Silencing the Lambs

Stock valuation issues

The Revenue's views on the appropriate methods to be followed for the valuation of livestock in farmers accounts are set out in detail in the well known Business Economic Note No 19, (BEN19) and need no reiteration here.

However, many farmers will be facing their annual stock valuation at this time and will be (indeed already have been) asking about the appropriate method of valuation to be adopted in the current market in which they are unable to move their animals off the farm to market. This may well leave their advisers in something of a quandary as the valuation of livestock in these circumstances is arguably a very difficult task, indeed some would say impossible. After all, if the livestock auctions are all closed, and there is no permitted movement of animals except for slaughter in restricted circumstances, then how can a farmer compare the cost of his animals with their net realisable value without facing the prospect that net realisable value is in fact currently £nil? Does this represent a clear argument in favour of the reduction of the balance sheet value of those animals to £nil or very low value indeed?

It is to be hoped that the Revenue will shortly produce a statement on the valuation issue as this represents a major dilemma for farmers and their advisers alike. It did so in 1996 during the height of the BSE market slump when beef animals were effectively worthless for a considerable period of time. In that case it introduced alternative valuation options for animals affected by the state of the market which provided some relief for some farmers. Perhaps it may do so again soon.

If it does, then perhaps this will provide a practical and working solution for accountants to the issue as it did in 1996. But some very serious questions remain unanswered even from the 1996 BSE Statement; (see Revenue press release 29 April 1996). In particular the 1996 Statement was for a specified and relatively short period between 20 March and 31 May 1996. This was because in the Revenue's view, there was a disturbed market for only a short period of time as mentioned above. This has subsequently been seen to be a rather hollow gesture as the disturbance in the market eventually lasted for years and prices have indeed never really recovered in many markets.

Additionally some commentators were never truly happy that the Revenue's approach to the valuation issue at the time of the BSE crises was correct. Specifically the 1996 BSE Statement seemed to impose valuation arguments in the arena of the taxation of income which owed their existence to capital gains legislation and the concept of an open market in stocks and shares with readily ascertainable prices on any given day. This was clearly not the case in the disturbed BSE market where prices were truly non-existent for a time.

Such is also arguably the case now. Where farmers have no market and none is likely to be available for the foreseeable future, then there seems to be a strong argument for saying that their stock is indeed worthless.

Of course it is tempting to see the opportunity to reduce stock values to £nil as a tax planning possibility with the option to make tax allowable losses which could perhaps be relieved advantageously, but in fact few farmers will have this option available to them. Some of course may also have profitable tourist based ventures associated with their farm against which such losses could be set, but by and large these are not kept separate from the farm accounts. Furthermore the reaction of a farmer's bankers to the sudden absence from the balance sheet of a stock valuation, (or commonly a note recording that the herd has a value far in excess of its recorded balance sheet cost), might predictably be rather negative and could indeed precipitate a review of the bank's support of the farm at just the wrong moment.

It is difficult to suggest the appropriate course of action in these circumstances. It is to be hoped that the Revenue does move quickly in this area again. Its 1996 Statement did indeed give farmers alternative valuation options and perhaps something along those lines is needed now. It should not of course be overlooked as well that the valuation issue was of considerably less impact in 1996 because most farmers' 1996 valuation dates fell slap bang in the middle of the transition to the current year basis of assessment and, as such, the 1996 valuations were in fact of little consequence as their profits for two years were averaged and so the middle valuation could effectively be ignored in many cases. Such serendipity is not the farmers' lot this time around.

For the moment it is suggested that farmers should obtain their normal valuation, as if proceeding to sale in a normal market, but should also specifically ask their valuer to append a note to the valuation indicating that it was made during the foot and mouth crisis and as such should be regarded as subject to any special rules or procedures which are eventually introduced to acknowledge the special market conditions appertaining during this period.

For the above reasons it is also suggested that accountants should perhaps not finalise farm accounts with significant livestock valuations in them at least for the time being until the Revenue has issued a formal statement on the valuation issue or until the eventual outturn of the livestock markets become clearer. Where it is necessary to submit accounts to the bank in the meantime, the impact of the Foot and Mouth crisis and the potential impact of stock valuations should probably be mentioned in a covering letter.

Accounting dates?

There may be cases where a change of accounting date might be under consideration as a tax planning ploy, but will this achieve any deferral of tax, or could it in fact cause an acceleration?

A non-herd basis farmer receiving compensation may have the opportunity to use the spreading provisions under Extra-statutory Concession B11 (as mentioned in the first part of this article, published in last week's issue of Taxation). This will be particularly relevant where the animals culled are immature 'followers' for which an election for herd basis cannot be made. In such circumstances consideration might be given to a change of accounting date.

A farmer with a 30 April year-end shortening to 31 March and then receiving the compensation in April 2001 would initially end up being treated as taxable on the compensation for the accounting period to 31 March 2002. This would then be treated as an accounting profit of the year of assessment 2001-2002, but could be removed from that tax computation and then spread over the three years 2002-2003 — 2004-2005. This is in fact the same position as if the compensation had been left in an unaltered year to 30 April 2001, so the change of accounting date achieves no deferral in such a case.

An existing accounting date of 31 March could perhaps be extended to 30 April under the current year basis, although this has not generally been seen as sensible tax planning for a variety of other reasons and should be approached with care. Where the year to 31 March 2001 is extended to, say, 30 April 2001, no accounting date at all would then fall in the tax year 2000-2001. This would result in that year being treated as the 'year of change' for the change of accounting date rules under the current year basis (section 62(5), Taxes Act 1988). This is illustrated by example 1.40 on page 10 of Revenue Booklet SAT.

Provided the conditions of section 62(2), Taxes Act 1988 are met, (notification of the change and no other disqualifying changes, etc.) section 62(5) will define the change as having been made in 2000-2001 because this is the first year in which accounts are not made up to the old accounting date. As such, the assessment for the year 2001-2002 will be on the profits of the twelve months to 30 April 2001 and the profits assessable for the year 2000-2001 will be on the twelve months to the new date in that year, i.e. the profits of the twelve months to 30 April 2000. This would mean that the profits of the eleven months to 31 March 2000 will have been assessed twice and will thus be carried forward as overlap profit to be relieved on the subsequent cessation of the farming business or on a later qualifying change of accounting date.

This would mean that any compensation receipt arising in the month of April 2001 would remain as part of the accounting profits initially treated as arising for the year 2001-2002 and could then be spread over 2002-2003 to 2004-2005 as in the first example outlined above, so again no real planning options seem to arise here. There could, however, be some beneficial results if profits have been rising, (unusually) because the resultant assessment for 2001-2002 might then be on the lower taxable profits of the earlier year.

Similarly where a farmer has entitlement to compensation arising in an accounting period to 31 March 2001 and chooses not to opt for the spreading option, perhaps because of an imminent cessation of the business, then an extension of the accounting date to 30 April 2001 would presumably mean that the compensation would then be taxed one year later than would otherwise apply; i.e. in 2001-2002 rather than 2000-2001. However, care is needed here as the adviser and the client would then need to satisfy themselves that all the relevant conditions under section 62A, Taxes Act 1988 were met in full.

Other tax issues?

Self-assessment payments on account?

Early consideration should certainly be given to the submission of claims to reduce payments on account for all self-employed traders and those in partnerships if profits are likely to fall, or even to previous such claims if profits are likely to rise.

The impact of the foot and mouth epidemic is likely to mean that many businesses will see their profits drop very significantly indeed. Unfortunately for many businesses their profits for the period which forms the basis of their assessment for 2000-2001 will be those up to 31 March 2001 or even earlier, whilst some will have 30 April 2001 as their year-end.

For those in the first category it is probably too late to make a claim to reduce payments on account. Assessable profits for the 2000-2001 tax year will be based on the year to 31 March 2001 and these are likely to have been only marginally affected. Many tourist businesses would not normally have seen a significant upturn in their trade occurring during March, especially as Easter occurred well into April this year, so a reduction of the payment on account due in July may actually be premature. Furthermore care should be taken in making such requests where it is clear that there is no evidence on which to base such a claim. Where, however, a business has indeed been significantly affected before 31 March then submission of form SA303 to reduce the 31 July 2001 payment on account should be considered as a matter of urgency to alleviate cash flow problems.

Clearly consideration of the payment on account situation also becomes relevant for a business with a 30 April year-end. The liability for 2001-2002 will be based on the profits to 30 April 2001 with payments on account being based on profits to 30 April 2000. Submission of requests to reduce the payments on account due on 31 January and 31 July 2002 will be essential for businesses which are to survive the crisis.

It should be pointed out that the reduction of payments on account because of cash flow problems arising currently is not strictly acceptable under the self-assessment régime which effectively assumes that the taxpayer has put money aside from the relevant year's profits to meet his liabilities. In such circumstances the Revenue's foot and mouth helpline is probably the correct forum in which to raise such requests rather than through the normal channels.

Compensation for other businesses?

Many tourist and peripheral businesses will be affected by the foot and mouth outbreak, some more seriously than farmers. In most cases it seems unlikely that they will receive any compensation, although the situation changes daily and further advice may need to be given later if the Government alters its stance on this. If compensation is forthcoming, this is likely to be regarded as fully taxable as representing loss of profits compensation or consequential loss compensation.

Where such a business has insurance for consequential losses arising from some unforeseeable event such as foot and mouth disease, (although this is unlikely to have been viewed as a risk by most tourist related businesses), this is likely to be regarded as taxable since it is to fill the gap in trading profits left by the influence of the event giving rise to the compensation.

Redundancies

Where staff are made redundant as the result of the foot and mouth outbreak any redundancy payments made to them ought to be fully allowable against profits for tax purposes. These costs will be incurred in order to remain in business or as a consequence of the need to rationalise the business.

It is important to recognise that the 'wholly and exclusively test' in section 74, Taxes Act 1988 is not always met by redundancy payments. Provided the business is continuing this should not present a problem, but the situation may be more problematical where the impact of the foot and mouth disease actually forces a trader to go out of business. In such a case the 'trading purpose' test is unlikely to be met because the costs are being laid out to close down the business rather than keep it going. See Commissioners of Inland Revenue v Anglo Brewing Co Ltd, 12 TC 803. However, some comfort can probably be taken from the Privy Council decision in Commissioners of Inland Revenue v Cosmotron Manufacturing Co Ltd [1997] STC 1134.

Following this decision the Revenue issued instructions to Inspectors that they should not contend that payments made to employees under a pre-existing contractual or statutory obligation are disallowed under the Anglo Brewing principle. In most cases it is likely that employers facing imminent ruin as the result of foot and mouth will be paying employees only their contractual or statutory entitlements, so the Cosmotron rule ought to apply.

Stock values

It is likely that some non-farming businesses may find themselves with stock that they simply cannot sell as the result of the lack of trade in their particular market, e.g. tourist related clothing shops and gift shops, etc. Careful consideration will need to be given to the correct method of valuing their stocks if an accounting year-end falls during the crisis. Clearly where stocks are perishable over the medium term there may be a strong case for contending that such stocks will need to be written down to very low levels if trade is very poor. Other non-perishable goods should be valued as normal.

Additional costs

Disinfection

Some businesses will incur additional costs in protecting their trade against foot and mouth. Disinfection precautions ought to be treated as properly allowable for tax purposes against profits as being costs incurred in carrying on the business.

One-off costs — advertising

Other extra costs such as special advertising programmes should also be treated as allowable for tax purposes on normal principles.

Accommodation

Some businesses will incur extra accommodation expenditures. This can arise where the business proprietor lives away from the business premises and cannot return to his home because he lives in a restricted movement area. Similarly, such costs may arise in many cases which have been seen where the individual lives on a farm or in a farming community affected by the disease and is unable to return home at night because to do so would prevent him leaving again and then returning home subsequently.

Such accommodation expenses and related subsistence costs are potentially controversial. The Revenue has a history of rejecting accommodation and subsistence expenses where these are related to an individual's personal choice of location of residence, etc. However, it is suggested that the extra accommodation costs here should be treated as allowable deductions against profits and disclosed as such on self-assessment returns on the grounds that these are expenses arising directly from the carrying on of a business rather than the individual's domestic circumstances. Clearly, however, this might be an area in which significant dispute may arise with the Revenue. Again it seems desirable that further guidance on such matters be provided by the Revenue in due course.

I have already heard of one freelance professional lecturer who has had to leave home temporarily because her village had been placed under a restriction order and she was unlikely to be able to return home on a regular basis whilst the disease persisted in the locality. What is the tax deduction position as regards the extra accommodation costs being incurred by such an individual? There can be little doubt that such costs are as much to do with the individual's need for domestic shelter and comfort, etc. as they are for the purposes of carrying on the business, so might the Revenue argue that they are not properly to be charged against profits? Will the next couple of years see Inspectors selecting the accounts of such individuals for enquiry on the grounds that they contain unusually high travel and subsistence debits? Under self assessment such an individual would be brave indeed not to disclose the extra expenses in the 'white space' on his self-employed supplementary page. Having done so, will he have invited a challenge from the Revenue?

Some businesses may have to incur extra costs providing accommodation and food for their employees on their premises during the crisis if they are unable to return home due to local restrictions. Again it is suggested that these costs ought to be treated as properly allowable. In such circumstances it is also suggested that no taxable P11D benefit for accommodation provided 'by reason of the employment' should arise as the employees ought to be able to take advantage of the section 145(4)(a), Taxes Act 1988 benefits exemption on the grounds that it is necessary for the proper performance of the employee's duties that he should reside in the accommodation. Thus the employee would be required to stay on the premises in order to be able to continue to perform his duties during the crisis, as to leave the premises might mean that he could not return. In such circumstances a cautious employer might be advised to issue such employees with a letter asking them to accept a temporary revision to their terms of employment requiring them to live on the premises for as long as required during the foot and mouth crisis.

Accountancy firms — staffing issues?

Many accountants practising in rural areas have developed part of their practice as a specialist service for farmers and other businesses in the agricultural sectors over the years. Others have adopted a similar approach to the taxation and compliance issues facing hoteliers and others in the tourist industry. Such practices will also need to turn their attention to their own business effectiveness at some stage, and probably sooner rather than later if they too are to survive. I have already encountered one specialist agricultural accounting firm which has several staff who do nothing other than deal with farm accounts and taxation all year round which is having to lay staff off as the result of a severe downturn in their workload. After all, if you cannot afford to pay for your accounts you are unlikely to send your books in to the accountant at the normal time. Similar stories, some no doubt apocryphal but others certainly very real indeed, already abound about accountancy firms specialising in hotels and guesthouses having to offer 'buy now pay later' deals simply in order to keep their staff busy.

The impact of this epidemic is spreading into all corners of the tax practice and plans will have to be made to cope with the business as well as the taxation implication of the problem.

Capital gains tax

Cessations

Where the impact of the foot and mouth disease is so severe that it forces a business to close down permanently, other taxes may also have to be considered, particular capital gains tax. If the trader subsequently decides to realise assets in order to meet debt, the availability of the important capital gains tax reliefs taper relief and retirement relief will have to be considered.

For taper relief it should be clear in most cases that business asset status will be available so that disposals after 5 April 2001 should attract 50 per cent relief provided the asset was acquired pre-6 April 1998 and has been a business asset throughout that period. Of course where the status of the asset changed on 6 April 2000, as the result of the Finance Act 2000 changes, an apportionment of the gain will be necessary and non-business asset relief only will be due on any non-qualifying element at the rate of 10 per cent, (3 years plus 1) for disposals of such assets.

For retirement relief the threshold for 100 per cent relief on qualifying disposals fell from £150,000 to £100,000 of chargeable gains on 6 April 2001. Any disposals must take place in the twelve months after the cessation of trading in order to attract the relief, so care will need to be taken to ensure that this condition is complied with. Of course one is driven to speculate that in fact there may well be a sudden glut of farmland on the market over the coming months so that for someone looking to sell, prices may suddenly not be all that attractive with a resultant 'Catch 22' situation so that one will do better by waiting, only to see the availability of residual retirement relief eradicated once the twelve-month time limit is passed.

Conclusion

The foot and mouth epidemic is likely to last a while yet and the impact on many businesses will be very long term indeed. For many business people, farmers and non-farmers alike, taxation is probably the last thing on their minds as they fight for survival but for their advisers it represents a specific area of responsibility.

The above are some of the major issues which will need to be addressed over the coming weeks and months. It is of course easy to fall into the trap of seeming too apocalyptic in such circumstances but for some clients it is already too late, as was the help they are only now being half promised. Tax advice when you have already closed your business down and paid off your staff, as some have already been forced to do, is hardly likely to be welcome. A loss relief claim may perhaps alleviate the cash flow problems if one can carry it back to last year and get a refund of tax one paid then, but for most farmers this will not be relevant.

For many in tourism and leisure the pain is only just beginning. As they faced an Easter with no customers, and a summer season which looks increasingly like not happening at all in some parts of Cumbria, Devon and other affected tourism dependent counties, the least they can expect from their adviser is an informed awareness of the tax implications of the various decisions they may be faced with. It is to be hoped that some further relaxations of the various tax problems outlined above are forthcoming from the Revenue in the very near future. As a department it at least has shown itself willing to move quickly to offer help and support. If this does not happen, then extra uncertainty will be added unnecessarily to an already disastrous situation facing many small businesses in rural communities.

RUSSELL COCKBURN practices as an independent taxation consultant based in Cumbria. He was formerly an Inspector of Taxes. Russell can be contacted by telephone or fax on 01900 824542 or via e-mail to Bluebellhouse@cs.com.

Issue: 3806 / Categories: