Development opportunities need careful tax planning

The past 18 months have seen a flurry of farmers looking at developing land, following the radical change in planning rules in favour of development. There has also been very keen interest from housebuilders in some regions, writes Laura Macdonald , tax adviser at accountant Old Mill.

Proposals in this year’s Budget to allow conversion of existing farm buildings into residential dwellings without going through the usual planning process could see even more development opportunities taken up in the future. So what do landowners need to consider?

See also: 8 top tips for farm tax planning

Choosing a developer

It is important to select the right developer to work with, so take advice from an independent land agent. Ask for references from previous projects, and check the developer’s accounts at Companies House to confirm their financial position.

Landowners must also be careful how the development agreement is structured, to minimise potential tax bills. It is increasingly commonplace – particularly in the case of renewable energy projects – for landowners to enter into an agreement several years in advance of actually selling their land.

But there are some key tax issues around the way arrangements are structured that could cost landowners hundreds of thousands of pounds in the long term if correct advice is not taken.

Types of agreement

Broadly speaking, deals are structured either as an outright sale – often with overage provisions to enable the seller to claw back some of the increase in capital value once planning permission has been obtained – or as an option or promotion agreement.

Hybrid arrangements have been appearing recently, combining various structures to meet the specific requirements of landowner and developer. Each has differing tax implications.

Overage agreements need careful consideration, as the potential future uplift must be assessed at the time of signing, at which point tax on the overage must be paid. Unless the developer makes a sufficiently large upfront payment, the landowner risks a significant tax bill without having the funds to pay it.

Under an option agreement, the landowner commits to selling the land for an agreed price at some point in the future, if called upon to do so by the buyer. Options are normally exercised on the proviso that planning permission is obtained within a specified time frame.

This is generally a capital disposal, with the gain being charged to capital gains tax (CGT). Depending on what the asset has been used for during the landowner’s period of ownership, entrepreneurs’ relief may be available to reduce the rate of CGT to 10%.

Under a promotion agreement, an agent works with a landowner to maximise the land value in return for a percentage of the ultimate sale proceeds when the land is bought by a developer.

Promotion agreements are increasingly popular as the landowner and agent have a mutual desire to see the project to fruition. However, the tax treatment on the resulting proceeds can differ substantially, depending on the precise nature and wording of the agreement, and there are pitfalls for the unwary.

For example, if promotion agreements are not carefully prepared, HM Revenue and Customs could treat the landowner and developer as a partnership.

This has the potential to expose the landowner to higher rates of income tax by treating the uplift in land value as income – and therefore taxable at up to 45% – rather than capital gains, which incur slightly more palatable rates of up to 28%.

Landowners would also lose the potentially valuable CGT reliefs that could apply on a capital disposal, such as rollover and entrepreneur’s relief.

Treatment of development payments

Developers often offer landowners a cash payment on signing of the agreement. Generally speaking, this will be taxed as a capital receipt, with no scope for rollover or entrepreneur’s relief.

Other payments may be treated as either income or capital gains – and that depends on whether or not HMRC considers the activity to be carrying out a trade.

One of the fundamental tests is to determine the landowner’s intention at the point of acquiring the land. Did they intend to own it as an asset from which to conduct their trade? Did they inherit the land? If the answer to either of these questions is “yes” then the transaction is more likely to be capital in nature (and so benefit from CGT reliefs).

It is usually preferable for the proceeds of sale to be treated as capital gains (rather than income) as that tends to attract lower rates of tax as well as valuable CGT reliefs.

However, getting to the development stage can take several years. Depending on the type of agreement in place and the phasing of the development itself, payments may be sporadic.

But from a tax perspective, payments are generally assessed at the earliest possible date, which can lead to large tax liabilities arising before all the proceeds have been received.

In unusual cases, landowners may choose to be paid in developed houses rather than cash, but they should take advice before doing so as this could jeopardise valuable tax reliefs such as rollover relief from CGT.

What about VAT?

The input VAT of the landowner, particularly under a promotion agreement, can be a significant cost and is not reclaimable. Landowners would need to opt to tax the development land to recover the VAT, although specialist advice should be sought on this matter.

It is worth getting an accountant to review the draft agreement before signing, to ensure all tax implications are taken into account.

What if the land isn’t developed?

In some instances, landowners enter an option agreement, but the land is then not developed. This may trigger an uplift in value, known as “hope value”.

This would boost values significantly above agricultural levels, triggering a substantial capital gain upon gift or sale of the land.

Hope value can also occur even if the landowner never has any intention of entering an agreement or developing the land.

If hope values are not recognised during a farmer’s lifetime, this can result in a hefty inheritance tax burden, as they are not eligible for agricultural property relief.

It is therefore important that the land qualifies for business property relief (BPR), which means landowners must avoid letting it under a farm business tenancy, as that would preclude eligibility for BPR.

Considering the substantial values associated with development land, and the fundamental importance in the detail of the legal agreements entered into, it is vital that any contracts are properly structured in the beginning.

There is a huge difference between a 45% rate of tax and 28%, or even 10%, so it is essential to start planning as early on in the process as possible.

It can take a good couple of years to arrange assets and agreements for the best tax outcome.

Farmers may need to get tax plans in place years in advance of any potential development going ahead.