Farmers’ averaging election

If you carry on a farming or market gardening business, you can elect to average your profits over either two or five years.

Farming

Businesses that depend on a successful harvest are notoriously volatile in terms of profits. One bad crop can mean losing tens of thousands of pounds. Therefore, the Income Tax (Trading and Other Income) Act 2005 contains provisions that allow farmers and market gardeners to elect to average their profits over either two or five years. This can be especially useful where the differing profits mean tax is paid at a mix of different rates in each year.

The election works by adjusting the profits in the latest year, i.e. year two or year five, by an appropriate amount. The tax for earlier years is also recalculated based on the averaged profits, and over/underpayments are reconciled in that year; it does not change the tax payable for the previous years, rather it becomes an adjustment to tax payable for the latest year used in the averaging calculation. This is usually done on the tax return, but it can also be done as a standalone claim, for example where the return has already been filed and you don’t want to resubmit it.

Note. Only unincorporated businesses can use the election.

Two-year average

For two-year averaging, the profit for the year in question is simply averaged with the previous year’s profit. In order to make the election, the difference in the profits must be at least 25% of the result for the better year.

Example

James has profits of £50,000 in 2023/24, but only £20,000 in 2022/23. If he wishes, he could make a claim to treat both years as being taxed on the average profit of £35,000. This will clearly be beneficial, as it means no tax will be payable at the higher rate. Here the averaging adjustment will be -£15,000. The tax adjustment will be an increase, but this will be lower than the additional tax that would be due for 2023/24 if the election were not made.

Five-year average

A five-year averaging works on the same basis; however the latest year is averaged with the profits of the preceding four tax years. The election can be made if the difference in the profits of the latest year and average of the profits for the four previous tax years is more than 25% of the profits of the higher figure. This condition is also satisfied if any one of these years has nil profits or a loss.

Time limit

A claim for averaging must be made by the first anniversary of the filing deadling for the year the adjustment was made in. So to make a claim to average 2023/24 with 2022/23, a claim must be made by 31 January 2025.