Some self-employed individuals experience significant fluctuations in their profits from one year to the next. When this happens, HMRC’s averaging relief may help to regularise tax payments by levelling profits across more than one tax year.
However, the relief is only available to limited groups of taxpayers. Farmers and market gardeners can claim to average profits over either two or five consecutive tax years, while creators of literary or artistic works, such as authors, artists and composers, can average profits over two consecutive tax years.
Averaging relief is intended to reduce the impact of unusually high or low profits in a particular year. By spreading profits over the relevant period, it may reduce the amount of tax payable where income would otherwise push a taxpayer into a higher tax band or affect National Insurance liabilities.
The relief is most beneficial where your tax position differs between years. For example, it may reduce your tax bill if you pay tax at the basic rate in one year and the higher rate in another, or if your income falls below your personal allowances in one year but is taxable in another. However, it is unlikely to provide any benefit if you are already paying the highest rate of tax and Class 4 National Insurance contributions in every year being averaged.
The relief is not available to companies and generally cannot be claimed by businesses using the cash basis. Specific conditions must also be met before a claim can be made, including rules on the level of profit fluctuations between the relevant tax years.
Claims are made through self-assessment for the latest tax year. Rather than requiring earlier tax returns to be amended, HMRC adjusts the tax and National Insurance position for the claim year to reflect the averaging calculation.
If your profits vary considerably from year to year and work in a qualifying business, it is worth checking whether averaging relief is available. Claiming the relief where eligible could reduce your tax bill and provide a fairer reflection of your business profits over time.