Reclaiming the cost of losses: Tax relief options for rural businesses

By Heather Bright, Partner and ARA specialist

The past two years have presented many farming and rural businesses with greater losses than were ever anticipated.

A combination of poor yields, difficult weather, rising input costs due to geopolitical chaos and the unwinding of direct support payments has left a number of businesses recording losses for the first time.

When a business makes a loss, it is easy to focus on the immediate cash impact. Whilst this can’t be ignored, the tax system offers a range of mechanisms to offset those losses against profits or other income.

Understanding which relief applies to your situation, and using it correctly and at the right time, can make a material difference to the financial position of the business.

The main loss relief options

For sole traders and farming partnerships, the principal options are as follows:

Sideways loss relief

Trading losses can be set against other income in the same tax year or the previous tax year. For a farmer who also has employment income, rental income or other taxable sources, sideways relief can generate a refund or reduction relatively quickly.

However, losses from farming activities that have been made in each of the previous five years may be restricted under the ‘hobby farming’ rules, which are designed to prevent indefinite loss relief claims against other income.

Carry back

Where a loss cannot be fully relieved against current-year income, it may be possible to carry it back to the previous tax year and recover tax already paid. This can turn a previous loss into a cash repayment from HMRC.

Carry forward

If neither sideways relief nor carry back is possible or appropriate, trading losses can be carried forward and offset against future profits from the same trade. This is the most straightforward option but provides no immediate cash benefit. The value of the relief depends on when, and at what rate, the business returns to profit.

Terminal loss relief

Where a farming business is ceasing to trade, losses arising in the final 12 months can be carried back up to three years against profits of the same trade. This can be significant where a business has had profitable years prior to a difficult final period.

Capital losses

Where a capital asset, such as land, buildings or machinery, is disposed of at a loss, the loss can generally be offset against capital gains arising in the same or future tax years.

Farmers’ averaging

Loss reliefs deal with bad years one at a time. However, for many farming businesses, the deeper challenge is the volatility itself of moving from a strong year to a poor one and back again and the way the tax system can take a disproportionate bite out of the good years that should be funding the lean ones.

Farmers’ averaging is designed for exactly that. Available to sole traders and farming partnerships, but not to incorporated farming businesses, it allows qualifying farming profits to be averaged over either two years or five years, with tax then calculated on the averaged figure rather than the raw, year-by-year result.

Two-year averaging applies where one year’s profits are 75 per cent or less of the other – in other words, where the gap is more than 25 per cent.

Five-year averaging, introduced in 2016 specifically because farming cycles often run longer than two years, applies where the latest year’s profit differs from the average of the previous four by more than 25 per cent.

The volatility test is automatically met where any of the years in the claim is nil or a loss, which is why averaging has become particularly valuable for many businesses navigating the conditions of the past few years.

A few important interactions are worth noting. Losses are treated as nil within the averaging calculation itself, but loss relief remains fully available under the normal rules. This means a year with loss can both trigger an averaging claim and generate sideways or carry-back relief in its own right.

Averaging applies only to farming profits (after capital allowances), so income from diversified activities such as renewables, leisure or property letting must be considered separately.

Transitional profits arising under the recent basis period reform are also outside the averaging rules.

Used well, averaging is one of the most effective tools in a farmer’s tax armoury, particularly when good and bad years sit alongside one another.

Used poorly, or not at all, it leaves businesses paying tax on volatility rather than on underlying performance.

The position for companies

Incorporated farming businesses have a broadly similar set of options, though the mechanics behind each relief differs.

Companies can carry trading losses back against total profits of the previous 12 months, carry them forward against future total profits or, where the company is part of a group, potentially surrender losses to other group members.

There is no sideways relief equivalent for companies outside of the group relief rules.

One frequently overlooked point is the timing of when a loss is claimed, as this can significantly affect its value.

Practical steps

The most important step is not to assume that a loss year simply means a lower tax bill or no tax bill at all, as the rules are far more nuanced than this.

The mechanics of loss relief are often complex, particularly where a farming business has multiple income streams or where the ‘hobby farming’ rules apply.

If you would like to discuss how this may affect your farming business, the Moore Thompson ARA team would be happy to help. Please contact us at 01775 711333.