Whilst the current unprecedented circumstances create anxiety and uncertainty, they also present us with time. Time to spend with our close family but also time to think, time to plan and time to get around to those tasks that always end up at the bottom of a to-do list.
For many individuals, Inheritance Tax (IHT) is one of those subjects which is always put off until another day. While it can be a difficult subject to discuss, after all none of us likes to consider our own mortality, leaving the next generation with a hefty tax bill can be equally as difficult. With IHT being charged at a rate of 40% of the value of your assets, an unexpected tax bill can leave many people with no choice but to have to consider selling inherited assets to settle the liability. This is especially true in agricultural businesses. Many farmers believe that as their land and buildings are all ‘farming assets’ then there is automatically no IHT due. However, this is very rarely the case, especially if there is any development potential. However, with some tax planning, significant liabilities can be prevented enabling agricultural businesses to continue successfully for future generations. Below are some key areas that farming businesses should be looking at in order to ensure they are taking advantage of the maximum amount of Agricultural Property Relief (APR) and Business Property Relief (BPR). Review the Partnership Accounts When looking at a set of accounts, usually most business owners are primarily concerned about the profit and loss account, looking to see how well the business has done in the year. However, it is equally, if not more important to look at the balance sheet. Partners should check that all farming assets, including land and property are accurately recorded on the balance sheet. This should also include any cottages or rental properties that are on or around the farm. If land and property used in the business is not currently included in the accounts, tax and legal advice should be sought. Valuable IHT reliefs such as APR and BPR can be gained by bringing assets into the balance sheet; however, each case will need to be judged on its own facts. Adding land and property into a partnership balance sheet also needs to be done in the correct way and will require a formal deed to be drawn up. Once it has been established that land and property is within a partnership balance sheet, it is important to review how the ownership of the assets are shown within the accounts. Each partner will have a ‘current account’ in the business showing their share of the profits as well as drawings taken. There may also be partner capital accounts showing capital contributions into the business to fund partnership buildings and machinery. However, land and property should be recorded in separate, land capital accounts. These will clearly show the ownership of each parcel of land and each property between the partners.
One key point to look out for in partnership agreements for agricultural businesses is a clause stating that on the death of a partner, the remaining partners are required to purchase the interest of the deceased. Whilst this clause can be beneficial in ensuring that the partnership assets remain in place and the business can continue to trade following the death of a partner, it creates a binding contract for sale and means that no amount of APR or BPR are available on the partnership interest. There are potentially other ways of achieving the benefits of this clause without scuppering the availability of valuable tax reliefs. Watch out for ‘Hope’ The primary IHT relief available for individuals in the farming sector is Agricultural Property Relief (APR). This relief is valuable; however, it only covers the ‘agricultural value’. With the increasing need for new houses and permitted development rights, many agricultural assets also have an intrinsic ‘hope value’ over and above the agricultural value. This additional amount does not benefit from APR and could be subject to a 40% IHT liability. However, with some careful planning, this can be prevented. Look out for ‘Character’ Another asset with potential exposure to an IHT liability is a farmhouse. With most agricultural businesses now consisting of more than one generation farming together, farming partnerships can now have two or even three different properties that could be classified as farmhouses. APR is only available on farmhouses which are owned and occupied alongside farmland. HMRC also only allow APR where the farmhouse is ‘character appropriate’ in relation to the surrounding land. This takes into account the size and location of the house in comparison to the size of the occupied land, the history of the property as well as the current use. It is therefore important to establish and document where farming decisions are made through the use of minutes of meetings and location of the farm office. One common problem can be where the historical ‘main’ farmhouse is still occupied by the eldest generation who perhaps no longer take as active a role in the management of the farm as they once did. Unless there is evidence to demonstrate that farming decisions are made in the property, any claim for APR could be denied causing a significant IHT bill. What can be certain is that at the end of this pandemic, the government will have much larger borrowing and there is very likely to be a recession. This means that there will be a need for increased tax take by the Treasury. As well as raising the headline rate of some taxes, there will no doubt also be restrictions on some reliefs. A review of the effectiveness of Inheritance Tax was carried out by the Office for Tax Simplification and its second report was published in July 2019. The cost of APR and BPR was already under the spotlight and changes have been suggested even before the current need to raise tax revenues. It therefore seems likely that there will be some tightening of the rules for APR and BPR in the near future. Consequently, it is now the perfect time to review the IHT position of your agricultural business.
The Importance of Having an Up to Date Partnership Agreement
Alongside looking at the partnership accounts, it is vital to consider the partnership agreement, as well as setting out how income profits are to be split, there also needs to be mention of how capital profits are allocated between the partners. Whilst the existence of an up to date, well drafted partnership agreement is extremely helpful for tax planning reasons, it also provides many other benefits to a family business. Without a partnership agreement, the business is governed by The Partnership Act of 1890 and I cannot believe that any business will want to be regulated by a piece of legislation written 130 years ago.
Scrutton Bland can offer a range of specialist advice for agricultural clients including tax, insurance, business development, digital accounting and succession planning. For more information please email hello@scruttonbland.co.uk or call 0330 058 6559.
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