Potential tax savings are greater with high grain prices

Changing a farm business structure can be complex, but may also yield significant tax savings. Mike Butler, partner at accountant Old Mill, explains the pros and cons of different financial arrangements

Tax laws are constantly changing, and farmers must regularly assess whether they have the best structure for their business. This is particularly true at the moment, as higher commodity prices are likely to boost farm incomes, meaning the opportunities to save tax are even greater.

However, there are other factors to consider when deciding how to operate a business, whether they are practical issues, or relate to succession planning or risk management.

Most farming businesses have traditionally operated as sole traders or partnerships; both are simple to understand, and are very transparent, with family members working together and sharing profits. However, there are drawbacks, both from a tax and liability perspective.

Individuals are taxed on their share of the partnership profit, irrespective of how much they actually draw from the business; in some cases they can pay more tax than they actually draw down.

Partners are also jointly and severally liable for the debts of the business, and should the partnership be sued, each partner remains liable until the debt is cleared.

A remedy to this situation is to consider incorporating either all or part of the farming business into a limited company. Generally, if there is a claim made against the company then personal assets are protected – and if company assets carry a bank charge, they may also be restricted.

Using a company structure can also be extremely tax efficient. Corporation Tax now stands at 21% for profits up to £300,000 – significantly less than individual income tax rates of up to 50%.

Individuals can choose how much they draw from the company at any one time, and so control their own personal tax positions; keeping incomes below the higher rate tax band, for example. Any extra income can be saved within the company at the lower tax rate, building up investment funds more quickly.

The liquidation of a company will incur Capital Gains Tax if it has increased in value, but with Entrepreneurs’ Relief that charge can be slashed to 10%. Furthermore, when shares in trading companies pass down to the next generation they do so free of Inheritance Tax. At the time of transfer the shares are uplifted to the new market value, thereby eliminating the potential for Capital Gains Tax charges.

Mixing company structures

However, incorporation is not suitable for everyone, particularly where one needs to maintain capital tax reliefs such as Agricultural and Business Property Relief from Inheritance Tax. It may instead be appropriate to use a mixture of company and partnership structures.

For example, where farmers carry out a lot of contract work, they could establish a separate limited company for those operations, which would contract with third parties and the home business. As a consequence, the profit of the home business would be shared with the company, at a rate to be apportioned each year. This provides optimum tax efficiency, while retaining valuable tax reliefs for the home farm partnership.