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MATTHEW HUTTON highlights some planning points from this year's series of The October Countryside Tax Conferences presented by TACS Talk.
MATTHEW HUTTON highlights some planning points from this year's series of The October Countryside Tax Conferences presented by TACS Talk.
Bare licences of land owned outside the partnership
A hare seems to have been started, whereunder it is feared that the Capital Taxes Office will deny 100 per cent agricultural property relief for inheritance tax purposes to the interest of a landowner who owns land outside the partnership and which he makes available to the partnership on a bare licence in circumstances where there is no documentary evidence as to the terms of occupation.
The point is that, because he is not able to get vacant possession within twelve months, he is not able to secure 100 per cent relief under section 116(2)(a), Inheritance Tax Act 1984. In particular, because there is no tenancy in place, the extension of twelve to twenty-four months by Extra-statutory Concession F17 does not apply.
The argument appears to be that the landowner cannot recover vacant possession until twelve months have expired from the next accounting date, which puts the period beyond twelve months.
However, argued Adrian Baird, surely this is not the case. Subject to any agreement to the contrary among the parties, the basic rule under section 26, Partnership Act 1890 is that retirement can be secured simply by notice. On section 32 of that Act (dissolution by notice), Lindley and Banks 17th Edition on Partnership says at 24-19:
'… the partnership will be dissolved as soon as the notice is communicated to all partners or, if this is later, on the date specified in the notice …'
As Adrian suggested, obviously the easiest solution in such cases is to have a document confirming that the partnership can be dissolved and/or the landowner can recover his land (on payment of appropriate compensation) within a period of less than twelve months to satisfy the inheritance tax requirement.
In cases where there is currently no deed, there could be evidence in the form of a partnership minute that the partners had agreed to a notice period by the landowner of less than twelve months, which should put paid to any suggestion following the landowner's death that he could not so recover vacant possession.
Valuation: hope value
The recent Lands Tribunal decision in Prosser v Commissioners of Inland Revenue DET/1/2000 may provide a useful argument when it comes to agreeing valuations at death in a case where there is hope value but no planning consent in force, advised Dick Williams. In that case the deceased had owned a house with a garden in which there was space for a building plot. When he died, there had been no application for planning consent. The District Valuer estimated the value of the plot with the benefit of consent at £55,000 and then applied a 20 per cent deduction to allow for the fact that no application had been made for consent. The executors did apply for consent after the death, which was granted.
The tribunal estimated that at the date of death the likelihood of the grant of consent was 50/50 and held that a speculator would offer 25 per cent of the development value, viz £12,500 rather than £44,000. Dick considered that this was a realistic decision from the tribunal, in that in practice a developer does not pay cash upfront simply for hope value which may never materialise. The tribunal said 'If a prospective purchaser was seeking a plot on which to construct a house for his own occupation, he would probably prefer to await the outcome of a planning application and, if appropriate, pay the full value rather than pay half of that value and run the risk of losing his entire investment. Similarly, a speculator would in my view not be interested in a purchase unless the potential profit resulting from a successful planning application were significantly greater than the potential loss if permission were not forthcoming'.
Business property relief on let property?
It is a fundamental principle of the business property régime that the relief is not given to landlords. Consider, however, how the 1999 Special Commissioner's decision in Farmer & Giles (Farmer's Executors) v Commissioners of Inland Revenue (SpC 216) might be exploited. It was held in that case, that where some land and buildings in the middle of the farm had been taken out of agricultural use for letting, business property relief would be available on the let property (in addition to agricultural property relief on the agricultural property). This was because the Commissioner was able to find for a single business and that the business as a whole was not excluded from business property relief by reason of section 105(3), Inheritance Tax Act 1984, i.e. the business was not wholly or mainly one of holding investments. Although the lettings were more profitable than the farming, the market values of the asset underlying the two parts of the business, the turnover and the time spent clearly pointed to the business having an overall trading character.
Matthew Hutton observed that this principle could suggest some planning in appropriate cases, although it should not be taken too far. It was significant in particular that the property concerned was an integral part of the farm and had been so for very many years. In other words, the acquisition of property for letting on the edge of the farm should not be expected to attract business property relief.
Restarting the taper clock
'Tainted taper' is used to describe the situation caught by a change in the categories of business assets by Finance Act 2000 with effect from 6 April 2000. An asset which was a non-business asset for taper purposes from 6 April 1998 to 5 April 2000, but became a business asset from 6 April 2000 (for example a shareholding of less than 5 per cent in a quoted company of which the shareholder was an employee) will not achieve the full benefit of business assets taper (to produce an effective tax rate of 10 per cent) until there is a disposal on or after 6 April 2010. The traditional way of side-stepping the problem was to trigger, as soon after 6 April 2000 as possible, a transfer to a settlor-interested trust which would then hold the asset for at least four years, so that the maximum rate of taper would be obtained on the gain assessed on the settlor under section 77, Taxation of Chargeable Gains Act 1992. Adrian Baird suggested that if advantage of such a mechanism has not yet been taken, it is probably too late to do so now. This is because the acceleration from four to two years of the maximum rate of business taper, which we have been promised in Finance Bill 2002, means that the differential in effective tax rates from 2004-05 onwards will be too minimal to be of any real practical effect.
Liabilities and inheritance tax reliefs
Matthew Hutton emphasised the importance of treating agricultural property relief and business property relief as quite separate reliefs (which they are): where both apply, section 114, Inheritance Tax Act 1984 gives priority to agricultural property relief. One respect in which that difference appears is in the treatment of liabilities. For purposes of both reliefs, the effect of a liability secured on an item of agricultural or business property is by virtue of section 162(4), Inheritance Tax Act 1984 to reduce the value of the property for inheritance tax purposes and therefore the benefit of the relief. However, in addition for business property relief, what matters is the 'net value' of the business as defined under section 110: paragraph (b) makes it clear that liabilities incurred for the purposes of the business are to be taken into account in arriving at the net value. Accordingly, business liabilities which do not happen to be secured on business assets will have the effect of reducing the value of the business for purposes of business property relief.
In a situation where this principle might prove a problem, Matthew suggested the following structure. A partner owning non-business assets outside the partnership might borrow on the security of those assets and then contribute the borrowed money as partnership capital. There would then be no restriction on the availability of business property relief in respect of the interests in the partnership triggered by liabilities outside the business.
Taper relief and losses
Adrian Baird mentioned the rule in section 18(3), Taxation of Chargeable Gains Act 1992 as an example of an anti-avoidance principle which can be used to advantage by the taxpayer. Section 18(3) provides that any losses realised on a disposal to a connected person cannot be offset against gains generally, but must be carried forward and may be offset only against gains, accruing on a subsequent disposal to the same connected person. Although brought-forward losses can be used to reduce taxable gains to the upper threshold of the annual exemption, current year losses must be deducted from current year gains even if the effect is to waste part of the annual exemption. Under the taper relief régime, the strategy should be to use taper to reduce gains chargeable in that year to the upper threshold of the annual exempt amount (but no more). If in a given case the realisation of losses would mean the wastage of part of the annual exempt amount, consider a disposal of the loss-making asset to a settlor-interested trust as a connected person. Provided that the taxpayer is fairly certain that in subsequent years gains will be realised, which can be so realised through the same trust, this arrangement effectively maximises the benefit of taper relief by avoiding wastage of the annual exemption.
Holiday cottages
The deemed trade treatment for furnished holiday lettings given to income tax under section 503, Taxes Act 1988 is extended to most capital gains tax purposes but specifically not applied for inheritance tax. Traditionally the Capital Taxes Office has denied business property relief for let property and, with furnished holiday lets, one has had to work quite hard to get relief, noted Matthew Hutton. In particular, the Capital Taxes Office has traditionally required a minimum number of cottages to be included within the business if relief is to be available at all. This aspect in particular appears to have gone, the Capital Taxes Office Advanced Instruction Manual stating at L.99.3 under holiday lettings:
'You should therefore normally allow relief where:
- the lettings are short term (for example, weekly or fortnightly); and
- the owner – either himself or through an agent such as a relative or housekeeper – were substantially involved with the holidaymaker(s) in terms of their activities on and from the premises
even if the lettings were for part of the year only.
'You should continue to refer to Litigation Group cases where relief is claimed and the lettings are longer term (including Assured Shorthold Tenancies); or where the owner had little involvement with the holidaymaker(s) – for example a villa or apartment abroad; or where the lettings were to friends and relatives only; or where it is clear that no services were provided to the holidaymaker(s).'
Farmhouses and family companies
Principal private residence relief under section 222, Taxation of Chargeable Gains Act 1992 requires occupation by the individual to whom the gain accrues on disposal of an interest in a dwelling-house which has been his only or main residence. The interest disposed of by the taxpayer need not be an interest which gives him the right to occupation, observed Dick Williams.
Consider a structure whereby the land is farmed by a family company. While for general capital gains tax reasons it is advisable to keep the property outside the company, suppose the entire holding is let to the company. This structure should allow agricultural property relief after either two years occupation if the taxpayer controls the company, otherwise seven years. Main residence exemption from capital gains tax will be available to the taxpayer living in the farmhouse. It does not matter that the right to occupy arises from the tenancy under which the company provides the house rather than through the interest of the landowner. There is a downside, however, in that a Schedule E income tax charge is almost inevitable.
Accounting Standards
International Accounting Standard 41 – Agriculture was published in February 2001. The Standard covers the accounting treatment of agriculture, the presentation of financial statements and disclosure. Although this Standard is not due to take effect (either voluntary or by local regulation) until accounting periods beginning after 1 January 2003, professionals should start to consider its implications, advised Jeremy Moody. It introduces a number of new key points to agricultural accounting which, although perhaps consistent with wider accountancy developments, will have novel effects.
One major effect will be on stocktaking valuations where the Standard seems to overtake much of the Revenue's Business Economic Note 19: i.e. instead of the concept of prudence, there will be that of 'fair value', viz market value which will bring unrealised profits into tax before realisation. In practical terms the effect on stocktaking of a shift to fair value from taking the lower of the cost of production and the net realisable value is likely to include bringing tax into assessment earlier than currently and making farm accounts more volatile. This could give rise to a one-off acceleration of tax liability. The ideal solution to the problem would allow taxpayers to adopt a different basis for the opening valuation of the first accounting period affected by International Accounting Standard 41 from the closing valuation of the previous period. If (as is almost inevitable) the Revenue would not allow that, it might be prepared to consider a phase-in over a period of years (such as has been given to professional firms who must now value their files on an accruals basis at the balance sheet date, in allowing them a ten-year period to phase in the accelerated tax liability).
Part disposals
Where a landowner makes a disposal of part of the land which he owns, the primary question is whether there is a discrete disposal of land or whether, because the whole area out of which the disposal is made is a single asset with a common history of acquisition, the A/A + B part disposal rule in section 42, Taxation of Chargeable Gains Act 1992 should be applied. An alternative basis of computation is provided by Statement of Practice SP D1 which treats the part disposed of as a separate asset. However, the rules in SP D1 do not permit switching between the strict and the concessionary basis for future disposals of part of the same asset. Clearly if part of the asset (though not the part disposed of) is a business asset, it is likely that the strict A/A + B basis may produce a better result for taper purposes (except in the case of mixed use). However, each case must be examined on its own facts, advised Adrian Baird: the decision is made much more important by taper relief because it may be hard to predict the outcome on future disposals.
Options and fluctuations in value
Paragraph 10 of Schedule A1 to the Taxation of Chargeable Gains Act 1992 is an anti-avoidance rule, designed to restrict the advantage of business assets taper in relation to periods during which the owner of an asset has insulated himself from upward or downward movements in the value of the asset. For the paragraph to apply, there must be a period after 5 April 1998 when the taxpayer was:
- not exposed, or not exposed to any substantial extent, to the risk of loss from fluctuations in value; and
- not able to enjoy, or enjoy to any substantial extent, any opportunities to benefit from such fluctuations.
Note that there is no motive test within these rules. The question that arises, in relation to a person wanting to postpone a disposal now until after 6 April 2002 to benefit from maximum business assets taper, whether the rules apply to cross options. First, to avoid any argument by the Revenue that the options themselves constitute a disposal, consider having different periods for the put and the call options respectively. Second, however, if the options do express an exercise price, might paragraph 10 apply? Adrian Baird considered it would not. This would be on the basis that, as a result of commercial negotiation, the exercise price would already reflect a discounted price (to take account of the uncertainty of whether either option might in the event be exercised). Therefore there is no absence of exposure to fluctuations in value.
Two inheritance tax nil-rate bands for the price of one
Dick Williams considered the advantage of a transfer of agricultural or business property into a discretionary rather than a life interest or an accumulation and maintenance settlement, in the context of the claw-back rules in sections 113A and B and 124A and B, Inheritance Tax Act 1984. If, on the donor's death within seven years of making an outright gift, the claw-back rules bite (for example because the donee has sold the asset without reinvesting in replacement qualifying property), the benefit of the relief is retrospectively lost to the gift.
In the case of a life interest or an accumulation and maintenance trust, the now chargeable lifetime transfer is taken into account in computing the nil-rate band available in the deceased's estate. The same, however, does not apply if the gift was made to a discretionary settlement. For purposes of cumulation in the death estate the lifetime chargeable transfer carries the benefit of the relief. This is unaffected by sections 113A(2) and 124A(2), which merely provide that business or agricultural property relief is excluded in calculating the 'additional tax payable'.
The 'agricultural value' restriction
It is well known that agricultural property relief is given not on the market value but on the 'agricultural value' of any agricultural property. This expression is defined by section 115(3), Inheritance Tax Act 1984 as requiring the presumption of a perpetual covenant prohibiting non-agricultural use. Jeremy Moody made two points, in the light of the current attempts of District Valuers to argue down farmhouses by up to 30 per cent of their market value. First, it appears that the District Valuers are tending to place weight on planning restrictions, perhaps as being seen as less onerous than the section 115(3) test. However, Jeremy considered that a planning restriction which requires occupation of the house by a person wholly engaged in agriculture is much more restrictive and may make the property unmortgageable. By contrast section 115(3) is only a restriction on use and not on occupation. There are two goal posts between which the agricultural value must lie which depends upon the variables. This is an evolving debate but a one-third discount must be wrong.
The second point concerns lotting. Any attempt by the District Valuer to regard the farmhouse and garden or grounds as a valuation unit in isolation from the whole farm should be resisted. This is on the basis of the valuation rule in section 160, Inheritance Tax Act 1984 and the House of Lords decision in Buccleuch & Another v Commissioners of Inland Revenue [1967] 1 All ER 129. The rule is that the hypothetical vendor must be presumed to have marketed the property in such a way as secures the best possible price, without that entailing any undue expenditure of time or effort. The proper valuation unit on this basis is the whole farm and not the farmland on the one hand and the house on the other.
Rating and contract farming
Jeremy Moody warned of the exposure to business rates in respect of buildings used by a contractor to store machinery, fertiliser, etc. which he uses both on his own land and on that on a farm over which he has a contract (as opposed to a tenancy). This is because he does not occupy the contracted land, which he would if he were a tenant. Because the buildings are not used solely for farming land in the same occupation (and typically the scale of the contract farming exceeds any de minimis threshold), the buildings lose the benefit of agricultural ratings exemption. Farmers may be able to take some mitigating action by limiting the extent of the buildings that could be vulnerable in this way. Meanwhile, it appears that, while there has been no official announcement, the Government is aware in general terms of the problem. Before the Foot and Mouth outbreak, a Consultation Paper was issued on rating and new farming structures. However, nothing appears to have been heard since on this, although it goes back to the launch of the rural white paper in December 2000.
