How farmers can avoid inheritance tax traps

Poor planning means farming families often miss out on valuable inheritance tax reliefs. Solicitor Lorna Spear of Birketts explains how to avoid mistakes.

Ensuring that agricultural property relief (APR) and/or business property relief (BPR) is achieved on farm assets can mean the difference between a very large inheritance tax (IHT) bill or none at all.

Whether property is to pass by gift or inheritance, a review of the farming business and its ownership structure will identify opportunities or confirm you are on the right track.

Farmhouse, buildings and land ownership

Farming assets can have complex ownership. For example, land and property is often held by family members – in partnerships/farming companies or family trusts, and may be partly or wholly let.

See also: Business clinic: Tax elections must be considered in move to a company structure

If not properly structured, this can reduce the APR and BPR available and generate an unnecessary tax bill on death.

A common scenario is for a farmer to scale down his involvement in the farming operations and to gift land to farming children while retaining the farmhouse with just a small acreage, or even to let the land out on a tenancy to a third party.

This can be fatal to a claim for APR on the farmhouse as it may no longer meet the “character-appropriate” test for IHT relief. For a claim for APR on a farmhouse to be successful it needs to be owned with an appropriate area of land.

The character-appropriate test requires a suitable area of land to be associated with the farmhouse and this will vary depending on the size of the property. A bungalow will require less land than a six-bed substantial property.

Where the acreage is proportionately low, consider buying further land to strengthen a future claim on the farmhouse, if cash is available.

This can have the double effect of securing APR on a farmhouse that might otherwise be denied and achieving relief on additional value in the estate if the land is owned or occupied for the requisite periods (cash is subject to 40% IHT so converting it to land reduces the IHT liability).

If land is tenanted to a family partnership the owners of the farmhouse should remain partners.

It is also important to ensure that the profit share of the older generation is not reduced too far.

An example is where the owner of the farmhouse has a 20% capital and income profit share. If the holding is 400ha, HMRC is likely to only take 80ha into account when considering whether the farmhouse is character appropriate.

This may not be sufficient to secure APR on the farmhouse.

Also, some business and farming assets will only qualify for 50% BPR if owned personally by a partner farming through a farming partnership or farming company.

If the assets were transferred into the partnership or the company this could be raised to 100%. Such a transfer can have other tax consequences so advice should be taken before acting.

How to help your claim

HMRC is increasingly interested in farming APR claims and will make detailed investigations to establish whether relief is due.

Practical steps can be taken to ensure the likelihood of a successful claim.

  • The house must be occupied for the purposes of agriculture. This makes it essential that occupants retain an involvement in farming. If the farming operations are contracted out or family members other than the claimant are taking more of an active role it is critical that the farming occupant heads up the farming business in a management and decision-making capacity.
  • The farm office should be in the house. All paperwork should be kept in the office and minuted meetings with partners, contractors, farmworkers and professionals held there. Meeting minutes demonstrating the occupants’ involvement in the farming operations are extremely useful when HMRC asks for information after the death of a deceased.
  • Where land is farmed by a contractor, responsibility should be retained by the owner for operations such as hedging, fencing and ditching. There should be appropriate exposure to risk on the part of the landowner to demonstrate genuine commerciality. It is important that the landowner is making the decisions and instructing the contractor, rather than the other way round. Decisions on farming policy such as stock breeding programmes/cropping choices and so forth must be made by the landowner.
  • All buildings on which APR will be sought should be used for genuine farming purposes and not left redundant or used for non-agricultural purposes.

BPR on a farming business that includes let properties

Where there are both trading and investment businesses, for example farmland farmed in hand (trading) and cottages on the farm let on assured shorthold tenancies (ASTs), or buildings let as offices or workshops (investment) it should be possible to obtain BPR at 100% as long as the business is structured correctly.

The principle was established in the Farmer v IRC (1999) case that a business, whether run as a sole trade, a partnership or a company that attracts BPR (because it is not wholly or mainly an investment business in character) can achieve relief on assets within the business which are nonetheless of an investment nature.

The measurement of whether the business is wholly or mainly an investment one needs careful analysis.

The Farmer principles require a number of factors to be taken into account such as turnover, profitability, market values and time spent in the farming and letting sides of the business respectively.

Where it is hoped that BPR will be achievable on investment property, a full IHT audit by a professional adviser is recommended.

This would include preparing calculations on the basis of the tests used by the court in the Farmer and subsequent cases.

Convert old tenancies to uplift IHT from 50% to 100%

It is important to review old agricultural tenancies. Land let on pre-1995 Agricultural Holdings Act (AHA) tenancies will generally only attract APR at 50%, whereas land let on post-1995 tenancies (farm business tenancies) can benefit from IHT relief at 100%.

This can mean a potentially unnecessary tax bill on land that could have achieved 100% relief if the tenancy had been converted prior to the death of the landowner.

Understandably AHA tenants will be wary of losing the statutory protection of AHA tenancies such as security of tenure, by entering into new tenancy agreements.

However  the 2006 Tenancy Reform Industry Group (Trig) reforms mean a tenant can surrender an AHA tenancy in exchange for a new tenancy while retaining the same security as previously.

So a landlord and tenant can agree (subject to certain conditions) that a new tenancy to the existing tenant will be an AHA tenancy such that the tenant will retain the same protection enjoyed under the previous AHA tenancy, but simultaneously securing an uplift to 100% APR for the landlord.

Such tenancies need bespoke drafting and stamp duty land tax (SDLT) and capital gains tax (CGT) issues must also be considered. Specialist advice should be sought.

Development land complications

The ownership and transfer of development land or farmland that may in future have development potential requires complex planning – both IHT and capital gains tax need to be considered. It is important to plan as early as possible with professional advice, so that the correct structures can be put in place.

Partnership and shareholder agreements

Partnership and shareholder agreements should be reviewed to ensure:

  • There is no obligation to purchase the share of a deceased partner or shareholder as this may result in IHT relief being lost. An option agreement is a better alternative.
  • The will and the partnership/shareholders agreements are in harmony. Where the two conflict, as can be the case, particularly where documents have been drawn up at different times and by different advisers, they must be brought into line or there is a risk of assets passing in a way that is at odds with a testator’s wishes, with adverse tax consequences. It is not uncommon for a deceased’s will to give away assets that are actually not owned outright by him or her but held in a partnership and subject to the death provisions of the partnership agreement.
  • Above all, allow plenty of time for restructuring arrangements. A full review, advice and drafting takes time, but also the statutory periods for occupation and ownership that may be necessary for reliefs to apply need to be taken into consideration (see “Main IHT rates, thresholds and reliefs”, below).

HM Revenue & Customs sign

Main IHT rates, thresholds and reliefs

Inheritance tax rate – 40%

  • Nil rate band (before IHT becomes chargeable) £325,000 (individuals) or £650,000 (spouses)

APR at 100%

  • Land and buildings owned for seven years or occupied for two years by the transferor and used for the purposes of agriculture (throughout the full period). Where the transferor does not occupy the land himself he should have the right to vacant possession within 24 months (the latter is always the case with a post 1 September 1995 tenancy).
  • Land owned by the transferor and let on a pre-1981 tenancy where the “working farmer” conditions are satisfied.

APR at 50%

  • Land and buildings let on pre-1 September 1995 tenancies – usually AHA tenancies.
  • Other cases where the conditions for 100% relief are not met.

BPR at 100% 

  • A qualifying business or interest in a business.
  • Shares in an unquoted company.

BRP at 50%

  • Land, buildings, plant and machinery used in a partnership or company business in which the transferor is a partner, or if a company has control.
  • To qualify for BPR the business interest must be held for at least two years.

Hanson case

There is a possible exception to the need for a farmhouse to be owned with land but it should be approached with caution. The Hanson v Revenue and Customs Comrs (2012) case said that achieving APR on a farmhouse requires “common occupation” rather than “common ownership”.

Common occupation can arise without common ownership, for example where a farmer owns and lives in a farmhouse with say 20ha  (common ownership) and farms a further 40ha that he does not himself own but farms on a tenancy or has a right to occupy under a trust (common occupation).

The Hanson case concerned a house that was held in a trust and occupied by the individual farming the land, which he owned in his own right. APR was achieved on the farmhouse despite the lack of common ownership.

The full scope of the Hanson case has not yet been tested in the courts and uncertainties remain. To be “character appropriate” it is essential to ensure there is sufficient land with the house and to be prudent this would be in the same ownership rather than just the same occupation.

Are you, like many other farms, missing out on tax claims for R&D?

If you’re a limited company, you could be eligible for tax credits if you’re carrying out R&D on your farm. For more information and to find out if you’re eligible visit our R&D tax credits page.

Find out more