Thinking of diversifying? Be wary of the Inheritance Tax implications
With collapsing milk and grain prices amongst others, the increasing pressures on the traditional farming operation have encouraged farmers to diversify. Whilst this may lead to increased income, there is a risk of losing the agricultural property relief (APR) that may reduce an inheritance tax (IHT) bill for farmland. Without the availability of APR, farmers are left to rely on business property relief (BPR) to reduce their IHT liability. However, depending on the circumstances, this is not always available.
For the purposes of IHT, HM Revenue & Customs (HMRC) tend to assess a farm in a piecemeal way (i.e. by looking at the different uses of the land and the way it is occupied). It is therefore necessary to examine whether relief is applicable to each aspect of a farming operation. One of the most common examples of diversification is the use of land as a caravan park. Caravan parks are a quick and easy way to make money from surplus land. However, they are problematic when it comes to IHT reliefs. APR is not relevant here, and for the purposes of BPR, HMRC do not generally treat caravan parks as a business unless there are other services or facilities provided that make the income exceed the pitch/rental fees from the caravans.
Another common use of land is stables from which livery services are provided. HMRC do not consider the keeping of horses as an agricultural purpose unless the operation is a commercial stud farm. BPR may be available here if the owner of the land actively provides full livery services. If the farmer simply rents out the stables, then the operation is unlikely to qualify for BPR. In addition, any land simply used to graze horses is unlikely to qualify for APR.
So as a farmer who has diversified but no longer needs the additional income from diversifying, how can you cover your IHT bill? One option is to take out a life assurance policy to cover any IHT liability that might arise on your death. Any policy taken out should be written in trust so it is held outside your estate for IHT purposes. For the older farmer, the monthly premiums might be prohibitive.
Another option is to give away some of your farm to the next generation either outright or by way of a trust. If a gift is given outright during your lifetime, there will be no immediate IHT to pay. However you will need to survive seven years from the date of the gift to avoid the value of the land gifted forming part of your estate for IHT purposes. Any gift made may be subject to capital gains tax (CGT) on any gain in the value of the asset since it was originally acquired. The likely rate of CGT will be 20% (post budget 2016).
The other option is to give some of your farm away by putting it into a trust which then passes it on to the underlying beneficiaries. The advantage of this option is that any inherent gain can be transferred to the beneficiaries thereby avoiding an immediate charge to CGT. Your beneficiaries would have to pay CGT on any future disposal of the land. Any gift into a trust over and above a person’s IHT allowance will attract an immediate IHT liability of 20% (unless reliefs apply) and a further 20% liability if you fail to survive the date of transfer by seven years.
There are also other options available depending on your situation. With careful planning, IHT can still be avoided where relief has been lost because of farm diversification. As to which option is best depends on the values of the land involved and your individual circumstances.
This article first appeared in the April 2016 issue of South East Farmer.