Contract farming – a taxing dilemma
Why Contract Farm
You may be considering contract farming for a number of reasons. The potential withdrawal of BPS payments has brought this issue into particularly sharp focus. Perhaps your machinery is reaching end of life and you don’t want the capital outlay of replacing it, you want to release capital to fund living expenses or you simply want to avoid the employment headaches that are frequently a feature of in-hand farming. The scale of your farming enterprise may make profitable farming difficult, particularly in the arable sector. Whatever your motivation, you need to tread carefully if your contract farming arrangement is to be viewed in a favourable light by the tax authorities.
Benefits of Contract Farming
The appeal of contract farming is clear. Get it right and there can be substantial management, financial and tax benefits including the ability to offset farm expenses against trading income and retain Agricultural Property Relief from Inheritance Tax. It may also free up time and capital to allow you to focus on other business opportunities while maintaining your status as a farmer within the rural community.
Whether contract farming turns out to be the best decision you ever made or ends in tears hinges on two critical aspects:
•your reasons for taking this route
•how well the Contract Farming Agreement (CFA) has been drawn up.
I always advise farmers to think very carefully and honestly about their reasons for entering into a contract farming arrangement as this will determine whether another structure may be more suitable.
“It is vital as a farmer to prove you still call the shots and are exposed to a substantial degree of risk.”
The right balance for Contract Farming
The Contract Farming Agreement must strike the right balance between in-hand farming at one end of the spectrum, where you are responsible for every aspect of your farm operation and, at the other extreme, you effectively create tenancy. In our experience, if a farmer delegates too much of the day-to-day management of the farm to a contractor this can lead to disputes over tax relief. (For this very reason, we usually advise against the imposition of a prior charge – all too frequently looking like a rent). An incentivised profit sharing arrangement is acceptable but the majority of the profit, and in effect also the loss, must be retained by the farmer.
Risks associated with Contract Farming
If you are deemed to have created a partnership or tenancy rather than a contract farming agreement you will lose valuable tax breaks so it is vital as a farmer to prove you still call the shots and are exposed to a substantial degree of risk.
ractice, this means making all the important decisions such as what crops to grow and running the farm bank account. Here, the devil really is in the detail. Ensure your seed merchant sends invoices and sale receipts to you at the farm address, maintain the accounts and bookkeeping, VAT returns and overdraft where necessary. The small details can be equally important. Maintain your membership of the NFU and local agricultural society and even keep winner’s rosettes for any agricultural prizes.
As regards day-to-day management of the farm, we recommend that you continue with certain in-hand activities such as hedge-cutting, ditching and fencing. This may seem overly cautious but under the current tax regime with its focus on closing tax loopholes, be assured the tax inspector will scrutinise your affairs in painstaking detail to verify you really are actively farming and, indeed, are the farmer.
This is why I started by suggesting you reflect on your reasons for considering contract farming in the first place. If the carrot of potential tax-savings lies behind its appeal, you will need to go to what may seem like extreme lengths to prove the scheme’s legitimacy.
Conversely, if tax is not an issue, you may prefer to simply hand over the running of the farm to a third party who will take on the responsibility of running the farm account, bankrolling everyday expenditure, and invoicing you annually.
I recently advised one client who, having inherited a farm from his parents, wanted to minimise Capital Gains Tax on any subsequent sale but, ultimately, did not want to remain a farmer long-term.
He appointed a neighbouring farmer to cultivate the land, effectively treating him as contract labour.
The Contract Farming Agreement we designed allocates all the profits (or losses) to him with no profit share or incentives for the contractor who is instead rewarded for good performance through a higher per hectare rate than normal on a ‘stubble-to-stubble’ basis. The contractor recognises the need to deliver results if the contract is to be renewed but, crucially, the farm’s new owner will make all decisions and shoulder 100% of the risk to ensure the arrangement passes muster with the authorities when it’s time to sell.
In summary, my advice is:
1. Identify your reasons for choosing contract farming;
2. Obtain proper advice on drawing up a suitable Contract Farming Agreement and review it every couple of years because circumstances and tax rules change; and lastly,
3. Do not be afraid to admit that contract farming may not, after all, be right for you.
For more information please contact:
Leo Hickish FRICS MBIAC
Head of Rural Asset Management