The purpose of tax planning is to ensure all elements of the financial plan work together in the most tax-efficient way. This is achieved by analysing a financial situation or plan from a tax perspective. Below is some guidance on planning for agricultural property, ‘don’t let the rail wag the dog’ and more.

Is it time to let the tax tail wag the dog?

According to the popular expression “Don’t let the tail wag the dog”, we should not have to structure our property and land purchases or disposals around tax laws but instead make decisions according to what best suits us. That must surely still be true but, unfortunately, these days the financial implications of failing to consider capital taxation can be (to use a non-technical term) absolutely horrendous.

Tax Planning

Tax Planning

The good news is both Inheritance Tax and Capital Gains Tax can be mitigated with a degree of forward-planning. Agricultural Property Relief and Business Property Relief are two of the vehicles commonly used to reduce landowners’ Inheritance Tax liabilities. As regards any disposal, with proper advice, Capital Gains Tax liability can either be eliminated or substantially reduced through the correct use of Entrepreneurs’ Relief, where the effective tax rate is reduced, or Roll-Over Relief where all of the gain may be rolled over and thus all tax avoided. While it is heartening that the Spring Budget announced reductions in CGT rates for some categories of property, this remains a very aggressive form of taxation. For private domestic property of course Private Residence Relief remains extremely important, but here also the rules need to be very carefully considered – this is a subject for another article.

Let us look in more detail at Inheritance Tax issues…

As most will know, there are two main forms of relief – Agricultural Property Relief (APR) and Business Property Relief (BPR). With APR under threat and HMRC increasingly investigating any APR claims it is useful to look more carefully at a few of the main issues that we are asked to advise upon for our clients.

Agricultural Property

Agricultural Property Relief (APR) is one of the biggest reliefs from Inheritance Tax (IHT), allowing certain agricultural assets to be granted 100% relief from IHT and hugely reducing a family’s exposure to tax. This makes it a great opportunity to safeguard farming assets and businesses and pass them down to future generations provided they meet the specified criteria.

Assuming that one first meets the requirements for ownership and/or occupation of any agricultural property, one next needs to consider how far APR will apply. The first question is what in HMRC’s eyes constitutes ‘agricultural property’? The definition includes agricultural land, pasture and farmhouses, farm cottages and various farm buildings. The tax authorities use a fairly reasonable interpretation of what qualifies as ‘agricultural land use’ that includes:

Agricultural land use

Agricultural land use

• Growing food for human and animal consumption

• Supporting livestock kept to produce food or other products for human consumption such as milk, meat or wool

• Land used for the breeding or grazing of racehorses

• Land set aside to lie fallow

• Commercial cultivation of short rotation coppices in which particular fast-growing tree species are grown as an energy crop, to produce charcoal or use in fencing or shipbuilding.

But what about farm woodland or diversified uses? Rapidly you may find a major part of your farm does not qualify for APR. There remain valid arguments regarding smaller woods and shaws, however, and such cases should always be vigorously defended. Where life becomes interesting is in interpreting what constitutes the agricultural value. More and more, HMRC (and the Valuation Office who advise them) is arguing that APR should only apply to the agricultural element of the property. If there is an element of ‘amenity’ value then APR should not apply. This principle is most commonly applied to the farmhouse. So if your farmhouse is worth, say, £1m they may grant you relief on just 70% of its value, claim the remaining 30% is amenity value and tax you on £300,000 accordingly.

“The law has not changed: it is simply HMRC’s interpretation of its provisions that has become more stringent.”

The important lesson here is that the 30% argument is not based on fact but merely custom. Certainly market evidence does not support this figure. Our database of transactions provides evidence well below this rate, with several examples of near zero discount. These cases need to be tackled head on and a robust position taken in dealings with HMRC. This is well illustrated by the most recent case we won where for a farmhouse we accepted was perhaps at the upper end of the spectrum, we secured a settlement at 20% and a resultant saving in IHT of over £80,000.

Once HMRC has won this argument with a farmhouse there is nothing to stop them following it through to its logical conclusion, attempting to apply this selective approach to all your assets – land, woodland, farm workers cottages and so on. With so much at stake, it is vital to have documented evidence to support your case rather than simply assume it will automatically qualify for APR.

I should stress at this point that the law has not changed: it is simply HMRC’s interpretation of its provisions that has become more stringent.

The ‘Character Appropriate’ Test

We should perhaps return to the fundamental question. For APR, what qualifies as the farmhouse?

The 'elephant' test

The ‘elephant’ test

The first test, of course, is one of occupation by the farmer, but even here there are interesting aspects, such as what land runs with the farmhouse and in whose ownership are the respective assets. The most important question for eligibility is whether the house meets the ‘character appropriate’ test. As there is no official definition of what this means, HMRC tends to determine this using the ‘elephant test’ – hard to describe but you know it when you see it. The problem is that this is quite subjective. With depressed agricultural incomes and viability one can see HMRC sharpening their pencils.

When it comes to farm cottages, the relief is usually only granted for cottages occupied by staff or family members employed solely for agricultural purposes on the holding. Arguments have arisen where the staff member is only employed part-time on that holding.