Averaging profits for farmers and market gardeners

Farmers, market gardeners and certain others have the ability to average their profits to smooth out fluctuating results, which may otherwise result in volatile tax bills. But how can they benefit from an averaging election and what key points should they be aware of? Partner Vivien Hogg explains.

Eligible and available?
‘Averaging’ is available to sole traders and partners, (excluding corporate partners, executors, personal representative and trustees) who are carrying on a trade of farming or market gardening, or the intensive rearing of fish or livestock for human consumption. It is also available to certain other traders, e.g. creative artists. It is not available to companies and eligible traders can choose whether to average their profits over two or five consecutive years.

A claim cannot be made for the tax year in which the trade commences or the tax year in which a partner joins the partnership.

Averaging is not available where accounts are prepared on the cash basis.

Profits which can be averaged
The profits which are available for averaging are the trade profits chargeable to income tax after the deduction of capital allowances and balancing allowances and the addition of balancing charges. After any adjustment for compensation for the compulsory slaughter of animals, but before any deduction for losses.

For averaging purposes, losses are counted as nil.

Once profits have been averaged, they are used in any later averaging claim, rather than the original (pre-averaging) profits.

Two-year averaging
A claim can be made to average the profits of two consecutive years if one year is less than 75% of the profits of the other year, or if the profits of one year (but not both years) are nil.

EXAMPLE. Gillian has been trading for many years as a market gardener. She has profits of £7,000 in 2023/24 and £55,000 in 2024/25. The 75% test is met, and she makes an averaging claim. As a result, her profits for 2023/24 and 2024/25 are adjusted to £31,000. This is beneficial, as it prevents part of her 2023/24 personal allowance from being wasted and stops her paying tax at the higher rate in 2024/25.

Five-year averaging
A five-year averaging claim can be made if the volatility condition is met. This is the case if one of the following is less than 75% of the other:

• The average of the relevant profits for the first four years to which the claim relates:

and

• The relevant profits of the last of the tax years to which the claim relates.

Making the claim
The claim must be made no later than the first anniversary of the normal self-assessment filing date for the last of the two years. So, where the last tax year for either a two-year or a five-year claim is 2024/25, the claim must be made before 31 January 2027. It can be made in the self-assessment tax return.

IN SUMMARY
If eligible, you should calculate average profits for the previous two and previous five consecutive tax years when you are preparing tax returns to see whether an averaging claim is beneficial. Remember, where a previous averaging claim has been made, the averaged profits are used in the new calculation.

Contact the JRW Hogg & Thorburn team to discuss this further and any other related questions you may have.