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HMRC internal manual

Business Income Manual

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HM Revenue & Customs
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Farming: herd basis: replacements

S116 Income Tax (Trading and Other Income) Act 2005, S114 Corporation Tax Act 2009

Where an animal leaving the herd is replaced (see BIM55520) by another animal:

  1. any proceeds from the sale of the animal leaving the herd (or insurance or compensation moneys received by reason of its death) should be included as a trading receipt; and
  2. the cost of the replacement animal, excluding the cost of any improvement in quality (see below), is an allowable deduction.

HOME-BRED AND HOME-REARED REPLACEMENTS

Where the replacement animal was previously part of the farmer’s trading stock (for example, a home-bred replacement), its cost will already have been deducted as an expense so no further adjustment is needed to give effect to (b). In practice therefore, the only adjustment that is required is the inclusion as a trading receipt of any proceeds etc from the sale or death of the old animal. (See the year ended 31 December 2009 in the example.)

REPLACEMENT WITH AN ANIMAL OF BETTER QUALITY.

Where the replacement is an animal of better quality than the animal it replaces, the allowable deduction under (b) is restricted to the amount it would have cost to replace with an animal of the same quality. The `improvement element’ is disallowed. (See the year ended 31 December 2010 in the example.)

COMPULSORY SLAUGHTER FOLLOWED BY REPLACEMENT WITH AN ANIMAL OF WORSE QUALITY.

Where an animal is compulsorily slaughtered on account of disease and is replaced by an animal of worse quality, the amount included as a receipt under (a) is not to exceed the cost of the replacement animal.

REPLACEMENT IN THE FOLLOWING ACCOUNTING PERIOD.

Where an animal disposed of in one accounting period is known to have been replaced in the following accounting period, no objection need be raised in practice if the proceeds of the disposal are held `in suspense’ until the second period when both adjustments can be made.

EXAMPLE

Alison is an established sheep farmer with a flock of 100 ewes and 3 rams. A herd basis election is in force and at 31 December 2007 the cost of the flock is:

100 ewes @ £20 £2,000
   
3 rams @ £100 £300
  £2,300

In the year ended 31 December 2008, Alison sells 25 ewes for a total of £760 and purchases 25 new ewes at £40 per head.

As set out in a) and b) above:

  • The £760 proceeds from the sale of the old ewes are included as a trading receipt.
  • The £1,000 cost of the new ewes is an allowable deduction.

This gives a net deduction of £240.

In practice animals within the herd basis election are often reflected on the Balance Sheet as Fixed Assets. On this basis, the disposal of 25 ewes will give rise to a profit on disposal in the trading account of £260 (£760 - £500). Both sale proceeds and the cost of the sale would be taken to the trading account. The £1,000 cost of the 25 replacement ewes would be debited to the Fixed Asset (herd) account so that as at 31 December 2008 the cost of the flock would be shown as:

75 ewes @ £20 £1,500  
     
25 ewes @ £40 £1,000  
    £2,500
3 rams @ £100   £300
    £2,800

An adjustment is required in the Income Tax Computation to reflect the difference between what the law requires and the trading account shows. To give effect to this adjustment, add back the cost of the animals disposed (£500) and deduct the cost of the replacements (£1,000).

Profit on disposal   £260
     
Adjustment in computation: Cost of animals disposed £500  
Cost of replacements (£1,000) (£500)
Net effect   (£240)

The herd has not changed, only the individual sheep making up the herd. The net cost of £240 is akin to the cost of maintaining the condition of the herd.

In the year ended 31 December 2009, Alison sells 20 of her original ewes for £640 and replaces them with 20 newly lambed gimmers (young ewes) which she has bred and reared herself at a cost of £30 each.

  • The £640 proceeds from the sale of the old ewes are included as a trading receipt.
  • The costs of breeding and rearing the replacements have already been deducted as part of Alison’s allowable trading expenses so no further adjustment is needed.

The herd now comprises:

55 ewes @ £20 1100  
     
25 ewes @ £40 1000  
20 gimmers @ £30 600 2700
3 rams @ £100 300 300
    3000

As above, the herd has not changed. The cost of breeding and rearing the replacements is the price of maintaining the condition of the herd.

In 2009 Alison’s accounts show a profit on disposal of £240 (£640-£400) which means that the cost of these disposals (£400) needs to be added back in the tax computation to arrive at the correct taxable profit. As the cost of the gimmers (£600) has already been deducted in the trading account as the cost of rearing and breeding no further adjustment is required for this.

Profit on disposal in trading account £240
   
Add back cost of disposal £400
Net effect on taxable profit £640

In the year ended 31 December 2010, Alison sells one ram for £30 and purchases a prize-winning pedigree ram for £4,000. The new ram is of better quality than the old. A replacement of like quality would have cost £500.

  • The £30 proceeds from the sale of the old ram are included as a trading receipt.
  • The allowable deduction in respect of the new ram is restricted to £500.
  • In this instance the herd has changed in that the ram quality has been improved. The improvement is reflected in the cost of the herd.
  • The herd account at 31 December 2010 in Alison’s accounts becomes:
55 ewes @ £20 £1,100  
     
25 ewes @ £40 £1000  
20 gimmers @ £30 £600 £2700
2 rams @ £100 £200  
1 ram @ £4000 £4,000 £4200
    £6900

The tax computation adjustments are as before. The only difference is that the cost of replacement is restricted to that what it would have cost to replace with like quality.

Loss on disposal in trading account   (£70)
     
Add back cost of disposal £100  
Deduct (restricted) replacement cost (£500) (£400)
Net deduction   (£470)