HMRC Consultation Document Income Tax: Extension of averaging period for farmers Response by the Chartered Institute of Taxation 1 Introduction 1.1 This consultation discusses the extension of the averaging period for famers profits to 5 years from tax year 2016-17 announced by the Government, and how the extension could be designed and implemented. 2 Executive summary 2.1 Overall, we support the proposals so long as they are adapted so that if averaging is possible under the current rules, it will also be possible under the proposed new rules. The exception would be where averaging is currently possible only through the marginal relief rules. We believe there is an overriding need for any changes introduced to provide a flexible and workable regime and this belief drives our comments. 2.2 We suggest that a 2 year averaging period will in many cases produce an equivalent outcome to a five year rolling averaging period. Accordingly, we propose that the current averaging period of 2 years should be retained as an option, in addition to an extended averaging period of 5 years. In some cases, averaging over 2 years may be all that is required to smooth the level of profits. In other cases, income may be more volatile over a prolonged period of time, such that a 5 year averaging would be beneficial. Whilst we accept that the provision of either a 2 or 5 year averaging period would be an additional complexity, it would give more flexibility to the farming sector, which we believe should be the decisive consideration. 2.3 We prefer Option A, adapted to continue the choice of 2 year averaging, as it is based on current rules and we think that there will be a better take up compared to Option B. In our view, it will be very difficult for a taxpayer to take the decision to make (or an adviser to recommend that their client makes) an irrevocable opt in
election for 5 years in advance (Option B), because income cannot usually be predicted. 2.4 We understand that some taxpayers do not claim averaging when it would have been worthwhile for them to do so, so we ask that in conjunction with these changes HMRC produce targeted publicity to ensure that all those affected are aware of the options available to them. 3 Question 1 Are there any other aspects of the current rules that should be retained? 3.1 The retention of the aspects of the current regime as detailed in paragraph 3.5 is welcome. The basic principles of the current relief are familiar and well understood. We see no reason to change them however see 3.2 and 3.3 below. 3.2 We understand that there are no plans to alter the rule that no averaging claim is permitted in the years of commencement or cessation (including the year a partner joins or leaves a partnership). Relaxing this restriction would be a significant simplification, particularly for large partnerships. 3.3 As mentioned above, we think the current 2 year averaging period should be retained as an option, as well as introducing an extended 5 year averaging period. This would increase the flexibility of the regime. 3.4 Currently, there is one set of averaging rules for all sectors to which averaging applies (farming, market gardening, the intensive rearing in the UK of livestock or fish on a commercial basis for the production of food for human consumption and profits from creative works). The consultation document proposes that the extension of the averaging period from 2 to 5 years will not apply to profits from creative works, meaning that in future there will be two different sets of averaging rules. 3.5 Whilst the number of taxpayers who will be directly affected by this discrepancy may be small (the author farmer ), having two sets of averaging rules does introduce a new level of complexity into the legislation. 3.6 We foresee that extending the averaging period to 5 years may cause difficulties for advisers where records have to be obtained from previous advisers following a change in agent. At present it is usual to request only the previous year s information, as that is all that is required for 2 year averaging. 3.7 Additionally, there will be increased compliance costs involved in averaging over a 5 year period, compared to a 2 year period. For example, often calculations are carried out manually as commercial software that is realistic and affordable does not usually offer averaging solutions. Carrying out an annual exercise for a 5 year period will be time consuming and will inevitably be reflected in fees passed to the farmer. 4 Question 2 Do you agree the proposed methodology for applying the volatility test under Option A, if not please explain your reasoning? 4.1 On the whole, yes. However, there are bound to be some occasions where the 5 year rule will not work with the 70% volatility rule. In other words, averaging may be P/tech/subsfinal/OMB/2015 2
possible over a 5 year period under current rules using a 2 year rolling averaging but it will not possible under the Option A proposal. 4.2 Therefore, where there is limited volatility within a five year period, it may be helpful to retain the option of a two year averaging period. 4.3 It seems sensible to define the volatility test as also having been met if a loss has arisen in any of the relevant 5 years. However, the volatility calculation of the 5 year option gives inconsistent results, eg a slight adjustment such as a 1 profit rather than 1 loss might mean that averaging was not available. 4.4 As the averaging claim would have the effect of averaging 5 years profits, we can foresee that this will be problematic where pension contributions have been made in a good year. An averaging claim could negate the net relevant earnings on which pension contributions are based, thus denying the farmer the opportunity to increase his retirement provisions with the support of tax relief. Indeed, it could lead to the pension contributions made even five years earlier being returned. This is one of the reasons why we favour retaining 2 year averaging alongside the introduction of 5 year averaging. 5 Question 3 Do you agree that a marginal relief should be omitted from the new rules? 5.1 Yes. This would be a welcome simplification. It clearly makes sense at the same time that the changes are being introduced to consider how the relief can be simplified in order to reduce complexity in the way averaging operates. 6 Question 4 Would Option A (including transitional arrangements) achieve the aim of delivering the 5 year extension to averaging while reducing complexity in the way that the relief works? 6.1 Yes, although see paragraphs 3.3 (retain current 2 year averaging) and 4.1 above. 6.2 We can also foresee that extending the averaging period to 5 years will make dealing with income tax payments on account more complex. 6.3 It might be that the rolling 5 year option could be changed to successive 5 year claims (in addition to retaining the current 2 year option). That could provide the benefit of the 5 year extension whilst also minimising compliance costs, as the extra calculations would only be needed in 5 year cycles. 7 Question 5 Would Option B (including transitional arrangements) achieve the aim of delivering the 5 year extension to averaging while reducing complexity in the way that the relief works? 7.1 In our view, an irrevocable opt in election for 5 years is not desirable because income cannot usually be foreseen. The purpose of averaging is to enable the taxpayer, legitimately in accordance with policy, to drop out of a higher tax bracket as P/tech/subsfinal/OMB/2015 3
a result, and this cannot be predicted. We note that many factors in addition to statutory tax bands and rates affect an individual s overall tax liability each year. 7.2 Option B would be less inflexible if there was an option to revoke the election if circumstances changed so that it became disadvantageous to claim averaging. However, this would have the disadvantage of introducing complexity into the system, and is another reason for rejecting Option B. 7.3 Averaging over a number of years may not always be advantageous for many reasons, for example if the taxpayer has other taxable income where sideways loss relief would be available or where pension contributions are made. Interaction with other factors, eg tax credits, student loans, gift aid and other income complicate the assessment of whether or not a 5 year election would be beneficial. 8 Question 6 - We would welcome your views on the two alternative frameworks. What are (a) the advantages and disadvantages of Option A? 8.1 We favour Option A because it will enable averaging only when it is clearly advantageous to do so. The retention of many aspects of the current system is also an advantage. However, we believe it should be augmented by retaining the current 2 year averaging as an option. 9 And what are (b) the advantages and disadvantages of Option B? 9.1 We can see that Option B has the advantage of being very simple to understand and administer, so it may be suitable for farmers with simple tax affairs. Its relative simplicity may also encourage those taxpayers who have previously not used averaging when it would have been advantageous to do so. However, we believe that it should only be considered as an opt in election rather than a mandatory regime. 9.2 We note that HMRC s conclusion (paragraph 3.23 of the consultation document) is that averaging over a number of years will almost always be advantageous (although there will be some exceptions) and we understand that calculations by the National Farmers Union based on DEFRA industry figures have shown that 5 year averaging will generally give a tax benefit. However, that is for average farmers and ignores the many farming businesses outside the middle ground. We think that it will be a difficult task to convince taxpayers that there are no risks attached to opting in to an irrevocable election. 9.3 Overall therefore, we believe that the advantages of Option B are outweighed by the disadvantage of it being an irrevocable election. This makes it too inflexible. It will be very difficult to advise a farming client that such an election is worthwhile since it is going to be impossible to predict future levels of income. It would be unfortunate to say the least if legislating for Option B produced a decline in the number of farmers taking advantage of averaging. 9.4 We prefer Option A (adapted to retain 2 year averaging), but if Option B were to be implemented, we think that consideration ought to be given to making it a revocable election. We also believe that retaining the current 2 year averaging as an additional choice should be included with Option B, just as for Option A. The reason is to improve flexibility to cater for widely differing personal circumstances. P/tech/subsfinal/OMB/2015 4
10 Question 7 - Do you consider that there are circumstances in which the options would give rise to outcomes inconsistent with the policy objectives outlined in paragraph 1.6 and, if so, in what circumstances and how might these situations be addressed? 10.1 No further comments. 11 The Chartered Institute of Taxation 11.1 The Chartered Institute of Taxation (CIOT) is the leading professional body in the United Kingdom concerned solely with taxation. The CIOT is an educational charity, promoting education and study of the administration and practice of taxation. One of our key aims is to work for a better, more efficient, tax system for all affected by it taxpayers, their advisers and the authorities. The CIOT s work covers all aspects of taxation, including direct and indirect taxes and duties. Through our Low Incomes Tax Reform Group (LITRG), the CIOT has a particular focus on improving the tax system, including tax credits and benefits, for the unrepresented taxpayer. The CIOT draws on our members experience in private practice, commerce and industry, government and academia to improve tax administration and propose and explain how tax policy objectives can most effectively be achieved. We also link to, and draw on, similar leading professional tax bodies in other countries. The CIOT s comments and recommendations on tax issues are made in line with our charitable objectives: we are politically neutral in our work. The CIOT s 17,000 members have the practising title of Chartered Tax Adviser and the designatory letters CTA, to represent the leading tax qualification. The Chartered Institute of Taxation 7 September 2015 P/tech/subsfinal/OMB/2015 5