Averaging of profit

By Tolley
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The following Owner-Managed Businesses guidance note by Tolley provides comprehensive and up to date tax information covering:

  • Averaging of profit
  • Situations where averaging relief is available
  • Conditions for a two-year averaging claim
  • Conditions for a five-year averaging claim
  • Computation of the adjustment ― two-year averaging
  • Computation of the adjustment ― five-year averaging
  • Marginal averaging relief applying before 6 April 2017
  • Claims for averaging relief
  • Should the taxpayer make a claim for averaging relief?

For certain taxpayers carrying on specified trades which are notoriously subject to widely fluctuating profit levels, a relief is available which aims to average taxable profits in consecutive years. For example, farming income is dependent on two uncontrollable factors: the weather and market prices. Due to these factors, farming income is unpredictable. The income of creative artists can be similarly unreliable.

ITTOIA 2005, s 221

The original rules applied averaging to two successive years. However, with effect for 2016/17 and subsequent years there is an alternative option for farmers and market gardeners (but not creative artists) to average profits over five years rather than two.

With effect from 2016/17, full averaging relief is available where the profits of one tax year are 75%, or less, of the profits of an adjacent year (70% or less before 2016/17). Before 2016/17, where there was some fluctuation but not sufficient to qualify for full averaging there was also a ‘marginal’ averaging relief available (see below).

Averaging seeks to provide a more predictable tax liability than that originally calculated. For example, it allows farmers to smooth out the effect of poor harvests, by averaging their taxable income between one or more tax years. The mechanics of the calculations are considered below.

Please note that averaging claims have no effect on the level of trading income for the purposes of tax credits. The profit used for tax credits is the taxable profit for the year before averaging is applied. See the Trading profits and losses and tax credits (subscription sensitive) guidance note for more information on how to assess the income for tax credits purposes.

SI 2002/2006, reg 6 (subscription sensitive)

Neither do averaging claims have an effect on the calculation of the self-employed income for the purposes of the universal credit.

SI 2013/376, regs 57–59 (subscription sensitive)

Unincorporated trades with turnover of less