Aricle by Arthur Sellwood, a former Inspector of Taxes who writes on tax subjects. Published in the December 2001 issue of Tax Adviser.
KEY POINTS - The profits of some professions are subject to fluctuation or early cessation
- New reliefs are available for creative artists
- Method of relief echoes that for farmers
- Claims are voluntary – not enforced
Some types of business, especially in professional fields, are prevented by special factors from having an enduring existence or one undisturbed by violent fluctuations. A professional sportsman’s career will often be relatively short. The strength and stamina of those such as Sir Steve Redgrave must eventually ebb and in the average case will do so more quickly than in his.
Profits of farmers may be much affected by weather, government restrictions, diseases and slaughter of livestock and unexpected contamination, or failures of crops. The taxation difficulties inherent in resultant fluctuating profits has been recognised for some years past by the provision of averaging relief in Taxes Act 1988 (TA1988), s. 96.
Creative artists
Taxpayers, like authors and artists, may have similar fluctuations in profits, although from different causes Compilation of a book may be spread over a long period because it needs much research or because the author is very slow and methodical. During such periods income may be small. At other times profits may accumulate very rapidly as, for instance, on the outright disposal of a copyright or the sale of theatrical or film rights. Without special legislation such situations could lead to great unevenness of profits and the consequential incidence of taxation. For some years, however, there has been legislation to give relief for some such problems The legislation, which did not apply to partnerships or companies, was to be found at TA1988, s. 534ff.
Authors of a literary, dramatic, musical or artistic work could, in the case of new works which took more than one year to write, spread income arising from the grant or assignment of copyrights backwards under TA1988, s. 534. If the period taken in production of the work exceeded 12 months but was less than 24 months the income could be spread back over two years. If the period was longer than 24 months the income could be spread back over three years. In the case of painters and sculptors TA1988, s. 538 permitted the application of the rules where although the work took less than a year to produce it formed part of an exhibition that took more than a year to prepare.
Where an author assigned, or granted an interest in, the copyright of a work more than ten years after the first publication of a work, the income arising could under TA1988, s.535 be spread forward. The consideration had to consist wholly or partly in a lump sum which would otherwise have been taxable in a single year of assessment and the copyright had to be assigned or granted for a period of not less than two years. If the period of assignment or grant was not less than six years the amount receivable could be spread forward evenly over six years. For shorter periods the spreading was in accordance with the number of complete years.
A new era
It has now been decided to bring to an end the system of relief set out above and to substitute a new one. By virtue of Finance Act 2001 (FA2001), s.71 the sections under which the old relief operates, namely TA1988 s. 534, 535, 537A and 538, are repealed with effect in relation to payments actually receivable on or after 6 April 2001. It would appear that while claims in respect of the year 2000/2001 are still in date, a claim may be made under the old rules in respect of events taking place in that year even if a claim is made for 2000/2001 and 2001/2002 under the new rules.
The new rules apply an averaging system, very similar to that for farmers, by the insertion into TA1988 of a new s. 95A which makes operative from 2000/2001 a new Sch. 4A. The first possible years for averaging are 2000/2001 and 2001/2002 and details of the provisions of new Sch. 4A are set out in FA 2001 Sch. 24. Publicity has been given to the fact that under the new system:
- profits as a whole rather than the proceeds of individual works are relieved,
- there is no longer a requirement that completion of a work must have exceeded 12 months,
- works created in partnership can be relieved.
The new system does, however, only apply to creative artists falling under Sch. D Cases I and II whereas the earlier system applied also to those assessed under Case VI. The rules specify that an individual may make an averaging claim if his profits from a qualifying trade, profession or vocation fluctuate from one year to the next. A qualifying trade, profession or vocation exists if the taxpayers’ profits from it are derived wholly or mainly from qualifying creative works and are chargeable to tax under Sch. D Cases I or II. Qualifying creative works are defined as meaning literary, dramatic, musical or artistic works or designs created by the taxpayer personally or, where the trade, profession or vocation is carried on in partnership, by one or more of the partners personally. Some authors and artists operate through companies and to some extent already average out their profits by way of deciding what they will draw by way of remuneration and dividends from the earnings paid into the companies. As companies cannot participate in the new relief such authors and artists may prefer to continue as before.
The operation of the relief
If the relevant profits for one of two consecutive years amount to no more than 70 per cent of the relevant profits of the other year the profits are averaged over the two years. If the profits of one of the two years are £25,000 and of the other year £15,000 the effect of the relief is to treat the taxable profit of each year as £20,000.
If the profits of the lower year are more than 70 per cent, but less than 75 per cent of those of the higher year, marginal relief may be claimed on the formula:
(D x 3) – (P x 0.75) where:
D is the difference between the relevant profits for the two years and
P is the taxpayer’s relevant profits of the higher year.
The amount brought out by this formula is added to the profits for the lower year and deducted from those of the higher year.
Example A – Marginal relief
An author’s profits for 2001/2 are £32,000 and in 2002/3 are £23,000.
Under the formula the result is £3,000 namely:
£32,000 - £23,000 = (£9,000 x 3) – (75 per cent x £32,000)
The profits for 2001/2 are reduced to £29,000 and those of 2002/3 are increased to £26,000.
Effect is given to a claim by adjusting the tax payable for the later of the two years. The liability for the earlier year is not amended. If the amount originally chargeable exceeds the amount due after averaging the difference is treated as an additional payment on account for the later year. If the amount due after averaging exceeds the original charge, the difference is added to the amount payable for the later years.
Some further points in the calculation
The profits to be averaged are those which after all tax adjustments, including those for capital allowances, are chargeable under Sch. D Cases I and II.
Where the calculation of this amount chargeable shows a loss the ‘profit’ to be averaged is nil and not a minus figure, but the amount of the loss remains available for relief in the ordinary way.
Example B – losses
A sculptor incurs a loss of £2,000 in 2001/2 but makes a profit of £35,000 in 2002/3. The averaged profit for each year is:
Nil + £35,000 ÷ 2 i.e. £17,500.
The loss of £2,000 remains eligible for relief – for instance, under TA1988, s. 380.
If a claim is made for averaging the profits of the later of two years (year two), already averaged with year one, with the profits of the year following it (year three) the profit of year two which is to be taken into account for this purpose is the profit after averaging with year one and not the original amount.
Class 4 National Insurance Contribution (NIC) is not specifically mentioned in the new Sch. 4A but if it is included in the calculations it may be found that this liability, taking the two years together, is increased.
Example C – Class 4 NIC
An author’s profits before averaging are £3,000 for 2000/1 and £49,000 for 2001/2 so that the average profit for the two years would be £26,000. There would be no Class 4 NIC on the original assessment for 2000/1 (below the lower limit), but on the averaged profit of £26,000 there would be liability on the excess of this over the lower limit. For 2001/2 there would, on the original assessment, be Class 4 liability on the excess of the higher limit (£29,900) over the lower limit. On the averaged profit of £26,000 the liability would only be reduced by £29,900 – 26,000 at seven per cent so that the increase in liability for 2000/1 would exceed the reduction for 2001/2.
Time limit for claim and effect on other claims
A claim for averaging relief must be made not later than 12 months after the 31 January following the end of the second of the two years the profits of which are to be averaged.
Where there is an adjustment to the total income of a year of assessment as the result of an averaging claim the taxpayer may wish to make or alter a claim for some other relief. Such a claim or alteration of claim may be made at a time not later than 12 months after the 31 January following the end of the second of the two years involved in the averaging claim. Where, but for this provision the claim for other relief would be out of time, relief is given in the second year in the same way as for the averaging claim.
If, after an averaging claim has been made, the profit for either of the years involved is for any reason adjusted, the claim is nullified but, if appropriate, a new claim may be made not later than 12 months after the 31 January following the end of the year of assessment in which the adjustment was made.
Claims are voluntary
Even if a claim is available by reference to relative percentages of profit the taxpayer is not obliged to make a claim. It may not be beneficial to do so when such factors as Class 4 NICs are taken into account. There may also be other factors such as other income or cash flow which militate against a claim.
Technical Department
020 7235 9381
December 2001 by Arthur Sellwood
