CHANGING the structure of a business can have tax implications which need to be considered to understand the true benefit of changes.
Letting a surplus farmworker’s cottage is a common example of an apparently sensible move to bring in income which may have longer term consequences.
It takes it out of the business and out of the scope of the valuable Inheritance Tax (IHT) reliefs available to farming.
However, the decision can be reversed as long as IHT is not already chargeable.
When a property can be brought back into agricultural use, then a two year time period must elapse before it counts as an agricultural asset used in the business and so qualifies again for IHT relief.
“Capital Gains Tax is less of an issue,” says accountant Rob Hitch, of Dodd & Co, Cumbria.
“An asset used in the business for two years or more attracts Business Asset Taper Relief at the maximum rate of 75%, which means it is effectively taxed at a maximum of 10% on the qualifying part of the capital gain.”
Taper relief is based on the last 10 years of ownership.
An asset used in the business for part of the 10 years, then in non-business use, still attracts a significant proportion of BATR.
But the longer the non-business use, the less relief against CGT on any future disposal.
The tax regime encourages giving assets away during lifetime, but many make the mistake of continuing to derive some benefit from those assets, which makes the gift invalid for IHT purposes, warns Mr Hitch.
Common examples include parents giving away land, houses or part of their capital account in the farm, but continuing to live in the house or retain their existing profit share.
The government has introduced a new rule for previously owned assets (POA) and many more gifts will be caught by this.
Affording retirement is a huge issue for farming families and there is no simple way round it, says Mr Hitch.
“Most people who want to give away farming assets are not in a position to take a drop in profit share or income and the older generation is often reluctant to release control over assets.
“The biggest issue is often the farmhouse, which would qualify for Agricultural Property Relief from IHT, but if it is gifted and the donor continues to live in it, the gift is invalid.”
With incomes under pressure, partnership profit shares can be changed so those eligible for benefits and tax credits benefit as much as possible from them.
This applies to working and childrens’ tax credits and educational maintenance allowances, says Mr Hitch.
Changing year ends can also affect the amount of income tax due.
The introduction of single farm payment gives a one-off chance for some businesses with an accounting year end soon after their 10-month period ends to bring it forward into that period.
This effectively gives a tax holiday with no SFP having to be accounted for in the first year with the new accounting year end.
However, this is a cash flow tool that can only be used once, warn accountants.
Businesses may change their year end for any reason once every five years and any changes within the next five-year period must be commercially justified.
Cash flow would not be a justification for this.
SFP also brings a number of IHT and CGT issues to any restructuring.
One of the biggest current problems is how to value entitlements, says Mr Hitch.
Confirmation of established entitlements will not be made until this autumn and the value of SFP is known.
Entitlements must have been used in the business for at least two years to be eligible for IHT relief.
They are deemed to come into being on 1 January, 2005, so none will be eligible for IHT relief until January 2007.
CGT relief in the form of BATR will be available at 50% in January 2006 and 75% in January 2007.
Further complications arise when it has to be decided who owns entitlements.
“Is it based on the partners and their shares in the reference period, or at December 2004, or when the entitlements are being disposed of or handed on?”
Anyone retiring from a farming partnership or changing profit sharing ratios must consider the CGT and IHT issues on any transfer of SFP entitlements.
Wills should also be revised to ensure that entitlements end up in the right place, says Mr Hitch.
They are not permanently attached to the land and unless dealt with specifically in the Will, will end up in the residue of the estate rather than with land.
For profitable businesses, trading as a company can bring a tax advantage, but great care must be taken over which assets ownership, says Mr Hitch.
“Generally, land should be held outside the company, with the company renting it on an FBT,” says Mr Hitch.
“Taper relief – from CGT – is not available for assets held in a company, which still attract indexation allowance.
Assets other than farmland on an FBT may only attract 50% IHT relief if held outside the company.”
Rules covering connected party transactions, capital losses and company treatment of intangible assets must also be considered before transferring assets to a farming company.
When your business is soon to cease trading, then you should be aware that capital allowances are not permitted to be claimed in the final year of trading, warns Mr Hitch.