Averaging profits
It could be argued that farmers, artists, musicians, market gardeners and authors would be strange bedfellows but that is the not the case in the tax world. They share a common relief known as averaging.
If you are a sole trader or a partnership where in excess of 50% of your income is derived from creative works, you can potentially average your profits over two consecutive tax years.
If you are a farmer or market gardener, as long as you are not carrying on an agricultural contracting trade and there are no substantial non-farming activities, you can go one better and possibly choose between averaging profits over 2 or 5 consecutive tax years.
Where averaging has taken place, the new averaged profits can be used in any claim for averaging in later years.
Depending upon the circumstances, the potential benefits from averaging might be:
► A reduction in the total amount of tax and NI payable over the 2 or 5 year aggregated tax years.
► Enabling an individual to pay more into their pension scheme.
► Mitigating or wiping out any high income child benefit charge. There are conditions attached of course, such as:
► Companies or corporate partners cannot make an averaging claim.
► No claim can be made as regards the profits arising in either the commencement or cessation years of trading.
► For a 2 year averaging claim to be made the average profit of the two years in aggregate must be more than 25% of the profits of the tax year with the better result, or one of the years the profit is nil (i.e. a loss making year).
For example:
►William Shakespeare’s profits for 2023/24 tax year were £10,000 and for 2022/23 tax year £40,000.
► If averaging is claimed the profit per tax year would be £25,000 which is greater than 25% of the 2022/23 profit figure – i.e. £10,000 (25% x £40,000).
► Therefore a claim can be made.
► For a five year averaging claim to be made the difference between the current tax year profit and the average of the previous 4 tax year profits must be more than 25% of the highest profit or one or more of the tax year profits is nil.
For example:
► Farmer Massey’s 5 years taxable profits are:
2023/24 £60,000
2022/23 £50,000
2021/22 £20,000
2020/21 £50,000
2019/20 £20,000
► If averaging is claimed the profit for each year becomes £40,000.
► The average profits for the tax years 2019/20 through to 2022/23 inclusive are £35,000.
► The difference between Massey’s profits for 2023/24 of £60,000 and the average of the previous 4 tax years
is £25,000. This is greater than 25% of the highest profit figure, i.e. £15,000 (25% of £60,000).
► Therefore a claim can be made.
Please do not hesitate to contact us if you would like us to review your situation to see if an averaging claim is feasible and of benefit to you.