Averaging of profit

Produced by Tolley

The following Owner-Managed Businesses guidance note Produced 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
  • Claims for averaging relief
  • Should the taxpayer make a claim for averaging relief?

Averaging of profit

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 in order to reduce the overall liability to income tax and Class 4 national insurance contributions (NIC). 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.

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 guidance note for more information on how to assess the income for tax credits purposes.

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

Unincorporated trades with turnover of less than £150,000 (or £300,000 for universal credit claimants) can opt to use the simplified cash basis. While within the simplified cash basis, no averaging claim can be made. Therefore, if the business is considering using the simplified cash basis but routinely makes averaging claims, consideration should be given to whether moving to the simplified cash basis is worthwhile. See the Eligibility for the simplified cash basis guidance note.

Situations where averaging relief is available

The relief is available to individuals in business in the following trades, professions and vocations (subsequently referred to here as ‘qualifying trades’):

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