BUSINESS AND LAND OCCUPATION CHANGES

BUSINESS CHANGES

Where there has been absolutely no change, this has been dealt with by the RPA on form SP1.

The three other situations dealt with by the RPA are covered below. Those producers qualifying to amend their reference period data will use form SP2A, which has an extended deadline of Jan 31, 2005.

It was initially only possible to drop a whole year or years, but now an individual scheme can be dropped. For example, a cereal/beef farm might keep all three arable claim years, but drop 2001 suckler cow premium because of the effect of foot-and-mouth.

Business changes (form SP3) are now possible up to the May 16, 2005, claim deadline.

New farmers who came into the industry during the reference period (form SP4) will have their historic entitlements calculated just on the year or years that they were farming in the reference period.

LAND OCCUPATION CHANGES

One of the major problem areas is the large number of businesses where there has been a change in land occupation during or since the reference period.

This whole area has been affected by slow decision making by UK ministers on the national reserve rules, many of which have to be taken on a UK basis. Most decisions have now been announced and readers should consult scheme literature relevant to their region for the final national reserve categories.

All land occupied in 2005 will at least establish the regional average payment element, but this starts at a very low level. So there is a large incentive to obtain some historic entitlements in addition.

There are three main alternative ways of gaining some historical top-up. The private contracts clause (PCC) and back-to-back (B2B) deals both require the co-operation of the reference period occupier. If this does not exist then the only route is the national reserve.

MECHANISMS

In England, the PCC route is only likely to be usable where land has been sold. Essentially, the reference period occupier (2000-02) has to establish his entitlements by declaring he is a farmer at the date of application. He then immediately transfers them through the IACS mechanism to the new occupier who makes the claim for the 2005 year.

Both parties must attach copies of the sales contract, specifying the intention to transfer historic entitlements. Where this did not exist at the time of the contract, a rider can be added.

B2B deals will probably be the least used of the possible mechanisms. These are likely to be used where the reference period occupier takes a lease on a very small area and concentrates his entitlements onto this area and subsequently passes them to the new occupier. This mechanism needs the sanction of the RPA who will be charged with looking at artificiality.

THE NATIONAL RESERVE 1

New entrants are now an “automatic” category. This covers those who have commenced farming between Dec 31, 2002, (or who didn”t make any aid claims in 2002) and Nov 2, 2004.

Farmers who invested in productive capacity or purchased land during or since the reference period will be eligible for a national reserve (NR) grant. But there is a cut-off date of May 15, 2004.

Others who entered into long leases (probably six years or longer) are to be treated as “land purchasers”.

The next category is farmers who have purchased (again before May 15, 2004) or inherited land coming out of a tenancy. Dairy farmers who converted from milk production into other supported enterprises (arable, beef and sheep) before May 15, 2004, will also be eligible.

Recently added categories include those who had national agri-environmental schemes, energy crops or were dairy farmers subject to exceptional circumstances in 2004/05.

THE NATIONAL RESERVE 2

The national reserve will be funded by reducing everyone”s initial entitlements by up to 3%. EU member states can also increase the initial 3% reduction if more money is needed.

There are certain restrictions that apply to entitlements from the NR. Such entitlements cannot be transferred by the recipient for five years from their allocation. This includes both sales and leases, but transfers on inheritance are allowed. Entitlements must also be used every year for the first five years, or they will revert to the NR.

TRANSFERRING HISTORY

Some of the most common land occupation changes are listed, and the various options to transfer claims history are indicated.

Where land has been purchased or a long lease has been taken out before May 15, 2004, the PCC route is likely to be favoured. If there is no co-operation the only route will be the NR.

For land purchased since May 15, 2004, the only likely route is the PCC. Where land has been taken on a short lease in England the only choice is a B2B deal.

Those who have expanded by investing in productive capacity (other than land purchase) only have the NR as an option and await rulings on what investments qualify. However, those who have taken short-term land could be included if investment in machinery, labour and working capital is included in the criteria. The final category of ex-dairy farmers have the NR as their only option.

DEDUCTIONS AND THEIR RECOVERY 

DEDUCTIONS

Producers who hold entitlements and comply with the payment conditions will receive SFP. However, the payment will be subject to several ongoing reductions.

Scalebacks of historic payments are possible to prevent breach of the national ceilings. And entitlements are likely to be initially reduced by 3% or more to fund the NR.

In addition, there is compulsory EU modulation starting at 3% in 2005 and rising to 5% for 2007 onwards. However, the first 5000 of aid will be exempt from these reductions.

The UK can also apply its own additional rates of “national” modulation on top of this – announced English rates are shown. Finally, financial discipline will apply from 2007; EU farm ministers will decide every year what % reductions are needed to keep within the CAP budget.

RURAL DEVELOPMENT (ELS and HLS)

Not all of the money deducted will be lost to farmers. The modulation will be “recycled” back into rural development schemes – the so-called second pillar of the CAP.

This modulation has to be match-funded by national governments, which will bring in extra money. The major rural development change in England for 2005 is the launch of the new Environmental Stewardship Scheme (ESS).

The entry level scheme of the ESS will be rolled-out countrywide. Features and management practices on-farm will generate points, and if enough points are accumulated, then a standard payment of around 30/ha will be received (60/ha for organic farms). The higher level scheme of the ESS will replace the existing Countryside Stewardship and Environmentally Sensitive Areas Schemes.

LAND MANAGEMENT

Cross-compliance and the ESS both require certain land management practices from farmers. What should result is a hierarchy of payments – the more farmers do for the public good, the more they are paid.

At the bottom will be the existing legal requirements. Farmers are not forced to participate beyond this level, though SFP would not be paid. To qualify for basic payment, they need to cross comply. However, there are incentives to go further with additional ESS tiers.

TAXATION ISSUES AND VALUES 

INCOME TAX ISSUES

How the Inland Revenue will treat the SFP for income tax purposes is still not definitively resolved. The SFP will be issued at some point from December 2005 to June 2006. Aside from tax problems, there may be cash flow implications for producers (especially arable farmers) who are used to receiving their AAPS cheque before Christmas.

Depending on financial year ends, two lots of subsidy receipts may end up being taxable in one year with the switch from the old system to the new SFP. Then there is a question of when the SFP is established for tax purposes.

The SFP is conditional on following cross-compliance rules for the whole of the calendar year, so should its value be apportioned across the 12 months?

Or, if cross-compliance conditions are onerous enough, should it only become taxable once it is certain that these have all been complied with – after Dec 31 in the scheme year? See box for probable income tax basis.

For most farm businesses (excluding companies), all previous subsidies were taxed as profits from trade. But what happens under the new system if active farming ceases and the farmer simply idles his land and takes the SFP as a pension? It is likely that each case will be considered on its own merits.

If it is decided that receipt of a SFP payment without active farming is not “profits from trade”, then such income may be taxed differently. This would result in a less favourable treatment of offsetting costs against income and allowances.

CAPITAL TAXES

Capital gains tax (CGT) will come into effect if entitlements are sold. Entitlements are likely to be treated the same as milk quota in that the asset has just been created and there is no base cost.

Taper relief is available to offset the effects of CGT. But if there is no “farming trade” being carried out will the sale of entitlements be eligible for the more generous business asset taper relief (BATR) provisions? Also, when are entitlements deemed to have been created for the purposes of BATR?

In some tenancies, there will be an agreement to hand-over entitlements at the end of the tenancy for a nominal sum (say 1). It is not clear whether this will be taken at face value. Also, will rollover relief be available on entitlement sales if there is no farming trade (when such sales will not be classed as business assets)?

And what of VAT and stamp duty on sales? Inheritance tax (IHT) will be triggered if entitlements are transferred at death or via a lifetime gift. But business property relief (BPR) is available on assets held by the farming business and it is assumed that entitlements will be included.

Agricultural property relief (APR) is available on farmland. Any move to fallow land and claim the SFP may cause problems when trying to justify whether a country property is really agricultural. One final point on inheritance relates to wills. Entitlements are a new creation and will not be covered in most wills.

VALUE OF ENTITLEMENTS

Until widespread trading occurs it will be very difficult to estimate market values for SFP.

Transfer deals are unlikely to be confirmed before December 2005 at the earliest, to ensure entitlements have been allocated correctly. Even then values may not be set by the open market as the lack of naked acres means little trading is likely to take place.

As an entitlement is a tradeable right to a future stream of income then they may have to be valued in that way. But there are many uncertainties as to the future income.

A high proportion of production support has always been capitalised into land values. This is more the case in arable farming where “IACS eligibility” of the land adds to the value. Values for eligible arable land may well fall towards that for grassland.

Otherwise, there may be very little change. Many other factors such as non-farming buyers, tax rules, farmers” wish to expand, local competition etc. are important issues in setting land values.

RENTAL VALUES AFTER MTR

The rental value of land will depend on its productive capacity and its SFP entitlement value. The chart attempts to analyse the situation for high and low productive value land, where the SFP goes to the landowner or the tenant.

It is not yet clear how the reforms will affect rents in “traditional” 1986 AHA tenancies. In many whole-farm rentals, a considerable portion of the value lies in the buildings, equipment, and particularly the housing included in the rental. The value of this is unlikely to be affected by decoupling.

INVESTING IN MILK QUOTA

The first column of the table shows the value of the dairy payments after deductions, and how the transitional percentages (as the SFP moves from historic to regional area payments) under the English system erode it.

The future income stream in subsidy terms of holding a litre of quota on Mar 31, 2005, is 6.89p/litre in England. With discounting at the relatively low rate of 3% this brings the value down to 6.31p/litre. Things are different in Wales and Scotland due to the historic system adopted. Here the value (before discounting) is around 14.5p/litre.

However, who is to say the historic system will last until 2012 in these regions? Producers buying quota might want to use a higher discount rate to reflect the risk involved. And producers should think carefully before investing in quota simply for the future subsidy receipts.

INDUSTRY SCENARIOS

INDUSTRY IMPLICATIONS

Decoupling will provide an added incentive to producers to examine unit costs of production. Dramatic change is not expected because the high initial element of historic subsidy will allow most businesses to take time to assess their strategy.

Some will need to make urgent change, especially those with an early “trigger” (succession issues, major capital expenditure, losses leading to equity drain).

We do expect considerable restructuring in all parts of the industry over the next 5-10 years with many farmers giving up/scaling down, but for the most part their land will be taken up by expanding farmers.

An increasingly volatile market environment will result in much more collaboration, leading to medium-term contracts with pricing agreements.

IMPACT ON ARABLE SECTOR

World prices will have the biggest impact on this sector. Although there will be input reductions at the margins, a move away from high yields on the more productive land is not expected because yield is such an important part of achieving low unit cost of production in this sector.

IMPACT ON LIVESTOCK SECTOR

In contrast to the arable sector, some livestock producers are more able to reduce unit costs of production by reducing purchased inputs (feed, fertiliser, vet and med) and farming more extensively, as long as land is available at the right price.

There has already been an extensification of UK livestock production and this trend is expected to accelerate following decoupling.