Farmers are allowed to average their profits for tax purposes so long as they meet the necessary conditions. This has the effect of smoothing out the effect of fluctuating profit levels, and therefore smoothing the farmer's tax payments.
Effective from 6 April 2016, farmers have the option to average their profits for tax purposes over any two consecutive years, or any five consecutive years. They can, of course, ignore the averaging provisions altogether and simply pay the tax due on the taxable profits arising in those years.
Averaging is available where the farmer passes the volatility test:
- For five year averaging – the average of the previous 4 years’ profits and the 5th year’s profit must not be within 75% of one another; or
- 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 the volatility conditions are met, the afrmer can average his profits over the relevant number of years and treat the average figure as his taxable profit in each of those years, smoothing his tax cash outflow and in some cases even generating a refund.
Partners in a farming partnership can claim averaging of their share of the partnership profits independently of one another, depending on their individual circumstances.
The averaging extends only to farming profits (after capital allowances), and not to other streams of income such as leisure, rental or renewable energy production.
The averaging rules are only applicable for income tax and can therefore only be used by unincorporated farming businesses.
New farmers may be restricted, since a full two- or five-year trading history is needed to take advantage of the averaging, and it cannot be used where the trade is ceasing.
Averaging is not permitted for contract farmers or where the cash basis of accounting is used.