Diversification into renewable energy requires careful planning. Shirley Mathieson from Saffery Champness provides advice on protecting family income and minimising tax
When considering on-farm renewable energy project, it is vital to see it from the outset in the context both of ownership and timing. This means matching income generation to income needs and structuring ownership to accommodate those changing needs and attitudes to risk.
It may be a 20-year wind project or a 40-year-plus hydro scheme that members of the family are involved in or in which they may want to be involved in future. So how can it span the generations effectively?
The value of the project and the ages of family members will determine what actions need to be taken and when. Likewise, how the project is structured as a business and who runs it needs to be planned.
The nature of the business, for example, whether it is trading (as in generating power or heat) or non-trading (as in leasing land to an operator/generator), is also important. It goes without saying that planning is crucial.
Changes to family ownership, if they are to be achieved at minimal or no tax cost, should usually be planned and implemented early, before any project commitments are made.
The value of a piece of hill ground will increase dramatically as it evolves from rough grazing through to a power-generation site, particularly as it gains a grid connection and planning consent. It therefore makes sense to transfer such land when its value is low.
There may also be implications for capital gains tax (CGT) where the land is not used in the trade of the person handing on or transferring the asset. Stamp duty land tax (SDLT) may also impact on restructuring, but both can be minimised by moving early.
Trading activities benefit from much more favourable tax reliefs than investment or non-trading activities. These include holdover of capital gains liability, business property relief from IHT on death and tax breaks through investment incentives. Where they can, owners should hold an interest in the trade of the project to access these tax benefits.
There is a range of structure options, whether in a joint venture with a developer or undertaking the project in-house.
Many factors can influence the level of involvement and the business structure used in renewable energy projects.
For example, developers may not be prepared to consider a joint venture; the farmer or landowner may not wish to be involved in the running of the business at all, simply preferring a regular rental payment; or the developer may want a capital contribution from the landowner that is not affordable. Therefore, consideration of risk is also very important.
Sole trader and partnership structures are only suitable for small-scale and family situations – these are easy to set up and manage, but the major drawback is that they have no limited liability protection.
A limited liability partnership (LLP) is similar to a partnership for tax purposes, providing investors with limited liability, but there is more compliance involved.
An LLP provides access to sideways loss relief which allows losses of one trade to be offset against income from other sources. However the benefit of this is limited to £50,000 or 25% of annual taxable income.
A limited company structure also provides limited liability and allows payment of different rates of dividend to distribute profits. A limited company structure can also help with limiting IHT exposure for older family members by them holding minority interests.
The Enterprise Investment Scheme (EIS) offers a number of benefits and is useful in maximising returns to investors and family through tax savings.
EIS gives 30% income tax relief on up to £1m invested, but in the renewable sector it is only available for anaerobic digestion, hydro and community projects.
Investors must have tax liabilities to utilise the relief and ownership is limited to 30%. EIS also allows deferral of capital gains that can still be accessed even with full ownership of the shares. Accessing EIS income tax relief increases return on investment from around 7% to 10%, and up to 16% with CGT deferral.
The rules for capital allowances are generally the same for renewable projects as for other assets, but with a number of exceptions. For example, where a project is eligible for Feed-in Tariffs payments, then 100% enhanced capital allowances do not apply.
There are also special rules for solar PV (on which 8% can be written down on a reducing balance basis), assets of 25 years’ span or more, and weirs and reservoirs.
The annual investment allowance (AIA) has been increased to £250,000 for two years (2013-14). Interest on loans provides an allowable expense, but is again subject to capping for sideways loss relief.
Succession planning and IHT
In terms of succession planning, there is also the potential to save considerable tax through options such as gifting, passing ownership to the next generation, or placing the asset into a trust.
Where there is trading status, the CGT charge can be avoided through “holding over” the gain, but where there is no trading there is no holdover, so an early move may again be advantageous.
Sale is another option, and where the trade has been operating for 12 months then entrepreneur’s relief (ER) should be available, giving a 10% CGT tax rate instead of 28% on up to £10m per person.
Where the interest is non-trading, there is no access to ER; however, 28% on a sale can be attractive compared to a potential 45% income tax rate.
If the project is trading, there is also access to business property relief (BPR) so IHT on death does not apply.
Conversely if the project is non-trading (leased land is not considered as trading), then there is no BPR on the renewables project and there could also be a knock-on impact on other assets losing their BPR status if the correct structures are not used to isolate the renewables project.
Vital early steps should be taken to decide who should take the income, who should be involved and what degree of risk is acceptable to the farmer or landowner, as this will determine whether a joint venture approach is an option to be considered.
The trading route is far tidier in terms of tax planning as many of the pitfalls can be avoided – but the right structure for the project at the outset is always essential.
Where the trading route is not an option, early planning is even more vital to achieve the most satisfactory results.