A taxing issue
PUBLISHED: 14:31 26 August 2010 | UPDATED: 18:27 31 March 2014
Nothing in life is certain except death and taxes, and smallholding businesses are no different
In this article we will endeavour to set out what should be borne in mind when setting up and running a smallholding to ensure that as much of your hard-earned cash stays in your pockets to reinvest in the business, rather than going out of the business in taxes.
Many accountants will be able to assist you in this respect, but it must be emphasised that it always pays to speak to somebody that speaks smallholding language and understands the small-scale nature of the enterprise involved, the seasonal nature of crops and livestock, as well as the irregular cashflows that these sorts of enterprises may generate.
Although the idea that one’s smallholding enterprises may be generating a profit may cause snorts of derision from many, it is not only the smallholders who have a well-established income stream which may benefit from organising their affairs in a tax efficient manner. Many businesses, in the early years, will be loss making. Until that great idea is put to the test and evolves into a business, it may not be at all certain as to whether the enterprise is really a goer.
The first step – registering as self-employed
To ensure that you can take advantage of any tax breaks available to smallholders you must register as self-employed first. (Although you may also trade as a company, it is assumed for the purposes of this article that this will not be the case.) If there is more than one person involved, then they must both register. It is particularly important that both people register as self-employed, even where, for example, one person will continue with their 9-5 job and the other will be doing the bulk of the day to day smallholding work. The business type will be farming. There is a form which can be downloaded from HM Revenue & Customs (HMRC) website or, alternatively, you can do it over the phone. It is worth noting that there are potential penalties for not registering a new business with HMRC within three months, so there may be a legal obligation to notify HMRC in any event.
Once registered as self-employed, you will have to fill in a tax return. The tax year runs to 5 April and you have until the following 31 January to file the tax return if doing it online – if submitting your return on a paper form you have until the following 31 October.
As self-employed you will have to pay Class 2 National Insurance contributions, which are currently £2.40 per week. This is normally collected monthly by direct debit. If you think your self employment income will be below £5,075, or if you are over the state pension age, then you can register for an exemption and will then pay nothing.
Doing the books
All items of expenditure and income related to the business should be recorded on a spreadsheet or in a manual cashbook. All invoices and receipts which relate to these items should also be filed away alphabetically by supplier and in date order for ease of reference.
What constitutes business expenditure and income?
Any expense directly incurred in carrying out the business activity and without which the business could not function is a business expense. Many expenses will be obviously business related, such as livestock feed and bedding or seeds, fertilisers and sprays. These can be clearly set off against any income from the enterprise and used to calculate the business profit or loss.
Expenses which are less clear cut are those which have some element of personal use and business use. These will be very familiar to every smallholder as the distinctions between one’s personal life and the smallholding activities inevitably become blurred. Therefore, the Aga, which at one moment is being used to cook the family supper, may at the next be used to revive a weakly or cold newborn lamb. Similarly, the once shiny car will be pressed into uses not previously dreamed of, such as taking animals to the vet or collecting a much needed bale or two of hay. Clearly some guidance is, therefore, required as to what proportion of, for example, your mind blowing electricity bill or the cost of righting the strange noises coming from the ‘trusty’ Land Rover again, may be set off as a business expense.
HM Revenue & Customs tax inspectors will, of course, try to insist that you keep meticulously detailed records of every journey in your car so that you can easily split your annual mileage between personal and business and, therefore, split all expenses accordingly. However, in the absence of such records, a view must clearly be taken and, although the facts of each situation must be looked at, HMRC will normally accept 30% business use as not unreasonable where the car is used for both family and smallholding uses.
Similar principles apply to household expenditure. Ideally, detailed records will be kept, but where there is only one meter for the electricity supply into the house and the buildings, then it will be very difficult to distinguish between the cost of cooking family meals and providing first aid to your woolly charges. In looking at what is a rule of thumb, anything between 15% and 30% is a good starting point for business use. Clearly, with the ever rising cost of running a home and car, getting tax relief for 30% of all household utility bills, including rent or mortgage interest, will be of great help in keeping as much cash as possible in the smallholder’s pocket.
Similarly with business income, much will be obvious such as sales of livestock and vegetables at the gate. However, care must be taken with smallholding enterprises when much or some produce is kept for home use. Where this is the case, it is important that the produce kept for home use is shown as income as well as the sales to third parties.
As any reader of Country Smallholder will be aware, there is a vast array of suppliers of gadgets, machinery and housing which promise all sorts of advantages in purchasing their particular brand. The very nature of smallholding means that wear and tear on your equipment will take its toll. Whether you decide to buy new or secondhand, you will inevitably find yourself spending money on capital items from time to time.
When producing your accounts, it would not be fair to put these capital expenses against the income of just the year of purchase as these items will be used for several years, you hope. They will, therefore, be entered on the balance sheet and depreciation charged to the profit and loss account each year. For tax purposes, depreciation is ignored and capital allowances must be calculated on your plant and machinery in order to calculate your taxable profit.
The capital allowance regime has recently changed and, generally speaking, these changes are favourable for small businesses such as smallholdings. The first £100,000 expenditure on plant and machinery in any tax year is eligible for 100% relief against income. Clearly, this is very helpful in years where you make a big investment such as a new tractor or other such large piece of equipment. However, in years where you have not bought very much you may be faced with much smaller allowances to set off. Any equipment which has not been totally written off for tax purposes in previous years is eligible for a writing down allowance of 20% on a reducing balance basis.
What constitutes plant and machinery is fairly easy to determine in most instances; for example, where the piece of equipment is mechanical and has moving parts, such as a weigh crate or trailer, it is definitely plant and machinery.
Buildings, housing and fencing, however, are a more difficult subject. Generally speaking, a building which cannot easily be moved, such as a barn or polytunnel, shed or semi-permanent field shelter, is not plant and machinery and, therefore, does not attract any tax relief. However, if the item is designed to be moved around and has wheels then it will generally qualify as plant and machinery. Examples of this category of expenditure include poultry arks and field shelters which are moveable and can be towed around.
Any repairs, whether to buildings, fences or machinery, are allowable as a business expense so long as no improvement to the original structure is undertaken.
Using losses from your smallholding business
After you have calculated your taxable income and set off all capital allowances you may very well find that you have made a taxable loss. The loss will be shared between all the people involved in the business and entered on the relevant personal tax returns. If they have other income earned elsewhere, the smallholding losses can be set off against this income. Assuming this other income has been taxed at source (eg under PAYE for employment income) you will most likely be eligible for a tax refund. There are various rules to prevent people with businesses not being run very commercially to take too much advantage of these losses.
Losses from smallholding or farming can only be set off against other income for five consecutive years. Therefore, the smallholding must make a profit within this time frame if relief for losses is to be continually enjoyed. Hopefully, however, this five year period will cover the set up period and within 3-4 years a healthy profit will be generated. Furthermore, there are additional rules which prevent an individual not working full time (less than 10 hours per week) in the business from claiming more than £25,000 losses per year.
Registering for VAT
Aside from the complexities of income tax, VAT (Value Added Tax) is a tax on consumers which is levied on most goods and services, apart from several notable exceptions which are very relevant to smallholding. Amongst these are food for animals and for human consumption, as well as the plants and animals themselves which are destined for the food chain.
Many of the inputs for smallholding businesses will be standard rated for VAT purposes and will, therefore, have VAT levied at 17.5%. Examples include machinery, animal housing, fuel and fencing. Many smallholding businesses will, therefore, be in a reclaim situation.
Although you are not required to register for VAT until your business turnover reaches £68,000 per annum, you can apply for voluntary registration. The form can be obtained from HMRC and, generally speaking, some proof of trading in the form of invoices will be required. Once registration is obtained, VAT returns must be completed either monthly or quarterly within 30 days of the month or quarter end.
A further advantage of VAT registration is that it imposes a good discipline on the person running the business as returns are required at least quarterly and, therefore, the paperwork and invoices must all be in good order to make the return. It is much easier to remember and sort out a pile of invoices every three months rather than try and attempt to sort out a year’s worth of mess just before the income tax return deadline. Of course, anybody reading this article will be keeping their cashbook on at least a weekly basis so this need not apply!
Registering your smallholding business for income tax purposes and for VAT can be very useful, not just because nobody likes paying any more tax than they have to, but also as a management tool for the owners to ensure that they can see exactly where their money is going within the business. It is very easy to spend money in running a smallholding, but very much more difficult to earn it back.
Furthermore, if the business is to grow, any person you wish to borrow money from will want to see evidence of how your business has been performing. Good sets of books will assist in this. As with any matter of complexity, good professional advisors can be extremely valuable and no advice should be relied upon without the advisor having full knowledge of the individual’s circumstances.
Tom Main is an accountant specialising in agricultural businesses and new business start-ups and, with his wife Sarah, runs a smallholding in Hampshire. Go to countrysmallholding.com and click on Writers to find out more about Tom.