Diversification has proved a popular source of alternative
revenue to combat shrinking farm incomes. But there
are plenty of tax pitfalls to catch the unwary.
Olivia Cooper reports
OVER 40% of farmers had diversified in some form by 1999, according to an NFU survey. And the number continues to grow.
But diversification can throw up tax problems and it is essential to seek professional advice before going ahead with plans, says Carlton Collister, senior tax manager for accountant Grant Thornton.
"Many projects fold in the first year through a failure to grasp the full consequences of the undertaking. It is essential to think your scheme through before you start. If you appreciate the tax implications, you can prepare for them."
Most tax traps do not become apparent until the property is sold, or the landowner retires or dies. But VAT can have a large and very immediate effect on new projects.
Value added tax
Normal farming practices are zero-rated for VAT purposes, but even minor changes can revoke this exemption, which can be very costly, says Mr Collister.
"Equine liveries are a common example. Although rent on DIY liveries is tax exempt, any services like exercising or feeding the horse will render it taxable at 17.5%. It is very easy to change from one to the other without realising."
A new VAT scheme was introduced by the Chancellor in his pre-Budget report on Nov 27, to come in over the next year. This will mainly affect contractors with a turnover of up to £100,000, allowing them to calculate VAT liability at a predetermined rate. The aim is to cut book-keeping costs by up to £1000/year, but the tax burden could actually increase, so this option needs to be considered carefully. Farmers who are repayment cases will not benefit from this measure.
Business ratings can pose another potential pitfall. Many contractors and machinery rings have found that barns where machinery is stored are subject to business ratings, costing up to 40% of the rental value. This may be unavoidable, but it is better to budget for the eventuality than not, says Mr Collister.
Capital gains tax
CGT taper relief was introduced in 1998 and gives a percentage of tax exemption to the capital gain on sale, depending on how long the asset has been owned.
Diversification, like the letting of property and land, can change farming assets to non-business assets, which alters taper relief calculations.
It can also impact on rollover relief, as full rollover relief is not available to non-business assets on sale. Although partial relief may be granted, all proceeds have to be re-invested, leaving no spare cash with which to pay the tax.
With most farmers looking to minimise costs, many are putting farming companies into voluntary liquidation, as it has become an expensive way to trade. But although capital gains on shares are eligible for taper relief, this can be complicated. Company activities are taken as an entirety, and must not have any "substantial" non-trading activities. This means not more than 20% of turnover, asset value, employee time or expenses can be concerned with non-farming activities.
Farm cottages may cause a problem here. If one is let on an assured shorthold tenancy or sold off, it may be worth double the value of a cottage tied to the farm, rendering the shares ineligible for taper relief.
On a more positive note, taper relief is to be altered as of Apr 6, 2002, to come in over two years rather than the current four (see table). "This will allow anyone who has temporarily diversified, creating non-business assets, to reset the clock and gain maximum exemption in just two years."
It should be remembered that taper relief is a replacement for retirement relief, which is being phased out. Subject to eligibility, retiring farmers over 50 years old can make a capital gain of up to £100,000 tax free, with the next £300,000 taxed at half the normal rate. From Apr 5, 2002, these limits will be halved, and retirement relief will disappear from April 2003.
"Retirement relief offers an absolute tax saving unlike taper relief, which never gives more than 75% exemption," says Mr Collister. "Anyone considering retirement should get on with it to avoid missing out."
Although changes to inheritance tax were widely expected in the Chancellors pre-Budget report, a reprieve was given this time round. But Mr Collister still predicts an upheaval this government term.
However, recent changes in the valuation of property for tax purposes are undermining the assumption that 100% agricultural property relief is available on farmhouses and associated buildings.
The problem arises when a farmhouse appears "too grand" to be purely agricultural. The Inland Revenue usually queries houses worth over £250,000. If the house is considered "too grand", the difference between the "agricultural value" and market value is taxable.
There are no definitive tests, and it is safest to assume that 100% APR will not be available, so plan your inheritance distribution through lifetime gifts and other tax-free methods or take out insurance to cover the tax costs, advises Mr Collister.
"An unexpected tax bill can shatter even the best of business plans," he says. "Consider all the implications of your project, and plan for any tax charges to minimise unnecessary costs." *
IHT problems can arise if a farmhouse appears too grand to be purely agricultural.
Inset: Be prepared… Think through the tax implications before diversifying, says Carlton Collister.
Number of % of gain % of gain
years in chargeable: chargeable:
qualifying business non-business
holding assets assets
1 50 100
2 25 100
3 25 95
4 25 90
5 25 85
6 25 80
7 25 75
8 25 70
9 25 65
10 or more 25 60
* April 2002 onwards
Even minor changes to the business, like equine liveries, can put an end to zero VAT status.