Farm Ireland

Sunday 18 February 2018

Think long and hard on income averaging

Healthy profits will lower tax rates but opt in or out at your peril

Michael Hough

It has generally been a good year for farmers, even if you don't feel too flush after all the outstanding bills from last year have been paid off.

All the experts predict that the gradual dismantling of the EU's protectionist policies in recent years will ensure that volatility is here to stay for farm prices. The dairy sector has been a textbook example of this since the record highs of 2007, followed by the record lows of last year and the return to decent prices again this year. Weather variations have only served to intensify the fluctuations in farming fortunes.

But what has any of this got to do with tax? Income averaging is an alternative method of assessment that was provided for farmers several years ago to allow them to cope better with fluctuating farm incomes.

Normally, income tax is assessed on what is described in the accountancy trade as the 'current year basis'. However, income averaging allows farming profits to be assessed for a particular year on the basis of the average profits of the three years that ended in that particular tax year. This has now become known as the average basis of assessment (see example 1).

However, not every farmer is entitled to use the average basis. It is only available to you if you elect to be charged in this way. In addition:

(a) You must have paid your income tax on the normal 'current year basis' in respect of your farming profits for the previous two years;

(b) You or your spouse must not have another business either solely, in partnership or through a company in which you or your spouse are directors and able to control more than 25pc of the share capital in that company.

Once the election is made the profits are assessed each year on the average basis, until:

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(a) You opt out of the system. You cannot do this until you have spent at least three years in it;

(b) You or your spouse starts another business;

(c) You stop farming.

If you opt out of income averaging but continue to farm, you will revert back to the normal 'current year basis' of assessment. In addition, you will be subject to a review of the average profit for the two years immediately preceding the final average year. An additional assessment arises if the profits assessed for either, or both, of those years is less than the average profit for the final average year (see example 2).

When the system was introduced, the thinking was that it would level out the peaks and troughs, which can be a feature of farming incomes. It was not intended that you should be taxed on any more or any less of the profits that you actually made.


Where the profit level is increasing, the system does reduce the amount of tax to be paid and improves cash flow in the short term. However, the figures will level out and, of course, sometimes reduce.

This will increase tax liability and, if provision is not made for this, it will be an added pressure on cash flow (see example 3).

While significant advantage arose in the past from pushing profits out to later years mainly because of the reduction in the tax rates and the increase in the rate bands, the reverse is now the case. While there have been no increases in the rate of income tax or reduction in the tax rate bands in recent years, there have been significant increases in the health levy and a new income levy introduced last year. These levies and PRSI now amount to 14pc of income for high-income, self-employed individuals for this year.

It is fair to say that the concept of the averaging is a good idea and, when it was introduced, it was supported by the farming organisations. It was successful in the 1990s and the early 2000s as the tax rates reduced from 30pc to 20pc for the low rates and from 53pc to 41pc for the high rates.

The situation going forward will be more problematic because of the higher rates of levies and what may be coming down the track for the 2011 tax year and subsequent years. In general terms, therefore, farmers entering the scheme need to consider the situation carefully, and those already in the scheme need to consider the possibility of opting out.

Michael Hough is a tax specialist with Owen Sweetman & Co in Balbriggan, Co Dublin

Irish Independent