Farmers and market gardeners in the UK may obtain relief by averaging the profits of consecutive years.
The rules relating to the averaging profits of farmers and creative artists 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.
Averaging can be claimed where the difference between the profits for the two years is 30% or between 25% and 30% (marginal relief). It can’t be claimed where profit differences are below 25%.
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
Averaging options for 2016-17 tax returns:
Finance Act 2016 extends the ability for profit averaging to five years and removes the marginal relief:
two year averaging
five year averaging
no averaging at all
The ‘volatility condition’ has to be met to qualify for averaging provision:
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 2016 to 2017 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.
An averaging claim must be made on or before the first anniversary of the normal self-assessment filing date for the last of the tax years to which the claim relates.
Generally averaging is NOT permitted in the following circumstances:
in the year of commencement or cessation of trade
for other streams of income for farmers such as letting of property, income from leisure activities or income generated from renewable energy etc
farming on a contract basis
when using cash accounting
partners who joined or left during the averaging period
no marginal relief is available after 1 April 2016
companies, including corporate partners
other bodies which are subject to corporation tax.
Most losses can be claimed against other income, but there are special rules which restrict the ability to claim if the farm is not commercial or if there was a run of losses (worked out before capital allowances) of more than five tax years.