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Finance tips: Offsetting rules for loss-making business

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The restriction on sideways loss relief for farmers who have suffered five successive years of losses prevent relief for losses being claimed against other income in the sixth year, resulting in increased tax bills. Sam Kirkham, of Albert Goodchild, explains.

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There is often a misunderstanding that this restriction only applies to ‘hobby’ farmers. However, over the last year we have seen increased activity by HM Revenue and Customs (HMRC) applying the restriction to genuine commercial farmers. The Income Taxes Act 2007 restricts sideways loss relief after five years, but this can be ignored where the farming activities meet the reasonable expectation of profit test.

 

Effectively to meet this test the farmer must show that:

 

a) He is a competent farmer

b) There is an expectation of profit, and

c)A hypothetical competent farmer would expect the same period of loss as that incurred by the actual farmer, if the hypothetical competent farmer was carrying out the same activities as the actual farmer in the current year at the beginning of the period of loss.

 

This test is designed to deny loss relief where the activities could never make a profit, however efficiently they were carried out.

Evidence

The onus is on the farmer to produce evidence to justify his claim of a reasonable expectation of future profits, like that which would be used to satisfy a bank manager.

 

The test was examined in the case of French v HMRC [2014] UKFTT 940. Following an enquiry, HMRC challenged the farmer’s claim to set farming losses against other income in three tax years. The farmer appealled.

 

 

The Tax Tribunal allowed the appeal of Mr and Mrs French.

 

During the case the Tribunal had to consider:

 

1. Whether the farmers had ceased farming for a period of time while they let the land to a tenant

 

2. On the basis there were more than five successive years of losses, whether these could still be set off against other income.

 

The farmers were classed as ceasing one farming trade (dairy), then for three years letting the land to a neighbour and then recommencing a trade as an arable farmer. This re-set the fiveyear clock. The Tribunal considered whether the objective of the tax law was to stop a farmer from enjoying sideways loss relief in excess of five years continuous losses if the actual farmer has been slower in achieving profit than a hypothetical competent one.

 

The Tribunal emphasised that to deny relief to competent farmers seemed illogical, and they tried to find an interpretation of the legislation that would give a sensible result. Their view was that the legislation could have been better worded to avoid confusion and ambiguity.

 

They thought if the taxpayer is competent, the actual period of losses may indeed be an indication of what the hypothetical competent farmer would anticipate. As a result the above tests would apply where there is a competent farmer, and more than five years losses could be offset.

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