Tax relief for farmers
You own and operate a farm, you are many years away from retirement but you would like to know about possible relief from inheritance tax, particularly in relation to your farmhouse. IHT expert Brona MacDougall discusses the key issues.
Generally speaking, agricultural property relief (APR) works in a similar way to business property relief (BPR), in that it reduces the value of qualifying assets when valuing the estate for inheritance tax purposes and can apply to both lifetime transfers and inheritance via a will. The applicable rate is either 100% or 50%, like BPR.
However, APR is far more restrictive than BPR and can only apply to qualifying agricultural property. As a result, HMRC looks at all claims for the agricultural property relief very closely, meaning that even though you are clearly carrying out farming, or other agricultural activities, you should seek ongoing advice.
The relief is restricted to the agricultural value of the property, not the market value.
Qualifying agricultural property is defined in the Inheritance Tax Act. It includes agricultural land or pasture used for growing crops or rearing animals intensively, but additionally can also include:
• Woodlands occupied with and ancillary to land or pasture
• Farm outbuildings, e.g. barns, occupied with and ancillary to land and pasture
• Farmhouses and cottages if they are of a “character appropriate” to the land or pasture; and
• Land being used for a habitat scheme
For relief to apply to the agricultural property, it must be in occupation for agricultural purposes at the time of the transfer. And for the purposes of this article, let us assume we are looking at a potential transfer on death.
This dual requirement means that simply buying a farmhouse with some surrounding fields is not effective IHT planning. It is the underlying activity that drives the relief, if there is no activity, there can be no relief.
Please note, the relief is restricted to land, and so cannot apply to equipment and machinery, livestock, crops, or any property subject to a binding contract for sale. However, BPR may be available in some cases. Shares can qualify for APR if the holding in question gives the owner a controlling interest, i.e. an incorporated farming business is not excluded.
There is no statutory definition of “agricultural purposes” for APR purposes. An example of where usage will fall on either side of a fine line would be grazing. Use of a field for grazing horses used in a farming business or stud farm would satisfy the condition. However, merely receiving payment for allowing horse owners to graze their animals is not, as there is no tie to an agricultural purpose. Relief may need to be restricted if there are two fields, one of which is used for agricultural purposes and the other is not. Interestingly, the legislation does not require the agricultural activity to be a profitable one, it is the scale of the activities that appears to be crucial.
There is of course a minimum period of ownership, similar to BPR. For APR, the holding period depends on whether the property is used for the qualifying purpose by the owner, or whether it is let out under an agricultural tenancy.
The holding period is:
• Two years, ending with the date of transfer if the owner occupies the land for agricultural purposes; or
• Seven years, ending with the date of transfer if the occupation for agricultural purposes is by someone else.
Rate of relief
The full 100% APR is given where the property:
• is in vacant possession by the transferor
• is subject to a lease granted on or after 1 September 1995
• includes a right to obtain vacant possession within 24 months
• has a tenant which is a company controlled by the transferor
In all other circumstances agricultural property that fits the eligibility and ownership criteria qualifies for relief at 50%.
It is crucial that you understand that the relief only applies to the agricultural value of the property in question. This means the value of the land if it were subject to a perpetual covenant prohibiting its use otherwise than as agricultural property.
A rule of thumb is to use 70% of the open market value as an approximation of the agricultural value, unless there are particular circumstances that dictate otherwise.
In practice, this value is usually lower than the unrestricted market value, especially if there is potential development value, e.g. for land. The excess cannot attract APR. However, if the owner is carrying on agricultural activity to a sufficient extent to constitute a “business”, the excess value may be covered by BPR. Obviously, this cannot generally apply if the land is tenanted with someone else. If there is a mixture of activities, it will depend on whether the enterprise is mainly of a business nature.
Reliance for planning
It is essential to ensure that the business is run as a single composite business. This should be done with long-term planning in mind, as HMRC is likely to take a strong stance against any relatively recent action taken to try to present the various business activities as a single entity. It will take more than just drawing up a single set of accounts.
You should have a single management hierarchy, with the business strategy, accounts, bank accounts and staffing done as a single business and you should keep the ownership structure as uncomplicated as possible.
You should also ensure that employees work on both trading and investment activities, and that time is recorded accurately to show this. Where there are assets like cottages, you should consider letting them to key farm workers.
As per the example above, perhaps the biggest concern will be whether the farmhouse will qualify for APR. It’s important to remember that APR can only relieve the agricultural value. The market value may be higher, for example if the property is located in a desirable area. The starting point is that the farmhouse must be occupied for the purposes of agriculture for APR to apply.
If there is farming activity linked to the house, the next test to consider is whether the house is of “character appropriate” to the farming business. This can cause issues where the house is very large, but the surrounding agricultural land is modest in comparison. There are no limits on size or guidance as to what would be considered “disproportionate” in the legislation.
Problems can arise for sole traders who retire or at least scale down their farming activities significantly, or need to move out of the farmhouse, e.g. to go into assisted accommodation. One way of avoiding issues would be to set up a partnership, say with one of the children who are intending to take over the business, with the house becoming a partnership asset. That partner can then occupy the farmhouse, potentially satisfying the condition of occupation for the agricultural purposes linked to the farmland.
As with BPR, it usually makes no sense from a tax perspective to leave assets qualifying for APR to a spouse or civil partner. You should consider the possibility of leaving other assets, e.g. cash or share investments, to a spouse instead, with the agricultural property left to the next generation or to a family trust. Of course, the spouse could then buy the land back.
The earlier that planning is undertaken, the better. If the intention is for children to inherit a farming business, using a farming partnership with the house and land held as an asset, rather than retaining personal ownership, can be a very efficient strategy.
However, this is a complex area and we would recommend working in conjunction with a solicitor who is familiar with agricultural matters when structuring the partnership.
Check that wills are structured efficiently so that assets qualifying for relief are not left to a spouse – as this would be exempt anyway. Consider leaving qualifying assets to children or a family trust instead. If you are not retiring in the short to medium term, consider setting up a partnership and bringing children into the fold to ensure continuity.