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Julie Butler looks at the potential fiscal benefits of purchasing a small farm or landed estate.

Why Tax Breaks as well as the Improved Economics of the Farming Industry are Attracting Buyers into the Market

The hard working entrepreneur is currently faced with some rather punishing tax penalties on both his income now and his accumulated wealth when he dies.

We are now dealing with a 50% top Income Tax rate, although the proposal is that this is to be phased out by 2015, with a rate of 2% National Insurance being introduced as proposed in the Budget, and with property values increasing, 40% Inheritance Tax on death with a very small Nil Rate Band of £325,000.

So How can a Farm Help Income Tax Relief?

The loss from the farming operation in the first four tax years of business can be carried back three years and set against other taxable income. This can result in a 50% tax relief advantage and if the proprietors are self-employed and paying some Class 4 National Insurance at an increased rate of 2% then losses can also be offset against this too.

A further question is why a loss, if farming is doing so well? The simple answer is that a lot of the initial expenditure on new plant, repairs and ensuring the landed estate is suitable for a commercial operation means that there will be initial year losses. With the current interest rate so low it could well be that part of the purchase and improvement is funded through borrowings and therefore there will be some high interest and if the purpose of the loan is to purchase a business then the interest is tax allowable.

The question has to be asked – will the taxman just allow these future losses to be offset against income without there being some safeguards? The answer is no. The hobby farming rules mean there must be a profit every six years and the fundamental principle to support these losses must be that it is commercial and that it can make a profit. More and more the Tax Office (HMRC) are looking into early year losses to check that there is not abuse or an unrealistic element of claim and therefore it is imperative, absolutely essential, that a business plan is produced to prove that this farming operation is commercial. Often the borrowing is secured on outside earnings, i.e., earnings outside of farming, but where possible the business plan should be presented to the bank manager to prove that it is an integral part of the borrowings and it is accepted as commercial.

VAT

Often the farms purchased are in need of repair and that involves a lot of input VAT being reclaimed. The majority of farming and agricultural activity is zero-rated, although diversified activities are normally standard-rated for VAT purposes and some elements like horse liveries may be exempt. So it can be quite complicated but in general terms all the input VAT could be reclaimed and this could be quite substantial and quite beneficial.

National Insurance

If the losses are set against total income there is an opportunity to claim losses against Class 4 National Insurance if the purchaser does have some form of self-employed earnings, e.g., profits from a law firm, profits from an unincorporated business.

Inheritance Tax

Provided that it can be proved that there is an agricultural activity going on which is commercial and that there is a business there will be the advantages of Agricultural Property Relief (APR) and Business Property Relief (BPR) for Inheritance Tax. It could be subject to a few questions on some elements of the farm and part of the farmhouse that almost all of the estate will escape Inheritance Tax. Obviously this is an area that HMRC have been attacking. The Office of Tax Simplification say that they are going to be reviewing Inheritance Tax, but this is how it stands at the current time.

Capital Gains Tax

There is no longer the opportunity to sell off just assets acquired in the original purchase for say development and achieve the effective 10% rate of Capital Gains Tax (CGT) because Business Asset Taper Relief was changed to Entrepreneurs’ Relief (ER) and it has to be part of a business or a whole business that is sold. However, there is a parachute to the investor that should they enjoy their purchase, they have reclaimed a large amount of VAT and improved the property and any capital gain that they make if they were to sell the whole property should be taxed at only 10% which is very attractive and a very attractive parachute for the purchaser. 

The purchase of the farm is actually a business asset and therefore those investors or entrepreneurs who already have a Capital Gains Tax liability can mitigate this by rolling it into the purchase of the farm.

Farming does now offer much greater opportunities to produce a commercial return with corn prices high and with commodities around the farm such as timber for logs becoming very attractive commercially. However, the temptation to delegate the whole farming operation to contractors can be vulnerable, as if it is run as a partnership there must be the 10 hours of active involvement in the business by each partner. In order to achieve the Inheritance Tax relief on the farmhouse there must be use of the farmhouse as an office and any form of farming in hand is much more protected by the tax reliefs that have been set out.

Conclusion

In summary, it can be seen why the purchase of the small farm or landed estate is very attractive in fiscal terms. Sometimes the motive might be to buy the farmhouse that has always been dreamt of in a remote location and to enjoy certain lifestyle factors such as shooting and lack of neighbours and there must be a much greater review of commerciality over lifestyle but the attraction of the tax breaks is clearly beneficial. It could be considered that the recent common agricultural property reform, the report on the EU CAP moving towards 2012 is also encouraging with regard to the purchase of a farm or landed estate as it is emphasising the need for economic efficiency, environmental efficiency and making the public aware of the important role that agriculture plays.