PLAN WITH CARE TO MAKE MOST OF F&M PAYMENTS
may seem substantial. But
as they are the only income
provider for many farm
businesses, great care
should be taken to
maximise their value, says
MANY farmers have yet to take advice on making the best use of foot-and-mouth compensation payments. Others have been given poor guidance, which could prove costly, says Cathy Barrow, agricultural manager at Devon-based accountant Davisons.
Sited in South Molton – the middle of an area that was a disease hotspot – she knows better than most of the need to protect every penny of compensation. For many producers, it will be the only source of income for months.
Careful planning to minimise tax liabilities is essential. But that planning must be done before restocking commences.
For tax purposes, compensation can be divided into three areas – herd animals, other livestock and deadstock compensation and cleaning money.
Profit on compensation to cover the loss of herd animals (mature animals kept for production/reproduction), where more than 20% of the herd has been culled under compulsory slaughter or welfare grounds, is tax free, provided restocking does not take place in the next five years.
"This is of tremendous benefit to those farmers who wish to leave the industry," says Ms Barrow. "Dont worry if your animals were not on herd basis, in compulsory slaughter circumstances you have a fresh opportunity to elect."
But for those wanting to restock within five years, its a different story. If the farm restocks with replacement animals of the same quality, which cost less than the compensation, the profit element will become taxable at the time of replacement, she warns.
But adjustments can be made if animals are of a different quality. "If slaughtered animals are replaced by animals of a lower quality, the amount of compensation included as a trading receipt should not exceed the cost of the animals. The excess compensation will, therefore, remain tax free."
There are other circumstances in which the tax payable upon restocking will be lower. For example, a sheep farmer may restock with ewe lambs for finishing. Provided these do not reproduce, they cannot be regarded as herd replacements and herd compensation will not become taxable.
Alternatively, a farmer could change his business structure, by admission or retirement of partners. "This ends the previous herd basis election, so there is no tax to pay on compensation. The new business can make an election in the future," says Ms Barrow. However, Inland Revenue guidelines state that this must be a "genuine change".
Other livestock (not classed as herd basis) is treated differently by the taxman. If compensation exceeds the cost of culled stock, the excess profit can be taken out of the year in which the cull took place and be spread over the following three tax years.
"And for those animals born in the year of slaughter, profit may be taken as 25% of compensation for sheep and pigs and 40% for cattle, where the cost of stock is taken to be a percentage of market value. This avoids unexpectedly high profits in the year of the cull, spreading the tax burden, and allows planning for tax savings," says Ms Barrow.
Farmers who retire face a tougher time. Compensation becomes taxable in the year of retirement. "The tax saved on herd compensation by retiring must be weighed up against losing spreading relief."
Alternatively, the farmer could continue farming by grass letting, provided the agreement is for less than 365 days, with no right of renewal and various tasks are undertaken by the farm. "Under these terms, the owner remains in occupation of the land, and must be technically growing grass rather than simply letting the land," she explains. "This can allow the tax liability to be spread over three years."
Deadstock compensation and cleaning money is treated much more simply, being taxable in the year it is received.
Farmers who cannot escape tax liabilities on compensation should reduce current trading profits to minimise the tax rate they will have to pay, says Ms Barrow (see box). "Most tax-saving ideas involve spending funds or making a commitment to do so. Care should be taken not to squander funds, but a quiet period before restocking could prove ideal for some tasks, such as property maintenance." *
Areas attracting 100% relief:
• Repairs to buildings and property – these must be replacements, renewals or repairs, but not capital additions which only attract 4% relief/annum.
• Paying reasonable wages to family – where they genuinely help on the farm. For the current year up to £4535 may be paid free of income tax and national insurance.
• Lime – fully tax deductible in the year it is spread.
• Repairs to working farmhouse – historically, 33% of repairs allowed, but Inland Revenue may consider proportion of rooms used for business and restrict allowance accordingly.
• Farm machinery – new or second-hand attracts 40% capital allowance.
• Cars – attract a 25% tax allowance, reduced according to extent of private use.
• Pension premiums – consider these, especially if paying top-rate tax of 40%.
To make a realistic estimate of tax liability arising from compensation, farmers should try to calculate current trading profits to establish their tax band.
But uncertainties of if and when farming will recommence, what type of farming and on what scale, let alone prevailing market conditions, make it extremely difficult to estimate likely income and expenses. That makes estimating profits for the current and following three tax years a real problem, says Ms Barrow.
Despite the difficulties, it is important to produce projections, not only to assess potential tax liabilities, but also to ensure business plans are viable and that optimum use is made of compensation.
Good use should be made of the Farm Business Advice Service, which provides up to five days of free advice for farmers who have lost stock due to foot-and-mouth.
Enough compensation should be set aside to cover known expenses, and to meet estimated expenditure to avoid cash flow problems later on. As tax liabilities arising on compensation may be significant, quantify the worst tax position and reserve funds to meet liabilities as they become due, says Ms Barrow. Actual trading results can always be adjusted by spending if necessary to reduce tax liabilities.
Remaining funds should be invested to maximise returns until they are needed.