Article by C R T Harris LLB ATII TEP, a past president of the East Anglian branch of the CIOT and a consultant in private practice. He is the author of Tolley’s Business and Agricultural Property Relief. (He is also an examiner in the subject of Trust and Estate Taxation for the Society of Trust and Estate Practitioners, hence the comment!) Published in the December 2001 issue of Tax Adviser. My response to John Whiting’s call for ‘Simpliwins’ was to consider the abolition of Agricultural Property Relief (APR), though only in the context of some relaxation of the rules for Business Property Relief (BPR).
The new form of Inland Revenue Account, in some respects more user-friendly than its predecessor, will encourage executors to file without the help of professional people. To help them do so efficiently and accurately must be in the interests of good government.
It has been noted, in commentary to the Tax Law Rewrite, that reliefs cause some of the complexities in our tax system. Often, no doubt, if the mandate to amend the legislation had been broader, simpler legislation could have been proposed albeit at some cost to the taxpayer in terms of lost reliefs.
Historical Perspective
Before 9 March 1981 the relationship between APR and BPR was different from what it is now. It was seldom necessary to claim APR on transfers after 26 October 1977 (and before 10 March 1981) because by then relief was available under BPR at 50 per cent and the qualifying conditions for APR were more difficult to satisfy. There were also problems because it used to be the practice to set off exemptions against the first eligible transfers in the year. The taxpayer was at a disadvantage if, during a tax year, his first gift was of agricultural property and he later made a gift of business property. The exemptions were applied in the least efficient manner.
There have been improvements since 1981. There is now broad similarity between the treatment of APR and BPR in:
- the application of each relief to property within discretionary trusts;
- the way that the relief works in each case by reducing the value transferred, rather than by reducing the transfer itself;
- the replacement property provisions;
- the succession provisions;
- the treatment of property which is subject to an immediate binding contract for sale;
- clawback;
- the gift with reservation provisions; and
- the rates of relief.
Nevertheless there are some important distinctions. APR may apply to agricultural property in the United Kingdom, the Channel Islands or the Isle of Man, whereas BPR is not so restricted. APR is limited in amount. The logic for that is questionable. I have in mind not only the so called transitional relief, better known as ‘working farmer’ relief, but also the limitation of APR to the agricultural value of agricultural land.
Agricultural Property Relief looks at specific assets whereas BPR looks at the concept of a business. This can produce striking anomalies, notably in the rules by which a contract for sale can deprive a taxpayer of relief. Where BPR is in issue, the exchange of one business asset for another does not automatically cause loss of the relief, since the relief is given in respect of the business rather than the particular assets. It is, on the other hand, quite possible for APR to be lost where a sale has taken place of one of a number of agricultural assets and their owner – who continues to farm with other assets –, is unable to find suitable replacement land within the (admittedly fairly generous) timescale permitted by the legislation.
Simplification
Why do we have two reliefs? The official line appears to be that ‘the purpose and scope of the two reliefs differ. Business relief is designed to encourage and protect investment in risk-taking family trading ventures generally whereas agricultural relief is focused more specifically on farmland and buildings and includes letting of farmland. But the practical outcome is that most trading companies and farms get 100 per cent exemption from inheritance tax’. That hardly does justice to the complexity of these reliefs, with their varying rates and numerous exceptions.
Before the election that brought Labour to power there was frantic action by those who feared that the existing benign taxation regime might come to a rapid end. Elderly farmers, who hitherto could not bring themselves to consider a transfer of land to their children for fear that the next (by now middle-aged) generation might not keep the family business intact, at last made substantial gifts. There was a further flurry of activity in the weeks running up to each of the Budgets which were introduced in the course of the last Parliament. Surely, advisers felt, sooner rather than later, the axe would fall and the Chancellor would cut down either the present rates of relief or the reliefs themselves.
There is scope for some simplification of the law by improving the terms of BPR at the expense of APR.
Targeting the relief
If the rationale for the relief is that the burden of taxation, if applied in full, might be greater than farming, as a business, can support, there is little logical justification for allowing relief in respect of land which does not form part of a ‘working farm’. That is the problem with an asset-based relief. It is very possible that some farm land is held, not because the owner wishes to make a living from farming, but merely (or mainly) because of the relief in Inheritance Tax Act 1984, (IHTA 1984) s. 115 (2). That may make farmland more expensive for working farmers than it might be otherwise. Certainly, if the test in IHTA 1984, s. 103(3) were to be applied to farming as a business, difficulties might arise, since that subsection excludes from relief a business that is carried on otherwise than for gain. It would not be difficult to apply to the relief a test similar to the ‘hobby farming’ provisions of ICTA 1988, s. 397.
Section 115 is remarkably generous in including not only the land itself but residences and woodland. The test is two-fold:
- are these assets ‘of a character appropriate to the property’; and
- are these assets ‘occupied … for the purposes of agriculture?’
The farmhouse Take the farmhouse itself. There is an ongoing debate between the professions and the Revenue as to what a farmhouse actually is. Why is relief available on the house? The small businessman who, for example, runs a printing business from premises immediately adjoining his house, knows from the outset that the value of his residence as such does not qualify for BPR. Insofar as the printer can show that part of the house is used for the purposes of the business, perhaps as an office, he may be able to gain relief in respect of the part of the value of the residence that is represented by the office itself. Looked at dispassionately, what is the justification for allowing APR on the farmhouse, except insofar as part of it is used for the purposes of the farm enterprise?
There is no consistency in this area between one tax and another. The treatment of the expenses of running the ‘business proportion’ of the farmhouse for income tax is not the same as the treatment of claims in respect of value added tax (VAT) incurred in maintaining the farmhouse, which do take some account of commercial reality.
The existence of relief in respect of farmhouses owes something to earlier legislation, which included the concept of three classes of residence, the mansion house, the farmhouse and the farm cottage. Not very many farm cottages are now occupied as such; the arguments advanced to support claims for APR in respect of substantial mansion houses occasionally look a bit thin. No doubt claims are made in respect of substantial residences which are no longer occupied with the acreages they once enjoyed. Arguments may be advanced to support claims for APR where the transferor has little or no personal connection with farming of any kind save that he makes arrangements for some other person to graze the meadows that adjoin the property. Sweep all that aside.
Cottages: an anomaly
The treatment of cottages differs between the two reliefs. A ‘true’ farm cottage, occupied as such by a farm worker, will not often qualify for 100 per cent APR, whilst a woodman’s bothy will usually qualify for 100 per cent BPR.
Replacement provisions
The existence of two reliefs running almost parallel gives rise to various technical difficulties, for example where agricultural property is sold and is replaced by business property. This was considered by the Revenue in RI95, to determine whether relief should be available in respect of the replacement property. The Revenue consider that, where agricultural property which is a farming business is replaced by non-agricultural property, the period of ownership of the original property will be relevant for applying the minimum ownership condition of the replacement property. BPR will be available on the replacement if all the conditions for that relief are satisfied. Equally, where non-agricultural property is replaced by a farming business and that business is not eligible for APR, it may still be possible to claim BPR under IHTA 1984,s. 114(1) if the conditions for that relief are satisfied. This would apply where, for example, agricultural land is not part of a farming business. In those circumstances the replacement could qualify for BPR only if the minimum ownership conditions were satisfied in relation to that property.
Take the situation where the value transferred by a potentially exempt transfer is of farming assets and the donee of those assets sells the farming business and replaces it with a business of a different kind. Section 124A(1) precludes APR. Section 114(1) does not exclude BPR if the conditions for that relief are satisfied. Where the transaction goes the other way and the subject matter of the gift is business assets which are sold and replaced by farming assets, the farming business that is acquired by the donee can qualify for BPR by virtue of IHTA 1984, s. 113B (3)(c). These are fine distinctions and may provide good material for sadistic examiners in this area of tax, but are they really necessary?
The taxpayer’s loss in the event of the demise of APR
At present APR is more generous than BPR as follows:
- land not farmed by the transferor;
- land which belongs to a sole trader which is transferred by him without a simultaneous transfer of the business that is carried on on that land;
- land which has the benefit of vacant possession and which is used by a partnership in circumstances where the person making the transfer is a partner, but the land itself does not belong to the partnership;
- land which is farmed by a company but not owned by it, where the transferor is the holder of only a minority of the shares in the farming company;
- land which is let and which is owned by a company which is controlled by the transferor; and
- as already noted, a farmhouse occupied by the transferor.
BPR could be extended somewhat to compensate for these losses.
Existing advantages of the BPR regime
BPR is already more favourable than APR in three situations:
- the assets of farming businesses other than land and buildings;
- minority shareholdings in unquoted farming companies; and
- those businesses where the ownership requirement is not yet sufficient for APR but which replace non-agricultural business assets, so that the assets themselves qualify for BPR under the replacement property rules as already noted.
The political angle The present rules for the two reliefs run side by side. APR takes precedence, but naturally the taxpayer will arrange his affairs so as to fit the regime which is more favourable to him. It is an anomaly that land which qualifies only for APR qualifies for that relief only in respect of its agricultural value regardless of its true economic value (and of the investment therefore required to run that particular farming business in that particular place).
The differential rates of relief allowed by IHTA 1984, s. 116(2) have no doubt led to the establishment of somewhat artificial arrangements, whether share farming or contract farming, which would not be necessary if the relief were in respect of the ownership of a business rather than of the underlying asset. Some stronger link between the relief in respect of ownership of the land and the carrying on of a business on it might be acceptable to many voters, who doubtless have considerable sympathy for the economic difficulties of ‘working’ farmers at the moment. The existence of footpaths or extensive access arrangements, akin to the regime for conditional exemption under IHTA 1984, s. 30 might make Inheritance Tax (IHT) relief in respect of landed estates more acceptable to the general public.
The Trade-off: something for taxpayers
By IHTA 1984, s. 105(3) BPR is excluded where the business carried on consists ‘wholly or mainly of … making or holding investments’. The number of cases which have come before the Special Commissioner, many concerning caravan parks, proves that this is a pressure point in the legislation. See for example the fairly recent case of Farmer and Another (Executors of Farmer deceased) v IR Commrs [1999] STC 321. The late Mr Farmer had both carried on a farming business and had let certain properties on the estate which were surplus to the farming enterprise. He made no distinction between the two business activities. For the purposes of the litigation it was possible to show that the turnover from farming was greater than the rents received although, perhaps not surprisingly these days, the net rental profit was greater than the net farming profit.
On appeal from the view of the Capital Taxes Office, that the business was not relevant business property, the Special Commissioner eventually found in favour of the executors, holding that all relevant factors must be considered and that profits were not the only test. He recognised that the business being carried on was that of a landed estate. Most of the land was used for farming and the let properties were subsidiary, both in that they occupied a relatively small acreage and that, since they were situated towards the centre of the land holding, they would not have existed but for the connection with the farm.
This surely is a reasonable decision. At present, however, it rests only on the authority of the Special Commissioner and advisers may be reluctant to rely on it. This is an area where, using the excellence of drafting which Lord Dahrendorf praised in connection with the Trustee Bill, one could make the law clearer by endorsing the view of the Special Commissioner.
Excepted assets
Consider finally one other area – ‘excepted assets’. It is understandable, given the generosity of BPR, that the government might not wish to allow taxpayers to use a business as a mere ‘money box’ into which they piled cash and investments that were, quite simply, not required for the purposes of the business. Nevertheless the law as it stands in IHTA 1984, s. 112 can operate partially so as to exclude from relief assets which, whilst not in daily or even yearly use for the purposes of the business, nevertheless lend it stability.
A business may perhaps originally have relied heavily on borrowing. As it (and its owner) mature, the balance sheet may strengthen. The owner may find that, almost by stealth, his financial prudence in failing to draw all of his profits each year is penalised through the application of s. 112. Financial stability is a ‘Good Thing’. By its treatment of the tax on dividends and tax credits, which some may have felt harsh, the government indicated a desire for businesses to retain profits for future investment. If retention of profits is beneficial in the corporate sector, similar rules should apply to sole traders and partnerships. Parliament could with advantage relax somewhat the rules for the unincorporated sector by an easing and clarification of s. 112.
The Simpliwins checklist
Revenue neutral?
No, not in absolute terms. However only a small minority pay IHT (though many more farmers might do, on the value of their houses).
Few winners/losers?
If BPR extended to all assets that were subject to any commercial risk, in fact a home that was partnership property (and thus excluded from main residence relief) might, as now, secure partial relief from IHT.
Easy to implement?
Fairly easy: the BPR code already exists. It would need some tweaking. Repeal of APR is but a stroke of the legislator’s pen.
Would it simplify administration and eliminate technicalities?
Yes, I think so. One form less in completing IHT 200. Fewer distinctions for the adviser to learn and remember. No more ‘elephant test’ on rural homes.
Technical Department
020 7235 9381
December 2001 by CRT Harris
