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Is it becoming more difficult to claim agricultural property relief?
KEY POINTS
- HMRC challenges to APR claims are rising
- Change of farming arrangements
- Importance of an element of control
- Sharing the commercial risk
- Occupation of agricultural land
HMRC seem to be taking an increasingly vigorous approach towards denying agricultural property relief (APR) from inheritance tax.
The approach is not limited to lifestyle farmers or manor houses formerly serving an extensive land holding which has diminished over generations.
Many families with a long history of farming are now finding claims for APR being challenged, particularly where the mode of operation of the agricultural business has varied over the years immediately before death, perhaps in response to the farmer’s increasing age, and where there may have been no obvious successor to take on the business during the farmer’s lifetime, or there has been a delay in bringing others into a farming partnership.
This article focuses on the availability of APR on farmhouses and the contentious issue of whether land and/or any farmhouse is “occupied… for the purposes of agriculture” for the purposes of IHTA 1984, s 117(a).
It is worth mentioning that there is a considerable overlap between APR and business property relief (BPR) when considering relief for the assets of an agricultural business, although BPR will not be available in relation to a farmhouse, other than those parts used for business purposes.
The issue of whether the farmer is in occupation of the land itself and the effects on this question of the various types of farming agreements that he might enter into, could be critical for both APR and BPR, with the financial effect of any denial of BPR potentially dwarfing the effect of denying APR on the farmhouse, particularly where the land is in a semi-rural area and has high development value.
In some cases, HMRC may contest the availability of APR in relation to a farmhouse, on the basis that it is no longer occupied by the farmer “for the purposes of agriculture” at the date of death, even though it may be accepted that the farmer remains legally in occupation.
In such cases, it is primarily the nature of the activities actually carried on by the farmer on the land that will be in question.
This article will focus on the situation where a farmhouse is or has been occupied by a farmer for the purposes of agricultural activities carried on by himself, on a holding of land in his own ownership.
Appropriate character
Before considering the issue of occupation and the purposes of agriculture test, there are two preliminary hurdles to cover.
IHTA 1984, s 115 defines “agricultural property” as, among other things, “agricultural land or pasture” and “such cottages, farm buildings and farmhouses… as are of a character appropriate to the property”.
A series of decisions, of both tax and lands tribunals, relate primarily to the “character appropriate” test; for example, Lloyds TSB as personal representative of Rosemary Antrobus Deceased [2002] SpC 336 and Arnander (Executors of McKenna Deceased) [2006] SpC 565.
Both Antrobus and McKenna involved substantial historic houses where the character-appropriate test was paramount.
HMRC are now proving equally enthusiastic in contesting claims for relief relating to much more modest properties, such as agricultural bungalows and even dwellings subject to an agricultural tie, where there is no suggestion that the dwelling is not of an essentially agricultural character.
An example of a claim relating to a more modest farmhouse of this sort arose in Golding’s executors (TC1211), in which the First-tier Tribunal reviewed the various tests first set out in Antrobus as to whether a farmhouse was “character appropriate”.
Another decision of the First-tier Tribunal to go against HMRC in this area was Hanson (TC1791), in which the tribunal found that, when considering whether a farmhouse was of character appropriate to the farm which is farmed from it, the house and land must be in the same occupation, but need not be in the same ownership.
This decision will be helpful in cases where an elderly farmer continues to farm land some of which he has already gifted to the next generation.
Although the taxpayer was successful in the First-tier Tribunal in Golding and Hanson, HMRC’s efforts in this area generally are paying dividends according to recently released statistics showing increased tax receipts resulting from challenges to claims for inheritance tax relief on deceased’s estates.
Vacant possession
IHTA 1984, s 116 sets out the basic provisions of APR and includes a requirement that the transferor must be entitled to obtain vacant possession of any relevant land or buildings within 12 months, if relief is not to be restricted to 50%.
This requirement is in effect extended to 24 months by concession.
Coming to the test of occupation for the purposes of agriculture, s 117(a) requires that property has been occupied by the transferor for such purposes throughout the period of two years ending with the date of transfer.
Section 117(b) provides an alternative basis for relief, which is that the relevant property was owned by the transferor throughout the period of seven years ending with the date of the transfer and was occupied throughout that period (by him or another) for the purposes of agriculture.
The second test may be satisfied where a farmer has moved out of the farmhouse and let the whole farm, including the house, on a farm business tenancy.
However, if the farmer remains in the farmhouse while others take a more active role in the agricultural business, he may be inadvertently storing up problems for the heirs with HMRC arguing, in relation to the farmhouse, that this is no longer occupied by the farmer for the purposes of agriculture.
The converse situation, where the farmer has to move out of his farmhouse to go into care, can also give rise to problems, as touched on in the recent article What a summer! by Julie Butler and Malcolm Gunn.
Arrangements
A common scenario is that a farmer, advancing in years and perhaps having sold off his own livestock, will enter into arrangements of various types under which he will agree to share occupation of his land with a third party for specified agricultural purposes.
These could encompass either sowing and harvesting of arable crops, or grazing of livestock on permanent pasture. Such agreements should always be in writing.
There is, equally, a wide variety of farming practices underlying any written agreements, and the practices actually adopted by the parties should be treated as the primary factor determining the tax treatment.
A farmer in this situation should take care not to prejudice his position as a result of entering into a written agreement which is unfavourably drafted and may not even reflect the reality of the relationship between the parties.
Agreements being used routinely may follow a traditional form and may not have been prepared with the farmer’s tax position in mind.
Now consider the case where land consists of permanent pasture and the farmer wishes to allow a third party to graze their livestock on the land.
Where reduced to writing, the agreement typically used in this situation would historically often be phrased as a licence between the farmer and the grazier.
Various points arise in relation to the preparation of these agreements, some of which are examined here.
What is the period of the agreement?
It is considered preferable for a grazing licence not to give access to land over a continuous period of 12 months.
In particular, it may become more difficult to demonstrate that a farmer is responsible for all the actions involved in growing a crop of grass on his land if a third party grazier is in occupation for such a period, albeit on a non-exclusive basis.
Does the licence grant an interest in land to the grazier?
The wording and the title given to a licence agreement, in itself, is not determinative of its status.
Clearly, the agreement must give the third party grazier certain rights to occupy the land.
It should however be possible to ensure that the farmer retains all responsibility for the crop and the grazier does not acquire any interest in the land (as would be the case under a tenancy).
If this is not the case, HMRC would be extremely likely to argue that the farmer is merely carrying on a property investment business at this stage, rather than an agricultural business.
What is the extent of the farmer’s obligations to maintain the land?
In short, the farmer should maintain an active interest in managing the land and should be obliged to do so under any agreement with the grazier.
However, HMRC may still argue that activities such as hedging and ditching, not directly related to producing a crop of grass, are more analogous to a landlord’s activities in maintaining an investment property, rather than indicating that the farmer is engaged in agriculture.
What activities does the farmer undertake in practice, in relation to growing the crop of grass, including reseeding, rolling, harrowing, liming and fertilising?
The farmer’s position will undoubtedly be greatly improved, where he actually undertakes all these activities (preferably using his own machinery), of which liming and fertilising the land are perhaps the most important.
It will also be essential, where the farmer has sold off his agricultural machinery and a contractor is engaged, that the contractor is not also the grazier under the grazing licence.
If so, this would give HMRC carte blanche to recharacterise the arrangements between the parties, for tax purposes, on the basis that it is the grazier/contractor that would, in effect, have almost exclusive occupation of the land.
How does this tie in with the farmer’s cross-compliance obligations for the purposes of the single farm payment regulations?
It is in a farmer’s interests to retain control of land management, not only for tax purposes, but also to avoid prejudicing their entitlement to subsidies, through breach of cross-compliance.
Does the farmer accept any responsibility in relation to the welfare of the livestock placed on the land by the grazier?
If the farmer accepts a level of responsibility in relation to the stock this may assist.
Farmers will generally be reluctant to accept any liability for loss in these circumstances, although it is conceivable that this could be accepted on the basis of a liquidated damages clause, taking effect as a reduction in any fee payable under the agreement.
What degree of control does the farmer have over livestock owned by the grazier?
The farmer should have the right to require that stock is moved within an agricultural holding, where necessary, for example, to preserve the condition of the pasture and prevent poaching in bad weather.
This may also help in demonstrating that the grazier does not have rights relating to any particular area of land and the farmer’s return is not simply derived from the exploitation of land, as such.
Does the farmer share in the commercial risks and rewards of the grazing activity, or is he simply paid a fixed licence fee?
It may be that this is in some ways the most fundamental point because it goes to the very nature of the farmer’s activities and whether these should be regarded as being more in the nature of an agricultural trade or a passive property investment.
Issues such as whether the farmer incurs up-front expenditure on liming and fertilising the land, potential liability for losses of livestock and potential uplift of any return, in recognition of him having maximised the crop of grass, will be relevant.
Safer alternatives
It is at this point that advisers may wish to consider whether a grazing licence is the most appropriate legal form in which to express the relationship between the farmer and grazier.
Any document prepared in the form of a licence is likely to attract HMRC’s attention, whereas if the legal arrangement takes the form of a “profit of pasturage” agreement this may be looked on more favourably.
One reason for this is that it is an essential element of a licence to give an express right of occupation over the farmer’s land.
It is conceptually therefore only a small step for HMRC to argue that a particular form of licence may give not only a non-exclusive right, but an exclusive right of occupation over the farmer’s land.
If the farmer can be argued to have surrendered his own paramount right of occupancy over the land, that has all of the adverse implications for both APR, in relation to the farmhouse, and BPR, in relation to the land which the farmer wishes to avoid.
Ironically, some historic arrangements popular in certain areas, such as “half-crease” (in which a farmer and grazier share in the crop of lambs produced by stock grazing on the land, giving the farmer a genuine commercial stake in the livestock itself) may go some way towards improving the farmer’s tax position.
Alternatively, an agreement could include terms on which the “headage” grazing the land would be reviewed on a regular basis, depending on the strength of the grass crop, reinforcing the point that it is the crop that determines the farmer’s return, rather than the mere use of land.
Rather than entering into a licence, giving rise to rights of occupation over the land, it may be preferable to structure and expressly document the transaction between farmer and grazier as a trading transaction whereby the farmer agrees to grow a crop of grass which, rather than being cut, is consumed as a standing crop by the grazier’s livestock.
A farmer may also consider various arrangements based on shared inputs and outputs, which could take the form of a share farming agreement, or even a partnership, although inevitably these can raise separate issues.
All the questions above will have implications for the farmer’s tax position and the strength or weakness of any case that can be made in rebuttal of the potential arguments which may be raised by HMRC in denying BPR in relation to land and APR in relation to a farmhouse.
Most of these points were reflected in a model “right of herbage” agreement, which was previously sanctioned by HMRC.
However, it is not necessarily the intention of such an agreement to give the farmer a commercial stake in the stock grazing the land or reward him for growing a high-quality crop of grass.
Whether it now remains safe for farmers to enter into licences and similar agreements was put into question by the Northern Irish Court of Appeal case of McCall v HMRC [2009] NICA 12.
This related primarily to the availability of BPR in relation to land with significant development value many times in excess of its agricultural value.
The case was concerned with traditional agistment agreements and highlighted the distinction to be drawn between cases where a farmer who has entered into grazing licences simply wishes to maximise the income from their land (regarded as an investment activity) and where they are concerned mainly with growing a crop of grass which is more readily describable as an agricultural trading activity.
On the facts, the farmer in that case fell on the investment side of the fence, although it was specifically noted in the judgments that if the farmer had arranged for fertilising the land and supervising the livestock, the result could have been different.
What purpose?
Having considered the nature of the relationship between the farmer and the grazier it is worth considering some of the variations on the arguments that may be raised by HMRC that a farmer has not been occupying land or a farmhouse, “for the purposes of agriculture”.
These are often aimed at demonstrating that the famer should not be treated as having been engaged in the business of farming on a day-to-day basis and include the following:
The farmer is not engaged in a sufficient degree of activity
There will inevitably be cases where HMRC will be able to argue that the farmer has in effect signed over his land to the grazier and has abnegated any interest in either land management or growing a crop of grass, whatever is stated to be the position under any written agreement.
In other cases HMRC may accept that a farmer has retained an active interest in the management of their land with a view to maximising its productivity and earning potential, but this in itself will not necessarily be sufficient to save a claim for APR if he is not seen to be growing a crop.
The activity does not constitute a trade; in support of this argument, it is often asserted by HMRC that the farmer’s activity is analogous to that of a landlord, in receipt of rental income
Trading status in itself is not a requirement for APR. Nevertheless, it may be relevant to consider whether a farmer is carrying on any other agricultural activities.
Should a farmer keep a few acres in hand for making hay or silage, or for growing another crop, or should he buy in some livestock of his own on a seasonal basis, in which case the third party grazing may be seen as part of a wider farming trade?
It will also be relevant to ask whether the farmer has maintained farm business accounts showing grazing income as a trading receipt (and claimed deductions for the costs associated with use of the farmhouse for business purposes) and whether these have been accepted by HMRC as the basis for income tax returns.
It would, in addition, be very helpful for the farmer to be able to point to regular meetings in the farmhouse, whenever appropriate (particularly when farming in partnership) to discuss and agree matters relating to the growing of crops on the land.
The activity does not constitute a business
HMRC may challenge the availability of BPR in relation to the agricultural land itself, by arguing that the land is not occupied by the farmer and not being used for a business.
It would follow from this, in HMRC’s view, that the farmhouse was not being used for the purposes of agriculture.
Again, this argument looks like an attempt by HMRC to read words into IHTA that are not there.
When these arguments are taken together, there will be cases where HMRC take the stance that the farmer is not a working farmer who is sufficiently involved in the farming activities, rather he is letting his land and occupying it as a landlord, not as a trader carrying on an agricultural business on the land.
Where this view prevails, APR may still be available on the land on the basis that it is being occupied for the purposes of agriculture, but there will be at least two adverse tax effects, namely:
- no BPR will be allowed on the development or amenity value of the land, because the farmer’s business will be regarded as a business of holding investments; and
- no APR will be given on the farmhouse unless there is other agricultural land occupied with it.
In many cases, where there is significant development or amenity value relating to the land, it will be seen that any denial of BPR in relation to the land, which could follow from using an inappropriately drafted agreement between farmer and grazier, could far outweigh the effect of denial of APR on the farmhouse.
The activity carried on by the farmer does not constitute agriculture
In some cases, HMRC go for the bull’s eye by arguing squarely that the activities of a farmer who allows a third party’s livestock on to his land for grazing do not constitute agriculture.
This approach seems to be at variance with the generally applicable principle that legislation should be interpreted according to a purposive and contextual approach, and terms used in UK tax legislation should be interpreted according to their ordinary meaning.
Various definitions of agriculture to be found elsewhere in UK legislation, including the Agricultural Holdings Act 1986 and the Agricultural Tenancies Act 1995, confirm that agriculture includes the use of land as grazing land.
On occasion, HMRC’s argument in this area appears to be based on little more than the fact that the livestock grazing the land are not in the same ownership as the land on which they are grazing.
However, there is no support for this approach in IHTA 1984 and it is thought that the average farmer or lay person who observes cattle grazing in fields would take the view that the farmer is using his land for the purposes of agriculture.
He would not say that his opinion on this issue would depend on first ascertaining the ownership of the livestock.
It seems to be accepted that this approach to statutory interpretation is valid in relation to the s 115 character appropriate test.
See, for example, the tests formulated by the Special Commissioners in Antrobus, and references in HMRC’s own Valuation Office Agency Manual in support of the view that would be taken by the “rural equivalent of the man on the Clapham omnibus”.
Why, therefore, is this approach not considered by HMRC to be valid when considering the meaning of agriculture?
Engaged in agriculture
Another aspect of this issue is that it seems to be a basic premise underlying HMRC’s position, that where more than one party is in non-exclusive occupation of agricultural land, each in a different legal capacity, only one of those parties can be treated as being engaged in agriculture for tax purposes.
The fact of dual occupation of the land seems to be the only conceivable justification for distinguishing between a case where a farmer grows a crop which is harvested and sold off site, as hay or silage (clearly farming) and a case where the same crop is grown by the farmer to be consumed on site by livestock belonging to a third party.
Indeed, this objection to dual occupation was reflected previously in HMRC’s approach to share farming operations, although more recently HMRC appear to have softened their views in that context and gone some way to accepting that it is possible that the person with the paramount interest in the land (also sometimes viewed in terms of the rateable interest) is engaged in agriculture.
Certainly, where the farmer follows some of the principles outlined above and takes care to retain paramount occupancy and undertakes full responsibility for growing a crop of grass, there should be grounds for optimism when taking the view that this takes precedence, in tax terms, over the more fleeting, ambulatory nature of occupation of the land by the grazier’s livestock, wandering over the grass crop in order to consume it.
If this is combined with an agreement between the parties that is more akin to a trading transaction than a licence, the position can be strengthened further.
As a general rule, where a farmer is prepared to accept a greater degree of commercial and financial risk in his relations with the third parties putting their livestock on his land and where he potentially enjoys an increased return dependent on his own activities, it is likely that he will be treated more favourably for tax purposes.
The conclusion is that there is still much that can be done, both to strengthen the tax position during the farmer’s lifetime and in post-death situations, to rebut HMRC’s arguments in relation to APR on farmhouses, where the farmer remains in occupation.
