It is now generally accepted that volatility is a feature in every farm enterprise resulting in variations in farm profits from one year to another with cash flow implications.
Such variations in farm profits can have significant consequences in terms of the payment of tax. For example, a dairy farm business with an accounting year end of the 31 March 2014 may have enjoyed a high profit, and, if that profit was retained in the business, the balance of tax for that year requires to be paid by 31 January 2015 in a period of declining prices.
The meeting of the January 2015 tax payment obligation may cause a cash flow problem.
Revenue & Customs recognise the cash flow implications of fluctuating profits by the existence of ‘averaging’ legislation. In order to avail of an averaging claim the trade must be either farming or market gardening, including the rearing of livestock and fish. Averaging is not available where the trade is agricultural contracting, haulage or a caravan site or where the farm business is carried on outside the UK. Only a person liable to UK income tax can make an averaging claim; this means sole traders, partners and executors, personal representatives of an Estate. A limited company or a partner in a corporate partnership cannot make an averaging claim. An averaging claim can cover any two consecutive years of assessment during which a farming trade was carried on except the year of assessment in which the trade commenced or ceased.
There are two types of averaging: full averaging and partial averaging.
Full averaging applies where the lower figure does not exceed 70% of the higher figure; partial averaging is where the lower figure is between 70% and 75% of the higher figure. Where the above applies, the two years may be averaged. The profit of the later year becomes the sum of the two profits divided by two. The profit of the earlier year is unchanged, but the tax due for the later year is adjusted up or down. The figure used for each year is the figure after Capital Allowances. A trading loss is treated as NIL profit for averaging purposes.
An averaging claim must be submitted to Revenue & Customs no later than 22 months after the end of the second year of assessment. Where the farm business is a partnership, not all partners need to elect; only those where a claim is beneficial.
Averaging of farm profit by sole traders or partners can be helpful to cash flow management in meeting tax liabilities. For many farms it may be relevant in relation to the tax payable by 31 January 2015.