Is now the time to switch your farm to a company?

Like many businesses, farmers will have good years and bad years.

Many farmers are facing the perfect storm of high tax bills coming off the back of an exceptionally good year in 2022 but are facing cashflow pressures this year due to subdued profits across many of the main farming sectors. 

Earlier this year, Teagasc were predicting a drop of over 50% in farming profits could be possible for both dairy and tillage farmers, and as the year has progressed that prediction seems to be translating more into reality. The settling up of the tax bills is no doubt causing pain and some farmers are left pondering is there something that they should be doing to avoid such a scenario from happening again. 

Of course, transitioning to a farming company is an option and can spare a farmer from lofty tax bills, most especially where a farmer is exposed to tax at the higher rate on a larger portion of their income. Like many businesses farmers will have good years and bad years, and the vast majority of farmers will re-invest a proportion of their revenue in growing and updating their business. 

It is incredibly unfair that a business which retains profits and carries them over for future years—investing or indeed are invested in assets within the year—are taxed on the underlying profits with no allowance for carryover of profits for future investment — and in the case of investment within the year an allowance is generally given for just one-eighth of the spend. 

One can accept one's fate and go with the highs and lows. If well-disciplined one can bank away money in a good year knowing that the tax bill will be coming down the tracks the following year. 

Human nature, though, means that the majority of business owners will either invest the money in growing their business, updating assets, paying down debt and perhaps even loosening the purse strings on personal living costs with banking away money for paying tax being the least favoured option. Here the dilemma is born where businesses benefiting from decent profits get nailed for tax the following year when the accounts are prepared and the realisation of the profits becomes known. 

There are two obvious options here for farmers faced with this dilemma, either opt into income averaging or opt to incorporate the farming business which means switching the business from a sole trader or partnership to a company. Deciding on the course of action is dependent on multiple factors. Each farmer and farm business is unique and the decision should be made taking a holistic view. 

Getting a grip on the following factors is useful:

• What level of tax is likely to be saved in the medium term through averaging or through incorporation?
• Is there likely to be heavy future capital expenditure which will limit future income tax bills?
• Does incorporating now result in a loss of allowances on expenditure already incurred?
• Are there tax benefits from continuing as a sole trader such as access to valuable tax reliefs in the future?
• How likely will the farmer be transferring the farm in the medium term?
• Are farm profits likely to drop in the medium term meaning averaging or incorporation are not appropriate strategies? 
• Is income averaging even an option? (i.e. averaging is not an option where the farm is relatively new or where the farmer opted out recently or had losses in recent years) 
• Is company incorporation now going to affect the tax return of the previous year? (a review of the previous tax year is performed on a calendar basis and without averaging where the farmer ceased) 
• Does the farm owner wish to bring in a successor in the medium term either to avail of additional grants, top-ups or succession tax credits, in which case averaging might not be appropriate? 

In summary, the tax system doesn’t seem fair where a business person can get hit with really hefty tax bills following a good year even though those profits might be either spent or are ringfenced for spending on assets for the future benefit of the company. 

The options that farmers do have to prevent major swings in profitability causing major swings in tax liabilities and major cashflow issues as a result include income averaging or company incorporation. Farmers should discuss their options with a tax consultant or accountant specialising in farm business and always in the context of understanding where the farmer and their business is at.