Farmers can average their profits for tax purposes over two or five consecutive tax years provided certain conditions are met, accountant Saffery says.
Farming businesses with fluctuating profits who want to average could smooth out tax and National Insurance payments, the firm says in this article.
Farmers may also save tax and National Insurance if they would otherwise be paying higher rates of tax in some years but not others, or don’t always use the full personal allowance.
Two-year averaging can be applied where one year’s profits are less than 75% of the other year’s profits, or the result for one of the years is a nil profit or a loss.
Five-year averaging can be applied where:
• The average of the previous four years’ profits is less than 75% of the fifth year’s profits;
• The fifth year’s profits are less than 75% of the average of the previous four years’ profits; or
• In at least one of the years, the profits are nil, or a loss is made.
Where there’s a loss, it’s treated as nil for the averaging rules, and the losses are available for normal relief. However, you can only make an averaging claim:
• For farming profits (after any capital allowances claimed), and not for other streams of income such as leisure, rental or renewable energy production,
• If you’re an unincorporated farming business (ie not a company and not a contract farmer);
• Where none of the years being averaged are either the year the business started or ended; and
• If you’re using the accruals basis of accounting (note that from the 2024-25 tax year, when the cash basis of accounting is the default method of calculating trading profits, if you want to make an averaging claim you will need to elect not to use the cash basis).
Martyn Dobinson, partner at Saffery says: “If the conditions are met, a farmer can average their profits over the relevant number of years and treat the average figure as their taxable profit in each of those years. This will smooth their tax cash outflow and may even result in a refund.
“Averaging doesn’t change the tax return or the amount of tax and Class 4 National Insurance Contributions (NICs) you pay in the earlier years of the claim.
"Instead, the adjustments to your tax and Class 4 NICs liability for all years of a claim are taken into account in the latest tax year of the claim.”
Will basis period reform affect the averaging option?
Under the basis period reform rules, from the 2024-25 tax year, unincorporated businesses will be taxed on their profits arising in the tax year, regardless of their accounting period.
This means that businesses which draw up their accounts to a date that isn’t between 31 March and 5 April (inclusive), must apportion their profits or losses to match the tax year.
As part of this change, transitional rules apply so that in 2023-24 businesses will be taxed on:
• Profits arising in the business’s accounting period ending in 2023-24 (as usual under the old rules), plus
• Profits for the period from the end of that accounting period until 5 April 2024 (the ‘transition’ profits)
Businesses can deduct any unused overlap profit from the opening years of the business from their transition profits, and any remaining transition profits can be spread over up to five years.
Transition profits are ignored for the purposes of farmers’ averaging, both when considering whether averaging can be used, and in calculating the averaging adjustment.
Mr Dobinson says: “Profit averaging claims can be made in your personal self-assessment tax return. Sole traders can claim in the self-employment pages and partners can claim in the partnership pages.
"Partners can claim averaging on their share of the partnership profits independently of one another, depending on their individual circumstances.
“It’s also important to note also that any averaging claim must be made within 12 months of the 31 January following the latest tax year covered by the claim.”
