Five-year averaging: two years on

8 May 2018

In the March budget of 2015 the government announced that self-employed farmers would be allowed to average their trading profits for income tax purposes over five years in addition to the existing two-year option.

This came into effect for the tax year ended 5 April 2017 and has now come to the end of its second year.

For many years it has been possible to average a farmer’s taxable profits over two years, effectively smoothing-out some of the fluctuations between the current year’s trading and the previous one. The introduction of the five-year option is a concession from a government supposedly aiming to encourage ‘a more efficient, productive and resilient agricultural industry in the UK’.

Many farmers will be eager to see if averaging can benefit them. However, before jumping head-first into five years’ worth of Income Tax recalculations, it is helpful to consider the basics. Averaging will only be beneficial if in the years in question there is a difference between the rates of tax you are paying.

For example, if a typical two-person partnership had taxable profits ranging from £20,000 up to £60,000 over the course of 5 (or 2) years, it is unlikely that averaging will yield any savings as at these levels the partners will be consistently paying Income Tax at the basic rate (assuming there is no other income). If, on the other hand, there have been years when a farm has made little or no profit, alongside ones where profits are such that tax is being paid at the higher rate, there is a great potential for savings.

If there have been recent years when you have not had tax to pay, it is possible you have not exploited your annual personal allowance (£11,500 for the 2017/18 tax year) which could make averaging particularly favourable where there have also been years when tax has been paid at 20% or even 40%.

A wet winter and spring, along with high commodity prices, mean many farmers face a disappointing outlook for 2018/19 profits. Five-year averaging opens the possibility of recouping some of the tax you may have paid in all the years back to 2014/15, when milk prices in particular were better, and profits were subsequently higher. Whilst a business should not set out to make less money in order to benefit from a tax saving, any sizeable reduction which averaging can offer will be a welcome relief.

Points to remember:

• Averaging can still be used if some of the previous year’s profits have already been averaged before.
• Making a loss does not automatically make averaging worthwhile as losses can be used in other ways, such as being carried forward to reduce taxable profits in the subsequent year(s), therefore effective tax planning in this area is important.
• Averaging is only applicable to Income Tax, and it is therefore not possible to average the profits of limited companies. However, where incorporation is a sensible tax-saving measure, a farmer should not be put off by the lack of averaging.
• Profits are not averaged for the farm as a whole but instead for its partners, so even if one person in the business does not stand to gain, the other(s) may still be able to benefit.

Your accountant should be able to identify whether your circumstances make five-year averaging a beneficial exercise. Old Mill proactively consider whether our clients stand to gain, and have already secured thousands of pound’s worth of savings for many individuals, more than justifying the extra time and cost of doing so. If you think averaging may be of benefit to you please contact Oliver Bond on 01392 351337 or email oliver{dot}bond{at}oldmillgroup{dot}co{dot}uk 

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