Farming Partnerships Revisited

Clients with milk quota may need to consider their options in the light of recent legislative changes, suggests NIGEL POPPLEWELL FTII.

THREE SIGNIFICANT LEGISLATIVE changes announced during 2003, may cause a reconsideration of the way in which those who own, or wish to own, milk quotas trade.

The first is a non tax change, and stems from the judgment in the European Court of Justice case of Thomsen (C-401/99) announced on 20 June 2002. The court ruled that, upon expiry of a rural lease of a dairy holding, the transfer to the lessor of quota was possible only where the lessor had the status of a producer within the meaning of the relevant European Community regulation (Council Regulation (EEC) No 3950/92) or acquired that status as soon as possible or if, at the date of expiry of the lease, it transferred that quota to a producer.

On 6 December 2002, the Department for Environment, Food and Rural Affairs announced that, in early 2003, a detailed consultation paper would be issued as a prelude to publishing regulations which will implement the changes to the Dairy Produce Quotas Regulations arising from this judgment. The main effect of the judgment for the United Kingdom will be on non producing quota holders, in that they will no longer be able to lease out their quota indefinitely.

Furthermore, on expiry of a lease of a dairy holding, the transfer of the quota to the lessor is possible only when the lessor has the status of producer or, on expiry of the lease, transfers quota to a third party who is a producer.

Thus it is a 'use it or lose it' régime. Non producing quota holders will be reluctant to go back into milking, and consideration should be given to going into partnership. This may safeguard the quota from confiscation as well as protecting the business for taper relief purposes.

Corporation tax change

The second group of legislative changes relate to corporation tax, and both were introduced in the Finance Act 2002. The first, brought in by section 32, introduces a starting rate of corporation tax of zero per cent for profits up to £10,000. For a lower or basic rate taxpayer, there is no tax on dividends. Thus, if a company makes £10,000 and dividends out the profits, that £10,000 is a tax-free receipt in both the company's and the shareholders' hands, so long as they are not higher rate taxpayers. This contrasts with the same amount being received by sole trader or partner where tax will be payable.

The second tax change was introduced by section 84 of, and Schedules 29 and 30 to the Finance Act 2002, and relates to gains and losses from intangible fixed assets of the company. In essence, a company can obtain a debit, which can be used against trading profits (if the quota is held on trading account) or general profits (if the quota is a non-trading asset) for both the cost of acquiring the quota and its subsequent amortisation in accordance with United Kingdom generally accepted accounting principles.

Non producing quota holders

While the detailed amendments to the Dairy Produce Quotas Regulations have yet to be discussed in detail or finalised, it seems fairly clear that non producing quota holders will need to become producers to safeguard their quota. One way in which this might be achieved involves using a limited partnership under the Limited Partnership Act 1907. The partnership is registered at Companies House; there is a registration fee, but there are no annual fees. The partners send a signed statement to the registrar, which includes a variety of particulars and which is open to public inspection.

In England, a limited partnership does not have a separate legal personality. It comprises a general partner and one or more limited partners. Its usefulness is that a limited partner's liability, provided he does not participate in the management of the limited partnership, is limited to the capital contributed.

The non producing quota holder needs to team up with the farmer to whom he would otherwise have leased his quota. Instead of entering into a leasing agreement, he enters into a limited partnership. The farmer is the general partner who has exclusive rights to manage and does so. The quota holder is a limited partner. He contributes a modest, say £10, amount of capital and then permits the partnership to use the quota under licence. The term of the partnership is the same as the term that would otherwise be imposed under the leasing agreement.

Active producer

The partnership becomes the active producer. The quota is registered with the Rural Payments Agency notwithstanding its ownership continues to be with the non-producing quota holder. It is the partnership which produces the milk and in whose name the quota is registered. This is commonplace at present where quota was originally allocated to one partner, but which has subsequently been used by a partnership. From a VAT point of view, it is unlikely that the retention of the quota, and its use under licence, combined with the non producing quota holder's profit share, will comprise a supply for VAT purposes. Customs' manuals make clear that 'the distribution of partnership profits are not consideration for any supply'. The VAT registration of the limited partnership is in the name of the general partner only, which further safeguards the non producing quota holder. The profit sharing arrangements are adjusted so that the quota holder obtains the same amount as he would had he received a rent. As a safeguard, this would be a prior share of profits. From a cashflow and security point of view, the quota holder can take drawings on account of his presumptive profits at the same times as he would have had rent under the leasing agreement, i.e. at the start.

The quota holder is not entitled to take any part in the management, which is the exclusive province of the farmer. The capital the quota holder contributes is modest, but he retains ownership of the quota and it stays with him once the partnership ends. In this way the quota holder becomes a producer by virtue of the trading arrangement with the farmer, and his income is converted from Schedule D, Case VI income, into Schedule D, Case I income.

Taper relief

He has also changed the status of the quota for taper relief purposes. Under Schedule A1 to the Taxation of Chargeable Gains Act 1992, quota is only a qualifying asset if it is used for the purposes of a trade carried on by an individual or by a partnership of which the individual was a member. Subject to what is said below, the straightforward leasing of quota is not a trading activity carried out by an individual, and thus the quota is not a business asset for taper purposes. Once the non producing quota holder joins a partnership, it becomes a trading asset. There are clearly apportionment problems, so if a non producing quota holder wishes to get the maximum benefit of taper, he should look to transfer the quota into a life interest trust of which he is the eligible beneficiary. He can then enter into the limited partnership and the quota will be a business asset pursuant to paragraph 5(3)(b) of Schedule A1, throughout the period of ownership of the trustees.

If the non producing quota holder, however, has been fortunate enough to let the quota to a trading company (even one in which he did not participate), then, for that period of letting after April 2000, the quota will be a business asset pursuant to paragraphs 5(2)(b) and 6(1)(a) of Schedule A1. If, since April 1998, it has been let partially to individuals/partnerships and partly to trading companies, apportionments will need to be made. It may be better therefore to start time running again by the use of a life interest trust, as above.

Use of companies

There are many sound commercial reasons for farmers, who currently trade on their own account or in partnership, to continue to do so. The main residence and agricultural property relief advantages of retaining the farmhouse in personal ownership are well known, and the benefit in kind issues arising from corporate ownership of that residence may be an administrative (as well as an economic) barrier.

Shares in a farming company benefit from 100 per cent business property relief and the business rate of taper (similar to assets owned by an individual/partnership). Assets owned by a shareholder and used by a company benefit from 50 per cent business property relief. Although this is the same as an asset owned outside, but used by a partnership, in practice it is possible to obtain 100 per cent agricultural property relief on the asset through the judicious use of farm business tenancies or alternatively less than 24-month notice periods. However, while the capital tax position may be broadly neutral, the simplicity, privacy, and transparency of an unincorporated entity have many commercial and administrative attractions.

Given the fact that major creditors such as landlords and banks will want personal guarantees from those running a company, thus lifting the corporate veil, the financial advantages for using a company must be compelling. Furthermore, there is no automatic fiscal transparency on a transfer of assets from an individual/partnership to a company. There are direct tax, VAT and stamp duty issues which must be considered and overcome. Stamp duty may be a significant hurdle if land and buildings are to be transferred. However, there are sound fiscal advantages for using a company to acquire quota.

The following fictional case study illustrates the principles.

Case study

A partnership comprises the mother, father and elder son. The partnership owns several 100 acres, several 100,000 litres of milk quota, and is a mixed dairy and arable enterprise. It makes profits of £75,000 a year (I can almost hear the eyebrows shooting up in my home county of Somerset).

The partnership is proposing to purchase £120,000 worth of milk quota, which at a price of £0.10 a litre is 1.2 million litres. The partnership will need to borrow all of the money required to purchase this quota on which it will pay interest of five per cent.

In the first scenario, the partnership carries on the entire business and buys the quota. In that year it makes profits of £75,000. Against that, it can set £6,000 interest, and individual and personal allowances of (collectively) £14,000. In other words, there is a £20,000 deduction, and the balance of £55,000 is therefore broadly taxed at 22 per cent, with a total liability of approximately £12,100 (disregarding National Insurance contributions).

If, however, the partnership activities were carried out by a company, the respective tax bills would be different. The company could make some £50,000 profit without paying any tax as a result of the following:

• the nil rate band on the first £10,000;


• £6,000 interest deduction on the loan to buy the quota;


• £14,000 is paid out by way of salary to the partners to use their personal annual allowance;


• writing down allowance of £20,000 on the milk quota by amortising it on a straight line basis over six years.

Thus, the company has a taxable profit of £25,000 taxed at 23.75 per cent, i.e. £5,937.50. This is the total tax bill on the profits of £75,000. The cash in the company which has not been paid to the Inland Revenue (£5,937.50) or the partners by way of salaries (£14,000) can be distributed by way of dividend on which there is no further tax since the partners are all basic rate taxpayers.

So the tax bill has gone down from a collective £12,000 to just under £6,000.

If this continues over a six-year period, i.e. until quotas are abolished in 2008, that amounts to a total saving of approximately £36,000.

The value of the quota amortisation is the bulk of the saving. A tax deduction of £120,000 over that period, ignoring inflation, etc., is a saving of some £26,400 if taxed at 22 per cent, and £28,500 if taxed at 23.75 per cent.

There is thus a considerable advantage for purchasing through a corporate vehicle. However, the partnership may well not wish to incorporate its entire business.

Establish a company

One way around this might be to establish a company which becomes a corporate member of the existing partnership. The shareholders of the corporate partner are the original partners in the same shares in which they share income profits under the partnership agreement. There is no need for any of the existing business activities to be transferred to the corporate partner. However, for the reasons given below, it might be sensible for a corporate partner to acquire the partnership's existing quota. All that needs to happen is for the company to become a member of the partnership and to purchase the quota that the partnership is intending to acquire for £120,000. It would also employ the three partners, for salaries equivalent to their personal allowances, and in consideration for the services which those partners will supply to the company to manage the dairy business.

The partnership deed should arrange the farming activities so that the corporate partner will be responsible for the dairy business, hence justifying the salaries which are being paid to the partners.

The company borrows to acquire the quota. It is permitted, as a member of the partnership, to use the assets owned by other members of the partnership (for example, the herd, milking parlour, grazing), to carry out the duties and run the dairy division.

The income profit sharing ratio of the partnership is amended so that the vast majority of the partnership income accrues to the corporate partner (97 per cent corporate partner, one per cent to each of the remaining partners, i.e. mother, father and son). This is notwithstanding that the corporate partner is charged with running the dairy division.

The capital assets of the partnership continue to be owned as before; that is either in the partnership, in which case the capital owned and capital profit sharing of the corporate partner is zero, or outside by the individuals who permit the partnership to use them.

The partnership is taxed in accordance with sections 114 to 116, Taxes Act 1988. The partnership is treated as if it were a company and the profits or losses of the partnership computed accordingly. However, once they are computed, they are apportioned among the partners in accordance with the partnerships income profit sharing ratio. Thus the corporate partner is treated as receiving 97 per cent of the profits, against which are set the deductions mentioned above.

Open market sale

If the partners want to put the existing quota into the corporate partner, in order to obtain an additional amortisation debit, a straight transfer will not work. However, they could sell that quota in the open market. They inject the proceeds (by way of loan or subscription) into the corporate partner which uses that money to purchase an equivalent amount of quota. The company can amortise this quota, since the anti avoidance provisions in paragraph 126 of Schedule 29 to the Finance Act 2002 do not appear to apply. If the cash is introduced by way of a loan, it may provide an additional source of finance since that loan could be repaid on terms. It means the company will achieve a greater write down, and thus could make greater profit without having to pay tax.

The sale of the quota in the open market might result in a gain by the partners. However, on the basis that the partners will get maximum taper relief and they each have capital gains tax annual exemptions of about £7,000, they could make gains of £160,000 or so (tapered by 75 per cent to £40,000 which is an annual exemption for two years for each of them) if they sell half the quota on 4 April and the balance on 7 April.

Assuming that this is all allocated quota (none has been purchased), with a quota price of 10 pence a litre, it means that 1.6 million litres of quota can be sold by the individuals without a chargeable gain arising.

Disappearing quota

What happens if quota disappears in 2008? If the quota is owned by the individuals, they will need to make an negligible loss claim under section 24, Taxation of Chargeable Gains Act 1992. If this results in a capital loss, then it will only be available for use against chargeable gains which the individuals may not have.

If the quota is owned by the company, then even if the disappearance of the quota is a realisation within paragraph 19, it is likely that since there are no cash proceeds, the transaction will take place at its written down value. In other words, there will be no gain, and thus no clawback of the debits that have accrued over the period since.

Throughout that period, any debits which generate trading losses may be offset against capital gains arising in the same year, as well as trading profits. Thus, the debits arising from the quota can be used more flexibly by the company than would be the case if they formed the basis of a negligible value claim by an individual.

A problem arises if the farmers want to sell the quota. Here, it is clear that the position is much better if it is owned by them individually (or it is a partnership asset) rather than having it owned by a corporate entity.

Using the above scenario, after two years the £120,000 worth of quota has increased in value by 50 per cent and is now worth £180,000. The partners want to sell it.

If the quota is owned by the partnership or by the partners individually, then the gain of £60,000 will be tapered to a quarter of that value, i.e. £15,000, and the partners' annual exemptions will mean there is no tax to pay. Of £180,000 proceeds, the partners will get £180,000 in their hands.

Contrast the position where the company owns the quota. On the basis that it has been amortised down to a book value of 80 in that two-year period, there is a credit of 100 when the quota is sold. If it is taxed at 19 per cent, the company has a £19,000 tax bill. It then has to get the £161,000 out to the partners. It could do this by dividends over two years which, provided that they are still basic rate taxpayers, means there is no further tax. However, the £19,000 downside far outweighs the two-year debit of £40,000, which, even at 23.75 per cent is a tax advantage of only £9,500.

Inheritance tax

For inheritance tax purposes, quota owned by individuals but permitted to be used by their partnership does not fall within any of the heads of relevant business property within section 105, Inheritance Tax Act 1984. Even if the value of the land held outside the partnership might benefit from the 50 per cent reduction in section 105(d), and that value might reflect the quota attaching to it, the quota itself does not qualify for relief.

However, if the asset is owned by the partnership and reflected in its balance sheet, then that is in turn reflected in each partners' interest in the partnership, then that interest qualifies for 100 per cent relief. This will be the case if the quota were owned by the company, the quota being on the company's balance sheet and hence reflected in the value of the shares in this company which, too, would qualify for 100 per cent relief. The two-year ownership period will need to be complied with.

Nigel Popplewell is a partner at Burges Salmon and can be contacted on 0117 902 2782.

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