The ability to offset farming losses against total income will be restricted from 6 April this year. A proposal for this is expected to be confirmed in the Budget on 20 March.
Currently, when an individual (sole trader or partner in a partnership) suffers a trading loss, this can be set against total income in the tax year of the loss, or the previous tax year.
This makes immediate tax relief available against business profits made in the previous year and also against non-farming income such as rental income, or income from diversified businesses.
The current loss relief can offer a significant cashflow advantage and is extremely useful for businesses such as fruit and potato growers, which tend to suffer “yo-yo” profits and losses.
For example, if a loss was suffered in a farm accounting year ended 30 April 2012, this can be set against total income for the tax year ended 5 April 2013 or for the year ended 5 April 2012.
The proposed change in the legislation will restrict the ability to set trading losses against total income to £50,000 or 25% of total income in any tax year, whichever is the greater.
To illustrate how the change in legislation will work, this example (see right) ignores the effect of farmers’ averaging of profits. Farmers’ averaging can reduce the impact of the change, but this depends on taxable profits and marginal rates of tax for earlier and later years.
The increase in Annual Investment Allowance on plant and machinery to £250,000 from January 2013, combined with the weather of the past 12 months, may mean that many farming sole traders and partnerships will have a tax loss in the year ended 5 April 2013 and 2014. The proposed change in legislation may restrict the ability to offset this loss.
The first accounting period to be affected is the first one ending after 5 April 2013 and many businesses may have an opportunity to reduce the impact of the proposed change.
Planning could include:
A sole trader introducing a spouse as a partner, or a spouse becoming an additional partner in a partnership to qualify more individuals for £50,000 each of loss relief in a tax year
Moving to a company structure before 5 April 2013 – depending on the year end of the business, this could crystallise a loss arising from the 2012 harvest before the loss relief restriction comes into force
Even where results from harvest 2012 will fall in the year ended 5 April 2013, for example a March year end, there may be tax benefits from transferring a business that is likely to have “yo-yo” profits to a company. This is because while a loss can be set against current year profits, a company can also set a trading loss against total profits for the previous 12 months with no upper limit.
However, where changes are planned to the structure of a farming business, the effect on the entitlement to single farm payments should be considered.
Review business structure
A farm business structure should be regularly reviewed to ensure that it is the most appropriate for the family, the business and future development.
While partnerships offer great flexibility this may not be the most tax-efficient structure.
There is a significant difference between the top rate of income tax paid by partners and sole traders at 50% and corporation tax rates of 20-25%. So, operating as a company can be tax efficient for a farming business and this can work alongside an existing partnership in some cases.
The retirement and/or introduction of a partner, or a change in the tax legislation, can be an ideal time to make a change in structure.
However, tax should not be the only consideration in choosing how to operate and specific advice should be taken on the implications of changes.
The company route is not for all and will be influenced by the level of profits extracted from the business and whether the business is financed by loans, as well as many other considerations.
• Peter Griffiths is a tax director with Hazlewoods LLP’s agriculture team