Profit averaging for farmers: harvesting the benefit

BLOG21st Oct 2016

Although farming businesses have had a tough time in recent years, there may be some relief in sight.

Farmers have in the past benefited from two-year averaging of their profits for tax purposes, which may have been helpful to some, but was still fairly restrictive. Many have therefore welcomed the extension of the averaging period to five years.

In the months since the EU referendum, farm gate prices have increased a little, but there are still a number of problems facing the agricultural sector. Subsidies are lower and trading conditions are generally poor. Any relief is therefore quite welcome.

What are the rules?

If your taxable profits after capital allowances in 2012/2013 were higher than in 2016/2017 and you faced significant tax bills, then you may be able to claim relief.

You need to be a sole trader or partnership with a financial year-end which ends in the year to 5th April 2017.

Annual reviews

It’s important to keep a record of your profit history and review it on an annual basis. The averaging exercise is designed to take out profit previously taxed at higher rates. You may be able to reinstate personal allowances or make use of those that were unused before.

Imagine you made £115,500 in profit in 2012/2013, £65,000 the next year and £26,000 in 2014/15. And let’s assume that your profitability continued to drop – to, say, £10,000 in 2015/16 and to zero in 2016/17.

In this scenario, you could save £5,800 in tax by electing to average the profits over five years rather than using the previous two-year averaging relief.

Issues to bear in mind

Unfortunately, you can’t five-year average every result. There’s a test for ‘volatility’. In order to make an averaging claim, you’ll need to show either that one or more of the five years shows zero profit or a loss or that the average of the previous four years, when compared to the fifth, is 75% or less than the other.

Losses in a year will be treated as being nil profits for the averaging calculation, so you can still make use of the loss in the normal way.

Only your farming profits count for these purposes, so if you’re renting out cottages or making money from wind turbines, you must exclude this profit from the claim.

Another rule is that if you are in a ‘year of commencement or cessation’, you can’t make a claim. (This includes individual partners joining or leaving a partnership.)

As there are some complexities here, it obviously makes sense to talk to your accountant about the issues if you think you’re going to take advantage of the scheme.