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Keeping it simple

Keeping it simple

A Guide to: Averaging farm profits

In Summary

Samuel Parish, Manager

8 May 2021

Due to the fluctuation of farming profits, farmers can average profits over 2 or 5 years to make fair payments.

Limited companies cannot claim

Famers’ averaging provides a lot of opportunities for minimising the income tax liabilities of a farming business but there are complications such as pension contributions.

Farming profits can fluctuate widely due to the weather, international commodity markets and a range of other factors beyond the control of most farmers. The Government recognise this would lead to unfairness in how farmers are taxed.  Farmers would be exposed to high tax rates in good years but would waste their lower tax rate bands and allowances in poorer years. 

This is particularly relevant at the present time with many arable farmers having made strong profits from the 2019 harvest, but 2020 harvest has been much less profitable due to the heavy rainfall followed by a long dry period in early 2020.

What you need to know about two year or five year averaging:

  • A form of averaging allowing farmers to average the profits of two successive years has been available since the 1970s. 
  • It is only available for farmers who operate as sole-traders, or as partners in a partnership.  Limited companies cannot claim. 
  • The profit or loss figure used for the averaging calculation is the taxable profit, rather than the accounting profit, so takes account of tax adjustments such as capital allowances. 
  • The claims may only be made when the difference in taxable profits between the two years is more than 25% of the higher figure – this is known as the volatility test.
  • In years when a loss is made, the profit for averaging purposes is zero.  The volatility test is automatically met if one year is a loss.

For the 2016/17 tax year onwards, profits may be averaged over a five year period.  This relief is also subject to a volatility test.  The difference between the profit for the fifth year and the average of the previous four years must be at least 25% of the higher figure.  Again the test is automatically met if any year is a loss.

Claims for loss relief continue to be made separately from averaging claims.

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