Creative Artists – Averaging of Profits Print
Individuals and partnerships whose profits are derived from qualifying creative works are able to average their profits to help smooth out the tax effects on fluctuating income. Creative works are defined as literary, dramatic, musical or artistic works, or designs created by the individual or by one or more of the partners personally.
A claim to averaging must be made not later than the first anniversary of 31 January following the second of the two years to be averaged. Accordingly, a claim for averaging the profits of the year 2019/20 with the profits of 2020/21 must be made by 31 January 2023. Full averaging is only available where the profit of one of the years is 70% or less than the profit of the other year.
John, an established artist has made profits of £60,000, and £26,000 for the years ended 31 March 2020, and 2021 respectively. John may claim that his taxable profit for each of these years be adjusted to £43,000. The benefit to John is that he is able to avoid higher rate tax on the taxable profits of £10,000 in excess of his personal allowance and the basic rate band for 2019/20 [i.e. £60,000 – (£12,500 + £37,500)] which is instead taxed at the basic rate for 2020/21.
Where the profit of one year is between 70% and 75% of the profit of the other year, a form of marginal relief is due, and the adjustment is calculated by applying the formula: (D x 3) – (P x 0.75)
D = the difference between the profits for the two years P = the higher of the two year’s profits
The adjustment figure arrived at is then added to the lower year’s profit, and deducted from the higher year’s profit.
Following on from the above example, if John’s profit for the year ending 31 March 2022 is £58,000, the adjustment for 2020/21 and 2021/22 would be as follows:
|Previously averaged profit for 2020/21||43,000|
|Profit for the year ending 31st March 2022||58,000|
|Applying the formula:||(15,000 x 3) – (58,000 x 0.75)
(45,000) – (43,500)
|The profit for 2020/21 now becomes||(43,000 + 1,500)||44,500|
|The profit for 2021/22 is adjusted to||(58,000 – 1,500)||56,500|
The effect of this would be to reduce the profit for 2021/22 on which higher rate tax is payable by £1,500, so the benefit of claiming averaging for these two years is £300. [£1,500 x (40% – 20%)] An averaging claim may also be effective to reduce a tax liability which would otherwise be chargeable at the top rate of 45%. This may be of particular relevance to authors who receive a large advance in year 1, and little, or no royalty income during the following year.
Where the profit for one of the years is more than 75% of the profit of the other year, no averaging claim may be made.
Averaging claims cannot be made for a tax year during which the individual begins, or permanently ceases to carry on the qualifying business, or the business begins, or ceases to be a qualifying trade, profession, or vocation.
Although an averaging claim affects the profit taxable for two years, the claim is actually given in the second year only. This is done by adjusting the second year’s profit to the averaged profit, and then adjusting the tax liability to take into account the adjustment required for the earlier year. If the adjustment to the earlier year is a reduction in tax, this is treated as additional payments on account in the second year. If the tax for the earlier year increases, this increase is added to the tax payable for the second year.
In the case of a partnership, the claim is made by each individual partner with regard to his own share of the profits. It is not necessary for all partners to claim this treatment, and whether a claim is beneficial may well depend upon other factors outside of the partnership. A claim to other reliefs, or a claim to have such reliefs amended or revoked, which would otherwise be out of date, may be included in an averaging claim at any time up to the latest date on which the averaging claim could be made.
The treatment for Class 4 NIC purposes follows the income tax treatment of the averaged profits.
Farmers have the option of averaging their profits over a 2 year period, or averaging over a 5 year period. The averaging period for creative artists remains at 2 years.