Last year was a perceived tough one for farming. However, not all farms had it as tough as thought. A good back-end weather wise led to increased output, particularly in dairying, leaving increased profit.

Income volatility measures are limited in the Irish tax code, although this may change in the future.

Income averaging was introduced in 1974 as a measure to allow a smoothing of farm incomes over a three-year average period.

The purpose was to ensure that farmers paid tax on an even amount of profit over this three-year period.

In 2015, with increased volatility a change was made in that the averaging period was changed from three to five years.

Under three-year averaging

  • 2013: €45,000.
  • 2014: €60,000.
  • 2015: €50,000.
  • Averaged profit: €51,666.
  • Under five-year averaging

  • 2011: €35,000.
  • 2012: €40,000.
  • 2013: €45,000.
  • 2014: €60,000.
  • 2015: €50,000.
  • Averaged profit: €46,000.
  • However, if we looked at 2016 and if this person had a further drop in income in 2016, then the effect would have been.

  • 2012: €40,000.
  • 2013: €45,000.
  • 2014: €60,000.
  • 2015: €50,000.
  • 2016: €30,000.
  • The averaged profit in this case would have been €45,000, resulting in a tax liability on €15,000 of income that was effectively deferred from other years.

    This diverting of profits would have resulted in cashflow difficulties for this individual in 2016 with tax being liable on €45,000.

    Recognising the problems, the budget successfully brought a relieving mechanism whereby the farmer could opt to be taxed on the actual profits, ie €30,000 and defer €15,000 over a couple of years to spread the tax cost over a few years.

    This was a major change and should be looked on as an incremental change.

    A lot of negativity has been written about averaging but this is written from the perspective of looking at it in one year only instead of over a number of years.

    If averaging is used correctly and income is rising or income is fluctuating, averaging will in most cases be beneficial.

    However, most people only focus on averaging when income is falling, forgetting about the benefits that may have arisen in other years.

    Averaging is not the panacea for volatility but is a mechanism that is useful as a medium- to longer-term solution.

    Like all tax breaks, there are a number of tax traps that can work against you.

  • You must be in business a number of years before you can claim.
  • If you or your spouse carry out another trade then you are precluded.
  • If you opt out of averaging, it takes a number of years before you can re-enter.
  • Options to manage volatility

  • Farm partnerships: this will spread the income in a good year over the partners and possibly ensure that you are taxed at the low rate only.
  • Farm limited company: if profits fluctuate wildly then why not consider a limited company? In a good year, it will preserve income as it will only be taxed at the low rate, ensuring you have a reserve for the poorer year.
  • Example of income averaging

    A drystock farmer changed his system to dairy over the last number of years –profit €150,000 in 2016. Without income averaging, his tax bill would be in the region of €50,000.

    With averaging, the position is:

  • 2012: €32,000.
  • 2013: €42,000.
  • 2014: €74,000.
  • 2015: €67,000.
  • 2016: €150,000.
  • However, on averaging, he will be taxed on €73,000 before capital allowance thus reducing his tax bill to approximately €15,000.

    However the high profit will be in the equation for the next number of years.

    If we take a reverse case where profits have dropped significantly, the averaging is a major disadvantage.

    However, if you opt out of averaging in a bad year you will not be able to re-enter for five years.

    Averaging is a tool that must be used and looked at over the medium term as against one year. Remember, with averaging tax planning within the farm gate is harder.

    Recommendations

  • In income averaging, you need to look at the effect/benefits over a number of years.
  • By opting off income averaging, you will be disqualifying yourself from entering back into it for a number of years.
  • If you opt off and there is a spike in profits over the next number of years, how can you control same from a tax management perspective?
  • Where there is complete cessation of the trade, eg by changing structure or moving to a limited company, the move off averaging could benefit the business in that there will only be a revision on the previous year – a one-year revision.
  • Review your remaining capital allowance claim for the next two to three years.
  • Averaging

  • 31 December year-end: where an individual is completing accounts to 31 December averaging is more likely to be beneficial for the year to 31 December 2015. As profits may fall for 31 December 2016 and with the move to the five-year averaging bringing in 31 December 2012, this will cause a higher average profit than normal.
  • 31 March year-end: if you are on a 31 March year-end, the effect of the move to five-year averaging will not fully hit until 31 March 2016. Accounts for 31 March 2015 will effectively be for the production year 2014, which is regarded as a good year in farming and averaging will still be beneficial in most cases. Then you look at 31 March 2017, which may not be as good but 31 March 2018 would be better.
  • Estimate your likely profit to 31 March 2018 and make a judgment call.
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