £31,000 Average profit £31,000
Tax and NIC due on average profit £6,404 Tax and NIC due on average profit £4,292
Difference of tax and NIC included in 2014/15

£9,014-£6,404=£2,610

Revised tax £1,682 (£4,292-£2,610)
Net tax and NIC due £9,014 (no change) Net tax and NIC £1,682
Net tax and NIC for both years if no average profit claim is made £12,496 Net tax and NIC for both years with average profit claim £10,696

From April 2016

New farmers’ averaging requirements will appear in the Finance Bill 2016. The essential features will be:

  • no requirement for a volatility test
  • no requirement for an annual claim
  • irrevocable opt in election for five years
  • transitional averaging for newer businesses.

Assuming it is unchanged, this means an averaging claim for 2016/17 will result in averaging 2012/13 to 2016/17 being calculated through five years.

Article extracted from ACCA “In Practice” Newsletter