Enter Your E-mail

TaxationWeb by Julie Butler, FCA

Julie Butler, FCA, of Butler & Co, examines farmers’ milk quota and some important related tax considerationsThe plight of the arable farmer is often the subject of nationwide coverage when there is bad weather, but what of the dairy farmer, who needs the summer rain to produce the lush grass for the dairy herd in order to produce a good volume of milk?

When and why were milk quotas introduced?

Milk quotas were introduced by the Council of EEC Agriculture Ministers on 2 April 1984 as a means of curbing excess milk production and reducing expenditure on the disposal of surplus milk and milk products.

What is ‘wholesale’ milk quota and ‘direct sales’ milk quota?

Wholesale quota is held by milk producers who deliver milk (produce of the milking cows) to a purchaser (generally a dairy or intermediary co-operative) while direct sales quota is held by producers who sell their milk directly to the market without going through a purchaser, or who sell products other than milk, e.g. cream, butter, yoghurt and cheese. Milk producers can hold one or both types of quota.

How can milk quota be transferred from one producer to another?

Quotas can be transferred either temporarily (i.e. by leasing) or permanently:-

• Temporary Transfers

Milk producers may lease quota in or out throughout the milk quota. Quota that is leased stays with the lessee until the beginning of the following quota year (1 April), when it then reverts back to its original owner.

• Permanent Transfers

There are three ways in which quota can be permanently transferred from one producer to another:

i) Through a lease of land - A producer wishing to obtain milk quota may lease some land which is used for milk production (and therefore has milk quota attached to it) for a minimum period of ten months in England and Wales. At the end of the lease, the land reverts back the original owner, but the milk quota stays with the lessee.

ii) Through a permanent transfer of land (e.g. sale, inheritance) with milk quota attached to it.

iii) Without land - due to scaling down, restructuring or cessation.

What happens to a tenant’s milk quota when a tenancy comes to an end?

Community regulations establish a bond between milk quota and the area used for milk production. As a consequence, departing tenants cannot generally take the milk quota attached to their tenanted land at the end of the tenancy. In the event of a tenancy that began after 1 September 1995, the provisions of the Agricultural Tenancies Act 1995 may provide for compensation if the quota remains with the landlord and certain other criteria, e.g. the giving of notice, are met.

Is Milk Quota a separate asset for IHT and CGT?

Does a milk quota comprise of an interest in the underlying land or should it be treated as a separate asset for capital gains tax purposes? The decision in Faulks v Faulks [1992] 1 EGLR 9, concerned a dispute between a surviving partner and the widow of a deceased former partner over the amount of compensation due to the estate. Comments made, suggested that a quota was indistinguishable from the underlying land. This approach, if well founded, could imply that the disposal of a milk quota should be treated as a part disposal of underlying land, with the need to apportion expenditure attributable to the acquisition cost. However, the capital gains tax case of Cottle v Coldicott [1995] STC (SCD) 239 has cast doubt on this treatment, where it was held that milk quota is a separate asset.

Is quota a fixed capital asset?

The Inspector’s Manual at BIM 55305 describes quotas as follows:

‘A farmer holds a quota primarily in order to make a profit from carrying on the particular farming activity which it covers. She or he does not ordinarily buy and sell quota in the course of the farming trade. The quota has the character of an enduring asset of the farmer’s business similar to the buildings or farm machinery. Quota is normally therefore a fixed capital asset of a farmer’s business.’

Sale of herds before quota

IHT – It has been Inland Revenue practice in the case of dairy farmers to combine the value of quota with the value of the agricultural land for agricultural property relief (APR) purposes. In any event APR (and business property relief) will not be due on milk quota where dairying activities cease, that is, the quota is held without a trading activity.

No income tax relief on purchase of quota – but what of corporation tax?

As the quota is normally a fixed capital asset of a farmer’s trade, such purchases and sales normally have no income tax consequences for the farmers concerned. In particular, there can be no question of farmers who have bought quota claiming a deduction for the amount of any expenditure such as levies or leasing charges, which they would have incurred if they had not bought it. That is, the sale is a CGT disposal and the purchase represents the CGT base cost for a future sale. The cost of leasing quota should achieve income tax relief.

Leasing quota when a dairy herd is sold

Leasing: the cost to the purchaser is a trading expense. If it is the lease of temporary surplus then it will be treated as trading income. However, if the enterprise has sold the herd then the leased out income is non-trading income. Clearly care must be taken with the income tax computation and the possible matching of quota.

Write off in the Limited Company – the advantage

With effect from 1 April 2002, agricultural quotas for new companies, (but not partnerships or sole traders) come under the new rules for the taxation of intangible assets contained in FA 2002, s 84, schedules 29, 30. These treat amortisation properly charged in the profit and loss account of farming companies as an allowable deduction, with sales being taxed as income.

Transitional rules ensure that assets held at commencement will be taxed on the old, (chargeable gains) basis. However, disposals thereof will not qualify for capital gains rollover relief except where reinvestment under the capital gains rules has taken place before 1 April 2002 and within the twelve-month period prior to the disposal.

Tax efficiency of leasing quota surplus to requirements

Receipts from the leasing of quota which is temporarily surplus to the requirements of a particular activity carried on by a farmer may be regarded as part of the farming trading income.

Also from 1 April 2002 new quota owned by a company will qualify for write off against profits either at 4% or at a preferred rate. As the future of quotas is not guaranteed beyond 2008 it could be prudent and tax efficient to write it off over a period to that date. This could have large benefits to farmers trading through a company. There are a number of anti-avoidance provisions including the exclusion of relief on quota purchased from a connected party.

However, income from leasing of quota which is not required because the activity to which the quota relates has ceased or substantially reduced should be dealt with as non-trading income.

Where quota is leased out by a non-farmer, (including an ex-farmer who has retained quota), the income is chargeable as non-trading income. It is highly unlikely that there would be evidence to justify trading income treatment.

The tax consequences of selling quota or leasing quota should be considered when looking at the commercial alternatives. For unincorporated businesses with the ability to use the fungible asset rule, the use of annual exemptions etc. the tax advantage of disposals should be built in when trying to weigh up disposal or leasing.

The intangible rollover trap

As mentioned above from 1 April 2002 there is a change in capital gains tax treatment of intangible assets, e.g. quotas. The gain on an intangible asset, will only be allowed to be rolled over into another intangible asset. The gain on a tangible asset, will not be allowed to be rolled over into an intangible asset. This will obviously affect the practical tax planning on quotas.

The potential negligible loss claim

From a tax planning point, potato quota now has £nil value, therefore a claim for the capital loss should be considered under TCGA 1982 s 24(2). The timing of the claim, as in all such claims, should be made, where possible, in the year of a gain above the annual exemption for CGT. The future value of milk quotas will be £nil and similar tax planning should be contemplated for milk quota in due course. It currently has a value but with a future life due to terminate in 2008/2012 tax planning should be considered. The current dairy market shows the best performing farmers are those with high input/ high output and purchasing quota has to be considered.

Planning the ‘fungible’ asset rule

The Revenue take the view that milk quota is a fungible asset. It is worth considering what benefit this could have to the farmer and what traps could be encountered.

The Capital Gains Manual, (at paragraph CG77821) states that a producer primarily holds milk quota to produce and sell milk profitably and not to run the risk of financial penalty for over production. The manual states that such producers do not ordinarily buy and sell quota in the course of their day-to-day trade. Quota is an enduring capital asset of the business in the same way as buildings or farm machinery. Thus, where some of a producer’s quota was allocated without cost in 1984 and some was subsequently purchased, the Revenue originally considered that the acquisition cost should be apportioned under TCGA 1992 s 52(4) by reference to the total holding, i.e. not matched by reference to each element of quotas owned.

This could seem unreasonable to the producer who has had to buy and sell quota to reach production targets. The result could be a high sale price matched with a relatively low acquisition cost. The Capital Gains Tax Manual now confirms that milk quotas are regarded as fungible assets, under TCGA 1992 s 104(3) and the same identification rules will apply as for shares and securities. For milk quota disposals before 6 April 1998, it could be said that the share pooling rules may be analogous with the apportionment rule in TCGA 1992 s 52(4), but disposals on or after that date should be identified with acquisitions under the share identification rules.

It could be argued that the application of TCGA 1992 s 54(4) was unfair on those producers who, from time to time, had to purchase and dispose of quota and the disposal was matched against the much reduced cost due to the inclusion in the apportionment of the 1984 allocation with £nil base cost. In these cases the disposal proceeds largely represented the gain, which was produced by what could be said was transitional, and better matched with the purchased quota. It is hoped that applying the current, ‘fungible asset’ rules will help to present a ‘fairer’ position and also a clearer representation of the correct position.

It could also arise that farmers could use both methods. The original method could produce gains to offset against any unused annual exemption, whilst keeping the base cost higher for future disposals. However, the latter treatment could produce gains, which would not otherwise have been taxed. There are clearly times when both methods have advantages but consistency must be used. The fungible asset rules do not apply to Limited Companies.

IHT on death

On the assumption that the quota is a separate asset then APR will be due on the land and BPR on the quota (it is not agricultural property). On the basis that death is not a chargeable event and the CGT base cost is low, there will be a tax-free uplift in value. It could be the Executors look for a quick disposal of herd and quota (goodbye to all that labour intensive milking). What of the tax treatment in the hands of the Executors?

September 2004

Julie Butler, FCA, Butler & Co, Bowland House, West Street, Alresford, Hampshire, SO24 9AT. Tel: 01962 735544. Email; j.butler@butler-co.co.uk.

Julie is the author of Tax Planning for Farm and Land Diversification and Equine Tax Planning.