Inheritance Tax planning in a changing world – a case study:
Background:
Mr and Mrs Knight have been in partnership for many years at Home Farm, which consists of 150 acres of grassland and ancillary woodland in a ring fence. There is a primary farmhouse and a cottage in the farmstead, together with a secondary stead of buildings on western edge of the estate. 250 acres of arable land is let from Manor Farm under a long term Farm Business Tenancy. For many years the farming enterprises consisted of forage and combinable crops on the let land, together with 250 ewes and 100 suckler cows which utilise the grassland and forage.
Mr and Mrs Knight’s son, William, and his wife, Imogen, returned home after a several years working away overseas and were admitted as Partners in the business. They have been developing new opportunities emerging from the disruption to traditional farming sectors.
Manor Farm obtained planning permission for a large array of solar panels and entered into an agreement with Home Farm to surrender the tenancy and to provide 50 acres from Home Farm for Biodiversity Net Gain offset. That land is let to the solar developer under a long term commercial agreement. William entered into other agreements with different parties to “stack” nitrate, phosphate, and BNG credits on the same 50 acres, which worked well to maximise the income per acre.
William and Imogen had been involved in an education programme when working on a re-wilding project in the Netherlands and were keen to bring some of the experience gained back to Home Farm. They established a “Nature School” that brought school children aged 5 – 16 to Home Farm on residential stays for a week at a time, re-engaging with nature to better understand how complex food webs and ecosystems function. This worked so well that after a while an eco-tourism business was established on the other side of the farm to allow adults similar opportunities, alongside a rustic cookery school focused on traditional foods.
To allow for the time and attention required by the new enterprises, the sheep flock was reduced to 100 ewes and the sucker cows were reduced to 25, with the western buildings becoming surplus to requirements.
Mr and Mrs Knight had mitigated exposure to higher rates of Income Tax over the years by making periodic pension contributions. They had accumulated substantial investment portfolios and were becoming wary of the volatile stock markets as Artificial Intelligence and other technologies disrupted many key industries. They wanted to invest their funds into something they felt more comfortable with and had more influence over.
Mr and Mrs Knight used their Self Invested Personal Pensions to acquire the buildings on the western side of Home Farm from the Partnership. William and Imogen used the proceeds to fund the development of the tourism business and cooking school.
The pension funds borrowed further funds from the bank and developed the farm buildings into a complex of business units for hi-tech startups developing emerging technologies for rural businesses, the “Home Farm Ag-Tech Hub”. The commercial rent roll was not taxable within the pension which enabled swift repayment of the borrowings. Latterly the rents provided an income to support Mr and Mrs Knight as they stepped back from the business.
What is Inheritance Tax:
Inheritance Tax (IHT) is levied on transfers of value and is charged at different rates depending on when it arises. IHT is levied on different events, such as on the death of an individual (40%), during lifetime when making gifts to certain types of trusts (20%), or on trustees periodically and when distributing property from trust (6%).
Individuals have a Nil Rate Band, currently £325,000, on which no tax liability arises. Where an individual’s death estate is valued below £2.35m they can also benefit from a Residential Nil Rate Band, currently up to £175,000, which is applied against the value of the deceased’s residence. Together these allowances result in up to £500,000 per individual, or £1m for a married couple, being free of tax.
As well as the allowances that all UK domiciled individuals are entitled to, there are reliefs that can apply or be claimed to reduce the taxable value of certain types of property.
What reliefs can farmers benefit from:
Agricultural Property Relief (APR) relieves eligible property, which includes land, buildings, farmhouses, and cottages, that are occupied for the purposes of agriculture throughout the requisite period. APR often relieves 100% of the agricultural value, although it can be reduced to 50% where property is subject to a lease commencing before 1 September 1995 and where the transferor cannot obtain vacant possession within 24 months.
Business Property Relief (BPR) relieves the value of relevant property, which can include plant, machinery, stocks, land, and buildings, which are used for qualifying business purposes throughout the requisite period. BPR can reduce the value of relevant property by 100% or 50%.Property that can qualify for 100% BPR includes interests in a business such as a sole trade or partnership, or shares in an unquoted company. Property that can qualify for 50% BPR includes land, buildings, and equipment used by a company controlled by the transferor, or by a partnership in which the transferor was a partner, and certain types of settled property where the beneficiary is entitled to a life interest in the trust assets and uses them within their business. To qualify a business must be mainly trading in nature.
BPR can therefore be more generous because a broader range of property can be relieved and it covers the market value, rather than the agricultural value. APR applies automatically where the qualifying criteria are satisfied, whereas BPR must be claimed. A claim for BPR cannot be made against value on which APR applies, so care is needed to understand how the two interact in different scenarios. This can be particularly important where there is non-agricultural value, such as where there is hope for development or amenity value, and even more so where any APR would be reduced to 50%, perhaps by the onerous provisions of a Partnership Agreement that prevents obtaining vacant possession of land within 24 months.
There is also an exemption for certain types of Heritage Property, albeit that is outside the scope of this article.
What about diversified businesses:
The case of Farmer v IRC (1999) established the principle that a single composite business can qualify for BPR, provided it mainly carries on trading activities. In this case the deceased carried on both farming and lettings activities, which the judge ruled amounted to one business that was mainly trading in nature. This principle has since been applied in other cases involving diversified farming businesses, such as HMRC v Brander (2010), which is sometimes known as the Balfour case. Judgements have established five tests to assess whether a business is mainly trading, being the proportion of turnover, profit, staff and management time, and capital employed that relates to the trading activities, and the historic context with the farm. Over time the judges appear to place more weight on turnover and profitability.
As farming businesses diversify, it is important to monitor the level of turnover and profitability of the different activities. Should the investment activities outweigh the trading activities BPR would be lost, significantly impacting the IHT exposure.
Review your options:
Revisiting our case study from above, as part of a periodic BPR review, the Partners of Home Farm established that with the reduction in farmed area and traditional enterprises, together with the growth in diversified activities, some of which lay in the grey are between investment and trading, the business was getting close to obtaining half of its turnover and profitability from investment activities, before the development of the western buildings.
To avoid jeopardising the availability of BPR on the investment assets held within the Partnership, they decided to transfer the western buildings into the pension funds before their conversion. That way the analysis of the Partnership remained comfortably on the correct side of the scales. As pension funds are not usually subject to IHT, the value of the commercial letting complex was still able to be handed down to the next generation without a charge to tax.
Summary:
There are many commercial pressures on farming businesses and they continue to evolve to remain sustainable. The tax system is trying to evolve alongside this, to remain fair and effective, hence the recent consultation launched by HMRC in March into the “taxation of environmental land management and ecosystem service markets”.
As your business adapts and evolves, ensure that you stay abreast of legislative changes that could impact on succession plans, exploring how best to structure asset ownership across business, personal, and pension vehicles to optimise your tax position.
Dan Knight FCA CTA MCIArb
Director
Dan joined the practice in 2019 having previously worked for a regional firm culminating as Head of Rural Tax.
Having grown up on a dairy farm on the Dorset/Somerset border, Dan spent a number of years working in agriculture before becoming a Chartered Accountant and a Chartered Tax Adviser. Harnessing both his practical and professional experience, Dan has spent the last decade advising farming businesses across the region on a wide range of issues.
Passionate about his work, Dan specialises in succession planning and restructuring, helping farming families to implement change, accomplish their ambition and enhance the legacy for future generations.
Dan is a keen shot in the field or facing the trap and thoroughly
enjoys supporting his young son on the football field.