Inheritance Tax and Capital Gains Tax Planning for Farmers

Because farmland enjoys generous reliefs from inheritance tax, HMRC examines all such claims very carefully. As a result there has been a succession of appeals to the tax tribunals concerning agricultural property relief in recent years, although there have been notable successes by both taxpayers and HMRC. One of the lessons to be learnt from these appeals is that even working farmers need to take advice about their inheritance tax position, as it is easy to lose the benefit of some of the reliefs.

A brief summary of those reliefs is as follows.

Agricultural property relief

Subject to a period of ownership test, agricultural property has 100 per cent relief in the following cases:

In all cases where it is farmed by the owner or let to a third party under a tenancy commencing on or after 1 September 1995.
Where let under a tenancy which commenced before that date, if the owner has the right to obtain vacant possession within 12 months.
Where it is let under a pre-10 March 1981 tenancy and the old ‘working farmer’ relief introduced in 1975 would have applied.

In any other case, the relief is available at only 50 per cent. It should also be noted that agricultural property relief applies only to the pure agricultural value of the land concerned, so that any possible hope value from possible sale for development purposes cannot qualify for agricultural property relief.

Until 2009 the relief has only applied to farmland in the UK. It is now recognised by the Government that this restriction is contrary to European law and accordingly the relief has been extended to farmland situated anywhere in the European Economic Area (EEA). This is effective from 22 April 2009. In addition where inheritance tax has been paid in the six years prior to that date on farmland in the EEA there are possibilities for claiming repayment.

Land farmed in hand is subject to a two year period of ownership test and let land is in most cases subject to a seven year ownership test.

Business property relief

In addition to agricultural property relief, farmland frequently collaterally qualifies for inheritance tax business property relief. This is not restricted to the agricultural value of the land and so may cover any hope value from redevelopment. However, to achieve 100 per cent business property relief, the land must be part of a business activity carried on by the owner. If the land is used by a company of which the owner has control, or a partnership in which he is a partner, business property relief is at only 50 per cent.

Following a recent Court of Appeal decision, even let cottages on a country estate can qualify for 100% business property relief where they are managed as part of a larger trade such as farming. Equally, farmers who diversify out of farming into other business activities, such as wind farms, holiday and leisure parks, fishing and fish farming, should continue to benefit from business property relief on the land, although agricultural property relief will cease to be available on the residence (see under farmhouses below).

Capital gains tax hold over

All land which qualifies for inheritance tax agricultural property relief, whether at 100 per cent or 50 per cent, can be given away, for example to the next generation, without liability to capital gains tax being incurred. The gain treated as arising on a gift can be ‘held over’ to the transferee, so that the transferee takes the land at the transferor’s original cost price.

The farmhouse

Cases where the farmhouse benefits from inheritance tax business property relief will be rare. Normally the significant element of private use of the farmhouse prohibits any relief as business property. However, the farmhouse can qualify for agricultural property relief but HMRC have taken a number of cases on appeal in recent years and have been successful in having relief refused in quite a few cases where it had previously been thought that relief should be due.

The statutory rules state that the farmhouse must be occupied with its surrounding farmland and must be of a character appropriate to the whole acreage involved. If therefore the farmhouse is of significant size, but the farmland is held within a family farming company, relief may well be denied in respect of the farmhouse because the land actually occupied with it does not satisfy the ‘character appropriate’ test.

In addition, several cases taken on appeal by taxpayers have demonstrated that to qualify for relief, the occupier of a farmhouse must be engaged in farming as a daily activity and the house must be the centre of the farming operations. This of course presents significant difficulties for elderly farmers who continue in occupation of the farmhouse, but due to advancing years are not able to carry on the farm business to any significant degree themselves. However a recent appeal case reported on this point offers some encouragement. It concerned a partner in a family farm partnership who became infirm due to advancing years and spent his final days in a care home. HMRC contended that as a result his residence ceased to qualify as a farmhouse and was thus liable to inheritance tax on his death. However the Tax Tribunal held that because the house was partnership property it remained eligible for agricultural property relief. Although the decision was a welcome one for the taxpayer, it is possible that a different conclusion would be reached a farmer who trades on his own and not in a partnership.

Even where the ‘character appropriate’ test is satisfied, HMRC have persuaded the Lands Tribunal in a number of recent cases that the agricultural value of the farmhouse is unlikely to exceed 70 per cent of its open market value. In many cases, this restriction seems entirely unfair, as if the property is relatively modest and is part of a sizeable farm, there would seem to be no warrant for any restriction in agricultural property relief on the farmhouse. Nevertheless, the 70 per cent rule is being fairly rigorously applied by HMRC.

Farm losses

Many farmers find it difficult to achieve profits from their activities and this can easily give rise to a further difficulty in relation to business property relief. It is a condition for business property relief (although not agricultural property relief) that the business is carried on for the realisation of profits, and if there has been a history of losses prior to the occasion on which business property relief is claimed (whether on the death of the owner, or on a lifetime gift of the business) business property relief may well be denied by HMRC

Sale of farmland for redevelopment

Many farmers find it possible to realise significant capital sums by the sale of land on the fringes of the relevant farm for redevelopment purposes. This will often give rise to a liability to capital gains tax on the profit realised from the disposal of the land concerned. Following the changes in the rates of capital gains tax in 2010, the gain is now likely to be taxable at the flat rate of 28 per cent. The lower rate of 10 per cent under entrepreneurs’ relief applies only if the sale constitutes a disposal of part of a business. Any gain can however be ‘rolled over’ if the proceeds of the sale are reinvested in the purchase of other business assets (for which there is a detailed definition). Under roll over relief the gain is deducted from the capital gains tax base cost of the assets purchased, so that tax liability on the gain does not arise until such time as the new assets are sold. Roll over relief applies to reinvestment in property to be used as furnished holiday lets, including the cost of converting barns etc. into residential accommodation to be let in this way.

Once significant sums have been realised from the sale of land for development purposes, it must be recognised that the proceeds themselves will not be eligible for any of the inheritance tax reliefs discussed above, unless the money is reinvested in another business activity or in the farm itself. Prior to the sale, the landowner may therefore consider transferring the land, or a share in it, to a trust for the next generation, holding over the capital gain and claiming exemption from inheritance tax on the transfer by virtue of business property or agricultural property relief. In the case of a future sale the rate of tax of the trustees will be 28 per cent.

This type of planning can be very tax efficient, but it must be recognised at the outset that the inheritance tax reliefs on the transfer will be withdrawn if the settlor dies within seven years of the creation of the settlement and at that point in time the land is no longer being used for business purposes. For example, if the land is sold by the trustees, and subsequent to the sale but still within the seven-year period from the time when the settlement was made the settlor dies, the inheritance tax reliefs will be withdrawn. Furthermore, if the land had not been transferred to the trust but had been retained by the farmer who continued to hold it at the time of death, the accrued capital gain on the land would be eliminated tax free and it would be inherited by the family at a new market value base cost for capital gains tax purposes.

Accordingly although much can be achieved in terms of IHT by lifetime gifts of farmland, it must be recognised that the planning can give highly adverse tax results in the event of the untimely death of the donor.

Tax planning in lifetime

Many farmers will want to pass the farm down to their children and they may start this process as they get to retirement age. In such cases it is vital that professional advice is taken in order not to lose the valuable inheritance reliefs on the estate. For example relief will be lost on the farmhouse if the land is given to the next generation, but the farmhouse is retained by the retired farmer. This will equally be the case if the farmhouse is given to children, but the land is retained, perhaps because the land qualifies in any event for inheritance tax relief on death. Various other permutations can be very inefficient in tax terms. As a general rule it is usually best to take the children into a farming partnership and to hold all the land and the farmhouse as a partnership asset, but careful structuring of the partnership arrangements is still advisable.

Tax-efficient wills for farmers

It is not usually tax efficient for anyone holding farmland to leave it by will to his or her surviving spouse. Nearly all gifts to the surviving spouse are completely exempt from inheritance tax and accordingly the opportunity of claiming agricultural property relief or business property relief for the land is wasted against the spouse exemption. The gift of the land to a family trust by will should be considered as an alternative.

Following the death of the owner, and the transfer of the land into the trust, the surviving spouse could consider buying the land from the trustees by exchanging it for other assets in his or her name (for example stock exchange investments) which have a value equal to the land in the trust. By this means, the land may once again provide a shelter from inheritance tax liability on the death of the surviving spouse, and equally the stock exchange investments have effectively been transferred into the trust without any inheritance tax liability arising.

To summarise

The various tax reliefs for farmland are generous and care should be taken to utilise them. Where it is inevitable that they will cease to be available in the foreseeable future, an immediate gift of the land to a family trust, or direct to the next generation, should be considered, but in all cases careful consideration and advice is desirable.

FOR GENERAL INFORMATION ONLY

Please note that this Memorandum is not intended to give specific technical advice and it should not be construed as doing so. It is designed to alert clients to some of the issues. It is not intended to give exhaustive coverage of the topic.

Professional advice should always be sought before action is either taken or refrained from as a result of information contained herein.