Averaging of trading profit

By Tolley
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The following Personal Tax guidance note by Tolley provides comprehensive and up to date tax information covering:

  • Averaging of trading profit
  • Introduction
  • Situations where averaging of profit is available
  • Conditions
  • Computation of the adjustment (from 6 April 2016)
  • Computation of the adjustment (up to 5 April 2016)
  • Making a claim
  • Should the taxpayer make a claim to average profits?

Introduction

For certain taxpayers carrying on specified trades which are notoriously subject to widely fluctuating profit levels, it may be possible to average taxable profits in order to reduce the overall liability to income tax and Class 4 national insurance contributions (NIC). One such trade is farming, which is vulnerable to both market prices and the weather.

ITTOIA 2005, s 221

The rules changed on 6 April 2016. Before this date, two years’ profits could be averaged where the profits of one year were 75% or less of the profits of an adjacent year, and full averaging or marginal averaging was available depending on the difference. After this date, depending on the type of trade, either two-year or five-year averaging is available provided the 75% volatility condition is met. Marginal averaging has been abolished.

Both sets of rules are considered in this guidance note. When considering the rules that applied before 6 April 2016, you will need to consult a historic version of the Yellow Tax Handbook.

Simplified cash basis

Unincorporated businesses with turnover of less than £150,000 (or £300,000 for universal credit claimants) can opt to use the simplified cash basis. These turnover thresholds apply from 2017/18 onwards. For the thresholds that applied between 2013/14 and 2016/17, see the Simplified cash basis for small unincorporated businesses guidance note.

ITTOIA 2005, ss 31A, 31B

Whilst the unincorporated business is within the simplified cash basis, no averaging claim can be made. Therefore, if your client is considering using the simplified cash basis but routinely makes averaging claims, you will need to carefully examine whether moving to the simplified cash basis is worthwhile.

ITTOIA 2005, s 221A
Tax credits and universal credit

Note that averaging claims have no effect on the level of trading income for the purposes of

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