Diversification – take time to check tax issues

Choosing the most appropriate structure for a new enterprise is important and should be considered at a very early stage, including whether a diversification should be part of the existing business.

There is no blueprint – what is right depends on the activity planned, its proposed scale and the scale of the existing business.

Advice should be sought early to ensure the chosen route does not give one tax advantage only to seriously jeopardise other reliefs later.

Consideration should also be given to protecting an existing business from the risks of a new venture – in some cases through the use of limited liability companies or limited liability partnerships.

However, we often see limited companies set up for a new activity only for this to be difficult to unravel when circumstances change and the limited liability status actually becomes an annoyance.

Generally, each distinct activity of a taxpayer is taxed separately and this creates an added administrative burden, possibly including the cost of separate accounts for the diversified activity.

Rules govern the offsetting of tax losses from one activity against the profit of another and it should not be assumed that a loss in one activity will automatically reduce the tax payable on the other.

VAT considerations

Depending on the nature and scale of the diversified activity, there may be advantages to separating it from the main farming activity to avoid the need to register for VAT.

For this to work it is vital that there is a clear and distinct separation of the new activity. This will extend to different ownership of the new enterprise – perhaps by running it through a separate limited company – as well as different bank accounts, ideally separate premises and offices and minimal shared facilities such as telephone and insurance.

Although there are often advantages to not including a new enterprise in the VAT registration, particularly where the customer is the general consumer, it may sometimes be better to include it in the farm VAT registration or for it to have its own registration to allow the recovery of VAT on costs.

For example, advantages can be achieved where a small letting business is incorporated into a much larger farming business in terms of being able to recover VAT on the costs incurred and being able to retain business property relief for inheritance tax (IHT) purposes.

Inheritance tax and capital gains tax

Assets used in agriculture will generally qualify for agricultural property relief (APR) from IHT, allowing them in many cases to transfer free of this tax. They are also usually capable of being passed on to the next generation during their lifetime without crystallising a capital gains tax liability.

However, once an asset is used in a non-agricultural diversified activity the risk of taxation on death or on passing through the generations will increase.

For example, a recent ruling denied relief for inheritance tax purposes on a property used for holiday letting.

While APR would be jeopardised by the use of a farm asset for non-agricultural purposes, as long as the activity is still a trading business the assets used in it are likely to be eligible for business property relief.

Assess effort and cost when planning new ventures 

New ventures should be costed and recorded on a standalone basis to help identify how much time, effort and finance is going into them and to understand what is profitable and what is not, advises solicitor Michael Aubrey of Mills & Reeve.

“Compare the proportion of management time spent on the new venture with the proportion of profit it earns,” he suggests, alongside consideration of several other key issues when setting up a new enterprise:

  • Beware of jeopardising tenancy succession through diversification – successors need to derive at least 50% of their income from the holding in question unless agreed with the landlord – organise diversification income accordingly.
  • Tax and legal issues may conflict – identify what is most important
  • Solutions likely to be different for tenants to those for owner-occupiers.
  • If the new business is risky, consider how that risk might affect the core business in future – for instance public or product liability – this might be a reason to consider separating the two.
  • Branding is becoming more important – will the image of the core business be affected by the diversification, or vice versa? They may complement each other, but if there is any potential conflict they may need separate branding. For example, for a food business and a waste disposal/treatment business.
  • Diversification offers opportunities to manage succession and plan how to hand on management of different parts of the business. 

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