• Date

    26 Aug 2021
  • Category

    Tax

Farmers’ Profit Averaging

Farmers may average their profits for tax purposes so long as they meet certain conditions. This has the effect of smoothing out the impact of varying profit levels, and therefore also creating more regular and predictable tax payments for farmers.

Since 6 April 2016, farmers have had the ability to average their profits for tax purposes over any two or any five consecutive tax years.  This is, of course, not mandatory and farmers may choose to pay their tax liabilities as they arise.

How it works

Averaging is available where the farmer passes a ‘Volatility Test’.

  • For five-year averaging - the average of the previous five years’ profits and the fifth year’s profits must not be within 75% of one another.
  • For two-year averaging - the current year and prior year’s profits must not be within 75% of one another; or
  • The profits of any one of the five, or two, years under consideration is nil or a loss. Where a loss exists, the result is treated as nil for the averaging and the losses are available for normal relief.

If any of the conditions of the volatility test are met, the farmer can average their profits over the required number of years and use the average figure as their taxable profit in each of those years, flattening out the annual tax cash payments and even in some years, receiving a refund. The relief is particularly useful when farmers’ profits make them liable for higher rate tax in some years, and not in others.

Partners in a farming partnership can independently decide whether they wish to make an averaging claim and enter it on their individual tax returns.

Averaging claims must be made within 12 months of the 31st of January following the end of the relevant tax year.

Example

Mrs Farmers' farming profits have been as follows in the last two years:

Year ended 31st March 2020                             £132,417

Year ended 31st March 2021                              £96,664

The latter year is 73% of the previous year so not within 75% and averaging is therefore possible. Mrs Farmer needs to make a claim by 31st January 2022 to be assessed on £114,540 for both years.

Restrictions

  • The averaging may only be claimed on the farming profits, not other streams of business income that the farmer may receive.
  • These rules are for Income Tax only, so farming companies may not profit averaging.
  • Since a two-year or five-year trading history is required, new farmers are restricted; farmers in their final year of trading are also prevented from using the relief.
  • Averaging is not permitted for contract farmers or where the cash basis of accounting is used.

More information can also be found on HMRC’s Farmers and Market Gardeners’ Help sheet 224 here.

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