Due to the nature of their work, authors and literary artists may end up facing high tax bills in some years, but pay little or no tax in others. However, averaging profits may help some of you to reduce the amount of tax that you pay and to smooth out the variations in your annual tax bill.
Averaging is available for those of you who are either self-employed or in partnership and whose profits are wholly or mainly from literary, dramatic, musical or artistic works or from designs that you have created yourselves. Further, the profits must come either from the disposal of the work or from royalties for allowing people to reproduce the work, and not from services provided.
An averaging claim can be made in respect of the profits of two successive years if the profits of the year which has the lower profits are less than 75% of the profits for the year which has the higher profits. The profits from the two years are added together and divided by 2 to give the average profits. The averaging adjustment is the difference between the average profits and the actual profits for the year. This adjustment is added to the profits of the lower year and deducted from the profits of the higher year, so the taxable profits for each year are the average profits.
Molly is a novelist. Her profits for 2015/16 are £5,000 and her profits for 2016/17 are £75,000. Without averaging she will pay no tax in 2015/16 and some tax at the higher rate in 2017/18.
She makes an averaging claim. Her average profits are £40,000. The averaging adjustment is £35,000. Her profits for 2015/16 are now £40,000 (£15,000 + £35,000), as are her profits for 2016/17 (£75,000 – £35,000). By making an averaging claim she is able to mop up the rest of her personal allowance for 2015/16 and move profits from the higher to the basic rate – reducing her overall bill.
Averaging cannot be used where accounts are prepared on the cash basis. It will not save tax if profits are taxed at the same rate in each year.