The average farmer and his tax bill
QUESTION: I am a farmer and my profits/losses fluctuate wildly from one year to the next caused by global prices and extreme weather conditions. I have heard of changes being introduced to farmers averaging and I would like to understand what this means for my tax bill. Can you explain?
Answer: Finance Bill 2016 is set to introduce an option for farmers to average their trading profits over a five-year period and to simplify the existing two-year averaging rules by removing marginal relief. The changes aim to ensure the tax system continues to support farmers with fluctuating profits as part of the overall objective of encouraging a more efficient, productive and resilient agricultural industry.
The proposed new rules are detailed in draft Finance Bill 2016, published on December 9 2015, and are expected to save taxpayers £10m in the first year and £30m per year thereafter.
The existing averaging rules provide that an individual (either alone or in partnership) carrying on a trade, profession or vocation: (a) in farming or market gardening in the UK; (b) in the intensive rearing in the UK of livestock or fish on a commercial basis for the production of food for human consumption; or (c) whose profits are derived wholly or mainly from creative works, can claim to average their profits in any two consecutive years where the profits in either year do not exceed a specified proportion of the profits for the other year.
An averaging claim may be made in relation to two consecutive tax years if:
(1)the relevant profits of one of the tax years are less than 75 per cent of the relevant profits of the other tax year; or
(2)the relevant profits of one of the tax years are nil.
The relevant profits of a tax year are profits before making any deduction for a loss made in any tax year, but after capital allowances. If the taxpayer makes a loss, the relevant profits of the tax year for averaging purposes are nil and the full loss is available to be offset.
An averaging claim cannot be made in respect of any tax year before a year in respect of which a claim for profit averaging relief has already been made. The averaging rules are not available to those calculating their profits on the cash basis nor in the year of commencement or cessation of a trade. The averaging adjustment is made in the tax return for the later year; the earlier year's return is not amended.
Full averaging is available if the farmer's profits for either year do not exceed 70% of his profits for the other year, or are nil, his profits for each such tax year are to be adjusted so as to be equal to 50% of his profits for the two years taken together or, as the case may be, for the year for which there are profits.
Peter, a farmer, has assessable farming profits of £55,000 in 2014–15 and assessable profits of £17,400 in 2015–16. Since his profits in 2015–16 do not exceed 70% of his profits in 2014–15, if he makes a claim for profit averaging the result will be that his profits in each year are to be added together and his averaged profits for each year will become one-half of £55,000 plus one-half of £17,400, ie £36,200 in each year.
A marginal relief claim is available if the claimant's profits for either year exceed 70% but are less than 75% of his profits for the other year.
Based on the draft Finance Bill 2016 clause, for averaging claims made for 2016–17 onwards, farmers will be able to claim to average their profits over five consecutive years for income tax purposes, subject to a volatility condition. For a farmer to meet the volatility condition, either the average of the first four years' relevant profits must be less than 75 per cent of the last year's relevant profits or vice versa or the relevant profits of one or more of the five tax years to which the claim relates must be nil (or there is a loss).
Claims to average profits will therefore continue to be made retrospectively and other rules will be the same as for two-year averaging, eg that relevant profits are before capital allowances, that an averaging claim cannot be made in respect of any tax year before a year in respect of which a claim for profit averaging relief has already been made and averaging will not be available to those using the cash basis nor in the year of commencement or cessation of a trade. Farmers will retain the option to average over two years. The current two-year averaging rules will be simplified by removing marginal relief so that full averaging relief will be available where the profits of one year are 75 per cent or less of the profits of the other year.
To enable farmers and their accountants to evaluate whether they should claim five-year averaging, two-year averaging or not to average at all, they will have to consider the numerous combinations of claims possible whilst having regard to their exact circumstances. Such considerations need to take into account that profit averaging can be a continuous process so may need to include prior and subsequent years.
The evaluations will include calculating the income tax and Class 4 National Insurance contributions due under each of the options, considering the implications of partially claiming or not claiming capital allowances at all, the effect on the cash flow of the farming business and the impact on any other reliefs.
The extension of farmers' averaging to five years will help farmers manage the impact of volatile profits caused by disease outbreaks, fluctuating global prices and extreme weather conditions. Although some will be disappointed that the new averaging rules apply for a fixed period of five years and not any period up to a maximum of five years, given that two-year averaging is to remain, it seems a sensible balance between the need for more flexibility and the need to keep things simple.
Consideration of the options will take longer as there are more permutations, with an estimated increased administrative burden to businesses of between £0.7m and £1.9m per year as their accountants and tax advisers assess whether averaging applies to them and whether it is advantageous to claim the relief over two or five years or not at all. The abolition of marginal relief for farmers and artists using two-year averaging is a welcome simplification.
:: Paddy Harty (p.harty@ pkffpm.com) is director at PKF-FPM Accountants (www. pkffpm.com).