Farm diversification: Why considering Inheritance Tax is key

The idea of farmers diversifying and using their land for non-farming activities is not a new one, but it is something that is gaining more and more traction. A 2017 study from DEFRA showed that around 60% of farms have diversified and the NFU’s recent report into diversification found that of the approximately 1,600 farmers questioned, over a third were already using land for non-farming purposes. This trend is only likely to increase as post-Brexit changes to agricultural support come in.

Diversification can generate key income for farmers, with the above mentioned report from the NFU showing that of those who have diversified, it makes up 16% of their turnover. Popular types of diversification include camping and holiday lets, renewables, livery and equestrian and farm shops.

Any diversification requires very careful planning and it is sensible to take expert advice at the earliest opportunity. Carried out correctly, diversification can form a key part of succession planning, and help to ensure farmers can pass down a thriving business to the next generation. However, one element that is often over looked when it comes to diversification, is the impact it can have down the line in terms of Inheritance Tax (IHT).

The importance of estate planning

IHT is currently charged at a rate of 40% on the part of an estate above the nil rate band threshold of £325,000 (but this amount may vary depending on circumstances). For large estates this can present a significant amount of IHT. However, Agricultural Relief (AR) of up to 100% is currently available for farming activities.

AR only covers agricultural property and land that is used to grow crops or to rear animals intensively.  The relief is restricted to the agricultural value which may vary from the open market value.  AR may also include:

• Stud farms for breeding and rearing horses and grazing
• Woodland, where ancillary to the main farming
• Trees that are planted and harvested at least every 10 years (short-rotation coppice) for renewable fuel
• Some farmland being managed under the Habitat Schemes
• Some agricultural shares and securities
• Farm buildings, farm cottages and farmhouses

This is not an exhaustive list and is subject to change. For example, vineyards and cider making orchards have recently become eligible for AR, having been previously excluded.

When it comes to IHT, HMRC looks at farming estates in the round, taking into account the various ways the land is used and occupied, among other factors. As such, any activity which diversifies from agricultural use may risk the whole business not qualifying for AR.

However, Business Relief (BR) may be applicable. This is typically less generous than AR, but can still help to reduce IHT liability. In addition, BR is not always available, as to qualify the land needs to be used for trading and generating an income rather than investment purposes. The Balfour test stipulates a ratio of 51% trading to 49% investing in land. As such, when it comes to diversification there is a fine balance between qualifying for either AR or BR and losing all IHT reliefs. Following a review of IHT generally, the split between trading and non-trading may become even more important for both AR and BR if the government increases the need for trading activity to an 80:20 split as has been suggested.

To put this into context, running a B&B would be seen as trade, but letting cottages out to holiday makers is seen as investing in the land unless significant extra services are provided. Similarly, running a full service livery yard can be counted as a trade, but renting out stables and field grazing to horse owners is seen as investing in the land. Farm owners should be particularly mindful of how the main farmhouse is used, as this is often a sizable asset.

With all of these factors in mind, it is advisable to make estate planning part of any wider diversification business plans, as the implications for IHT can have a large impact on the type of diversification pursued.

Mitigating risks

With careful and expert estate planning, there are steps that farm owners can take to reduce their IHT liability. However, the rules around AR and BR are complex and HMRC takes a robust and thorough approach, so it is vital to access advice from a specialist.

For example, it may be possible to separate the farm business into trading and non-trading activities. Alternatively, farmers nearing retirement may think about gifting some of the farm to the next generation. This can be done outright – in which case the giver will need to survive seven years from the date of the gift, otherwise the value of the land and/or property gifted will form part of the estate for IHT purposes.  However, if the giver fails to survive the gift by seven years all may not be lost if AR/BR applied to the gift when made and will continue to apply. It is worth keeping in mind that any outright gift may be liable for Capital Gains Tax (CGT).

It is also possible to pass any gift into a trust, although this may be liable for an immediate IHT charge of 20% if reliefs do not apply, with a further liability due if the donor does not survive for seven years. This option does have the benefit of being able to defer any immediate CGT bill however.

The right approach will depend very much on each farm owner’s circumstances and goals. What is important to remember is that there are options available to enable diversification while still minimising exposure to IHT. The key is to plan early.