Agriculture and IHT An Overview. Summary

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1 Agriculture and IHT An Overview Summary Agricultural property relief can qualify farmers and farmhouse owners for an exemption from inheritance tax APR Agricultural Property Relief is given on the agricultural value of land or buildings. The rate of relief is 100% or 50% as explained later and can effectively exempt assets from a charge to IHT. Agricultural Property Relief can be a valuable tool for farmers in reducing the impact of Inheritance Tax (IHT) on their estates. In this respect, it is the most important relief for farmers and their families. When you die, inheritance tax is charged on your estate at 0% on the first 325,000, and at 40% on the rest, but there are certain reliefs that reduce this charge, including Agricultural Property Relief ( APR ). APR reduces the value of agricultural property charged to inheritance tax by 100% in the case of a farm that you occupy for the purposes of agriculture yourself. If the executors of a lifestyle farmer can convince HMRC that he occupied his farm for the purposes of agriculture, then there may be no IHT to pay on the value of the land and the farmhouse. Background HMRC have been getting increasingly strict on the eligibility of the farmhouse for APR, and they have won several tax cases in the last few years, denying APR to what is often a very valuable asset. Every case is decided on its own merits. Most ordinary working farms are able to pass from parent to child without Inheritance Tax being paid. However, the Revenue is taking a closer look at all taxation. In 2010 a Compliance Unit was set up to check tax returns. In the past, quite a number of claims for Agricultural Relief have gone through because the Revenue is too busy to check. However, more inspectors means more challenges. The potential tax consequences of passing a farm on during the lifetime of the present owner must also be considered (see below).

2 What is the Farmhouse Issue? In order to qualify for APR, the farmhouse must be:- Occupied for the purpose of agriculture, and Be of character and appropriateness to the land holding to which it is attached. If it is an integral part of the farm then it may get relief, but it must be occupied for the purposes of the farm. So, if an elderly farmer has gone into a residential home then it is no longer occupied for agricultural purposes even if it had been occupied by him for most of his life and he wanted to go back there. Further Detail - What Sort of Farmhouse is it? The law says the farmhouse must be of a character appropriate to the land being farmed, so a Georgian manor house on 10 acres of cabbages is not going to work. The question of how appropriate the farmhouse is, should be decided by considering: The relationship between its size and value to the size, value, and profitability of the land being farmed The layout of the house so a bigger farm office and a smaller indoor swimming pool might be a good idea, where relevant. The layout of the farm outbuildings if the nearby outbuildings are stables for your horses (not a farming activity) and all the machinery is kept half a mile away in a modern barn, this would go against a claimant. Would a fair-minded person or an educated rural layman look at it and say that s a farmhouse, or would he say what a magnificent country mansion. This is known in the trade as the elephant test (hard to describe, but you know one when you see one). Agricultural Value Even if you get over all the above hurdles, you may still not get full relief for the value of the farmhouse because APR only applies to the agricultural value of the property. As many farmhouses are the most valuable farm asset, HMRC are looking at situations where relief has been claimed. They will often contend that the farmhouse is worth more than its agricultural value and attempt to restrict the APR to a percentage of its market value, often 70%. Some farmhouses have a tie, meaning they can only be occupied by someone who makes their living from farming, and this condition of occupancy reduces their value somewhat. APR is only due on that reduced value. So if there is no tie on the farmhouse, the difference between the tied value and the normal open market value does not qualify for APR. The difference depends on the particular case (for example, any hope value for future planning permission). The general rule seems to be that the agricultural value is only about two thirds of the open market value. This fact will be reflected by the The District Valuer.

3 Conditions The property must have been occupied by the deceased for the previous two years or owned for the last seven years and occupied by someone for agricultural purposes (i.e. let or licensed to someone else).** Types of Farm There is no relief on pony paddock value but a stud farm will get relief. What is a Farm cottage? Normally the HMRC contend there is only one farmhouse on a farm. All other houses are considered to be farm cottages. Where a cottage is occupied by an agricultural worker or a retired employee, or widow, then normally 100% APR will apply. Where a cottage is let out on an assured short-hold tenancy, even if it was built with an agricultural planning restriction, it will not be agricultural property and no relief will apply. What about other Farm buildings? Farm buildings used in the business will qualify for APR, but where they are let out they will not be considered agricultural property. Is Farmland subject to IHT? Where farmland is farmed in hand, or vacant possession can be gained within 24 months, or it is let on an FBT and has been owned for seven years, then 100% relief will apply to the agricultural value. Where the land is worth more than agricultural value perhaps because of hope value for development then the excess over agricultural value will be considered eligible for BPR where the conditions for BPR are met. Land let under a Farm Business Tenancy or a Grazing Agreement gets 100% relief. Where land is let on an AHA (1986) tenancy, then normally only 50% relief will apply. How do borrowings interact with IHT? The value of an asset for Inheritance Tax purposes is its market value less any associated borrowings. If a farm needs borrowings, no IHT saving is made if the security for these borrowings are assets which attract IHT reliefs. Therefore, it is advisable to secure farm borrowings against assets which do not qualify for IHT reliefs, e.g. let cottages. Points to Note A gift of farmland, whilst potentially attracting Agricultural Relief, could lose that relief if the donee gives up farming within seven years and the donor dies within the same period.

4 Other Reliefs BPR Business Relief is also important as it is available to the farm s business assets as long as they are used in a business operated by the deceased. What relief is available for Entitlement to the Single Farm Payment The new Entitlement is an asset separate to the land to which it applies. BPR is considered applicable to this separate asset, but only after the asset has been in existence for two years. How should we make best use of the Partnership capital accounts? A partner s capital account represents a share of the assets and growing crops etc used in the partnership. Normally BPR will apply to the capital account. However, watch out for any clause in the partnership agreement saying that a continuing partner will purchase a deceased partner s share, as BPR will then not apply. It is important that partnership agreements give the continuing partners an option to purchase rather than an obligation. Debts of the business can only be deducted if they are genuine business debts. Has the Farmer case helped? Yes, this tax case may be extremely helpful. It is about Mr Farmer, who was indeed a farmer in partnership with his son. They had let out a number of cottages and farm buildings and these assets were shown on the farm balance sheet. All rents were paid into the farm account and shown on the profit and loss statement and all properties were managed by the farm. When Mr Farmer died, his executors accepted that the let buildings were not agricultural property, but claimed BPR on the basis that the operation of these properties was part of a single business enterprise. The executors won this argument and BPR was granted on the let properties. This case should not be relied upon as general guidance, but certainly can be referred to in specific relevant cases. What is the pre-owned assets charge? It is fairly common for farmers to transfer the ownership of farming assets to the next generation during their own lifetime. However, as from April 2005 a new tax has been introduced. Where an asset is gifted and the donor continues to enjoy some benefit from that asset, then an income tax benefit in kind charge will arise. Careful planning is needed to ensure that a charge does not arise and that there is no reservation of benefit by the donor. Otherwise, there may either be an Income Tax charge or the asset will be aggregated with the donor s estate, or even worse both!

5 Background A Farmer? A recent case (the McKenna case) went before the Special Commissioners. The Special Commissioner was Nuala Brice Dr Brice denied APR on the McKenna farmhouse and in doing so gave a useful summary of how the law currently stands on this issue. These are the principles (and pitfalls) that the lifestyle farmer needs to consider: A farmhouse is the building where the farmer lives and from which the farm is managed so, if the farm is actually run by another farmer from the next valley, no relief will be due A farmer is the person who actually runs the farm on a day-to-day basis and is not necessarily the owner of the farm and the farmhouse.(hence the distinction between Professional vs. Lifestyle Farmers, who often employ a farm manager or go into partnership with a local professional farmer to manage their farm, in return for a share of profit.) Dirty Hands All this means that if you are a lifestyle farmer and you end each day without dirt under your fingernails, you may have an IHT problem. Even if you do get your hands dirty, then if, as you scrub them clean, you can see through the bathroom window to where a new development is being built just on the border of your land, you still may find that not all the value of the farmhouse will be free of inheritance tax. Conclusion A gift also attracts a notional gain if the land increases in value. The gain can be held over on a transfer by parent to child, but it is only held over. In other words no tax is payable by the donor at the time of the gift but the donee would pay tax on the gain if he sells the property. The gain that he would pay tax on would be the gain from the time of his parents purchase until his sale. There could be a case for transferring the farmhouse as any transfer would attract relief from Capital Gains Tax because of its residence status. If a parent leaves the same property to a child on his death then there is no Capital Gains Tax, although there is the possibility of Inheritance Tax. Under the present regime of agricultural relief it may well be best not to transfer the farm until the parents death. There will not usually be a problem with getting the relief on the land. It is usually the house that presents the problem as it must be occupied by the farmer someone who needs it for the operation of the farm. So it may pay for the parent(s) to move out and let the child and their family move into the house. If there are two houses on the farm then the child ought to live in the more valuable if it can be presented as the farmhouse. There is no doubt that it is important to keep up the appearance of farming the holding. The farmhouse must be occupied by a working farmer. If a farmer really wants to retire then he is best advised to let his child live in the house. If they are in partnership an obligation in the partnership deed requiring all partners to occupy houses on the farm may be helpful. It would also assist if the parent partner(s) can show real involvement in the business if relief is to be claimed on the house that they have moved in to.

6 Sources ** 3. Down_on_the_Farm_Inheritance_Tax_and_the_Farmhouse.html ( Originally published within Property Tax Insider Magazine) 4. Other Terms IHT Inheritance Tax is paid on Estates valued over 325,000 for 2011/12. Tax is usually paid at 40% on the balance above this level. Husbands and their Wives both have a nil rate band (currently 325,000) and effectively any unused element on the first death can be utilised on the second death. BPR Business Property Relief is given on the total value of any property which qualifies as business property (as compared to the agricultural value). The rate of relief is 100% for assets owned and used in the business, and 50% for assets which are off balance sheet. To obtain relief the asset must have been owned for at least two years. Medical Investment & Advisory Services LLP 2016