NASTY SHOCK IN TAX BILL?
Many farmers face the prospect of mammoth tax bills at
the end of next month. Denise Ranger looks at the
reasons and suggests some remedies
SELF-assessment arrived on Apr 6, 1996 and large numbers of tax-paying farmers are still confused by the new rules.
But many are in for a further shock, as there will be an extra large tax bill due on Jan 31, 1998.
For example, a farmer with a Sept 30 financial year end, may have made average profits in the two years to Sept 30, 1996 of £80,000, with a tax liability for 1996/97 of £27,000.
This is likely to be significantly more than the liability for 1995/96, since that was based on profits made in the year to Sept 30, 1994, when prices, yields and area payments were all lower. Assume for this example the tax bill for 1995/96 was £16,000.
Under self-assessment, the tax liability for a particular year is initially payable in two instalments – each one being half the previous years liability. These are made on Jan 31 in the tax year and July 31 following the tax year, with any balance being payable on the following Jan 31.
In the example, the 1996/97 tax bill (£27,000) will be settled as follows:
• First instalment, Jan 31, 1997 = £8,000
• Second instalment, July 31, 1997 = £8,000
• Balancing payment, Jan 31, 1998 = £11,000
The shock is that there will also be a further payment due on Jan 31, 1998 – the first instalment of the tax for 1997/98. This is based on 50% of the previous years tax due ie £13,500.
So the total payment to be made is £24,500, having a major cash flow implication for the farm business.
Few farmers have managed to maintain the 1995 and 1996 profits into 1997. This means that, in most cases, the actual tax liability for 1997/98 will be less than that incurred in 1996/97.
In the above example, profits may have fallen to £65,000, with the 1997/98 tax bill reduced to £21,000. But based on the 1996/97 tax liability (£27,000), the following payments would have been due:
• First instalment, Jan 31, 1998 = £13,500
• Second instalment, July 31, 1998 = £13,500
Therefore, an overpayment of £6000 is likely to be made, and this will only be refunded once the 1998 tax return has been processed.
Faced with this prospect, there are a number of possible courses of action which can be taken:
• Claim to reduce the instalments: This extra paperwork may be valuable, but beware of reducing the payments by too much, as interest could be payable. The objective is to ensure that accurate information is available as quickly as possible. (If, in the example, the farmer made no such claim, his tax return would not go in until Sept 1998, with his £6000 refund not going out until October at the earliest.)
• Submit tax return early: If the tax return is submitted in, say, June 1998, the second instalment of tax for 1997/98, due on July 31, 1998, will be reduced from £13,500 to £7500.
• Make pension payments: Self-assessment has also brought changes to the way in which pension payments can be relieved. The Inland Revenue no longer needs to be provided with evidence of contributions with the tax return. It is possible to have tax relief on contributions in the year of payment, or treat them as if they were paid in the previous year.
In the example, by making a pension payment of £12,000 in Dec 1997 and claiming relief in 1997/98 at 40%, the farmer will further reduce the tax bill for 1997/98 from £21,000 to £16,200. If no action is taken to reduce the instalments and the tax return is submitted in Sept 1998, then a repayment of £10,800 will be made.
There is clearly a cash flow advantage to be gained if the tax return is also submitted in June 1998, as the payment due on July 31, 1998 will be reduced from £13,500 to just £2700.
But, if it is decided to treat the pension payment of £12,000 as if it were made in 1996/97, and the claim is made immediately after making the contribution, then it will be the Jan 31, 1998 instalment which will be reduced to £2700.
And if the 1997 accounts had already been finalised, then both instalments could be reduced by a further £3000.
The message is that timing is everything. Completing both accounts and tax returns as quickly as possible means that you can plan your cash flow more accurately and avoid making loans to the Inland Revenue.
• Denise Ranger is a tax specialist with Swindon-based accountants Morison Stoneham.n