Down On The Farm

FARMERS ENJOY A number of tax breaks ranging from the taxation of income to inheritance tax exemptions and a special four per cent VAT rate for those in the flat-rate scheme for farmers. The inheritance tax exemption in particular attracts many wealthy investors to farming as a means of sheltering their estate from inheritance tax. The ability to obtain tax relief on losses -- almost invariably at the top rate -- makes hobby farming even more attractive. It is for this reason that loss relief can be restricted where there are repeated losses.
The direct tax rules described below apply equally to farmers and market gardeners, and also to both incorporated and unincorporated businesses, except where stated. For convenience, the term farmer is used to cover both occupations.
Under section 53(2), Taxes Act 1988, all farming activities carried on in the United Kingdom form one trade. This means that old losses on one farm can generally be set against future losses on another farm provided that the general rules in section 385 (or section 393 for companies) are satisfied, for the trade has continued.
The Inland Revenue's Inspector's Manual at paragraph 2263 states that an interval between the cessation of trade at one farm and the resumption of farming elsewhere should not be treated as a permanent cessation if the facts do not support the conclusion that a permanent cessation was intended.
Definitions of terms
Section 832(1), Taxes Act 1988 defines several words and phrases used in the Tax Acts, and includes the following:
'farming' is defined as the occupation of land in the United Kingdom wholly or mainly for the purposes of husbandry';
'market gardening' is the occupation of land in the United Kingdom 'as a nursery or garden for the sale of the produce (other than land used for the growth of hops)'.
'Husbandry' is not defined in section 832(1) but it covers all agricultural activities: from the growth of crops to the rearing of animals for their food and by-products.
Farmers' profits
Farmers' profits are calculated under normal rules (subject to an election to apply the herd basis, see below). When computing their assessable income, farmers can in certain circumstances average their profits of two successive years. Farming activities are also subject to certain restrictions on losses.
Averaging rules
The variability of a farmer's profits from one year to another is recognised in tax legislation. As a result, a farmer may choose to average his taxable profits over two years. This enables, for example, a farmer to reduce liability to higher rate tax in a good year when the farm just broke even in the previous year. The provisions relating to the averaging rules are set out in section 96, Taxes Act 1988, and in brief are as follows.
The averaging rules apply to profits on United Kingdom farming. They apply to income tax only, but can be used by farmers who trade alone and those in partnership. Where a farmer is in partnership, there is no requirement for all partners to make a claim under the averaging rules.
The rules apply to the taxable profits in two successive years of assessment, but not if there is little variation between the two figures concerned. Full averaging is available if the lower profits figure (L) in the two years is less than 70 per cent of the higher (H). In such cases the two years of assessment are treated as if the profits in both year were equal to: 1/2 x (H + L).
A tapered averaging is available if L is equal to or more than 70 per cent of H, but less than 75 per cent. In such cases, the profits of the year in which L applies are increased by: 3/4 x (3H -- 4L). The profits for the other year are reduced by the same amount.
Tapered averaging means that where L is exactly 70 per cent of H, then full averaging is achieved, and where L is 75 per cent of H then no averaging is available. In other words, the profits in the lower year are increased to: 1/4 x (9H -- 8L); and the profits in the higher year are reduced to: 1/4 x (12L -- 5H).
Averaging is not available in the first or last year of assessment relating to a trade. This includes deemed commencements and cessations under section 113. The appointment of a new partner or the retirement of an existing partner does not fall within section 113 provided that there is at least one trader in common before and after the change.
Averaging claims must be made in date order, but this does not preclude the second of two years affected being the first of another pair of years to be subject to a claim. In such cases, when applying the rules for the second pair of years, the profits for the first of those two years are as adjusted for the first claim.
If a farmer has made a loss in one of the two years, then the rules are given on the basis that that year's profits are nil. Loss relief continues to be available in respect of the actual loss incurred. The averaging claim takes effect on profits before any loss relief, whether or not the loss arises from farming, but after capital allowances.
Any claim must be made within the normal time limit for claims in respect of the second of the two years.
Effect of self assessment
If a claim is made, the self assessment of the first year is not affected. Instead, an adjustment is made to the liability of the second year based upon the income and rates applicable of the first year, as in paragraph 3 of Schedule 1B to the Taxes Management Act 1970.
As a consequence, payments on account of the second year (which are based upon the results of the first) are not revised to take into account the change in the profits attributed to the first year. This works to the farmer's advantage when profits are rising, but works against the farmer when the second year's profits are lower than those of the first. (The final tax liability in the second year will reflect both the revised profits figures and any adjustment in respect of the first year. This will have a knock-on effect on payments on account due for that and the next year. But on its own, an averaging claim will not affect the payments on account.)
Example 1: Averaging relief claim

Farmer Giles has the following results:

Year
Taxable profit/(loss)

1999-2000
10,000

2000-01
50,000

2001-02
22,000

2002-03
(10,000)

Giles may claim averaging relief for any pair of successive years, but it should be borne in mind that a claim may not be made in respect of an earlier pair of years after a claim has been made for a later pair.

Giles chooses to make a claim in respect of all pairs of years:

Year
Original
Averaging
1999-2000 and 2000-01
Averaging
2000-01and 2001-02
Averaging
2001-02 and 2002-03

1999-2000
10,000
30,000



2000-01
50,000
30,000
28,500


2001-02
22,000

23,500
11,750

2002-03
0


11,750

Notes

Full averaging
Tapered averaging because £22,000 is between 70% and 75% of £30,000
Full averaging -- loss relief continues to be available for the loss realised in 2002-03 under normal rules


Limit on loss relief
It is a general rule in tax that loss relief is not available for hobby activities. Section 384, Taxes Act 1988 deals with this in a subtle but effective way by restricting the set off against general income under section 380 of any losses that arise from an activity that is:
not being carried on on a commercial basis; and
not with a view to the realisation of profits in the trade.
The effect of this restriction is that loss relief continues to be available against future profits from this source should profits subsequently arise. The equivalent provision for corporation tax is in section 393A(3).
As mentioned earlier, farming losses are subject to an additional restriction that applies for both income and corporation taxes. The general rule (section 397(1) is that relief under section 380 (or section 393A(1) in the case of companies) is not available if the trade has resulted in losses for five previous years. For the purposes of this test, losses are before deduction for capital allowances.
To avoid this restriction, it is necessary for the farming trade to give rise to profits at least once every six years. If not, then losses are restricted for years (from the sixth) until profits are restored.
There is also a let out, provided by section 397(3), for farms that do have the potential for profit. To qualify, it is necessary that:
the whole of the farming activities in the sixth (or subsequent) year are of such a nature, and carried on in such a way, as would have justified a reasonable expectation of the realisation of profits in the future if they had been undertaken by a competent farmer; and
if that competent farmer had undertaken those activities at the beginning of the loss-making period, one could not reasonably have expected the activities to become profitable until after the end of the year in question.
To paraphrase, the losses must be inevitable (even to a competent farmer) and there must be a reasonable expectation of future profits.
The restriction on loss relief applies to farming and market gardening activities anywhere in the world.
A further temporary concession has been announced (Extra-statutory Concession B55) for 2000-01 and 2001-02. To reflect the depressed state of the farming economy, loss relief will continue to be available to farming businesses.
In 2000-01 (or, for companies, in accounting periods ending in the year to 31 March 2001), loss relief will be available even if it is the sixth consecutive loss-making year. But there must have been a profitable year immediately before the six consecutive loss-making years. There must also be another profitable year in one of the three years preceding that year. This additional rule is designed to prevent hobby farmers from benefiting from the concession.
For 2001-02 (or, for companies, in accounting periods ending in the year to 31 March 2002), the concession applies in the sixth or seventh consecutive loss-making year.
Example 2: Section 397 in action

A farming business last made profits (before deducting capital allowances or adding balancing charges) in 1997-98, but subsequently has made only losses. Relief is available under section 380 (subject to the other rules being satisfied) for the losses arising in 1998-99, 1999-2000, 2000-01, 2001-02 and 2002-03.

Regardless of whether section 380 relief is claimed in these years, relief will be denied for any losses arising after 2002-03 unless there is an earlier year which gives rise to a profit (or the losses are inevitable and there is a reasonable expectation of future profits).


Herd basis
The herd basis is an optional way to calculate profits arising from the sale of livestock. It applies for mature animals only, i.e., those that are able to reproduce.
Without a herd basis election, the acquisition of animals would be reflected as a cost of a sale, and the sale proceeds of the animal would be a trading receipt. Under the herd basis, the initial cost and the final disposal proceeds of a herd are not subject to tax -- the disposal proceeds and the replacement costs are subject to tax and deductions in the normal way.
The herd basis may apply to all living creatures (including birds, fish and insects, e.g., bees)). It may be used for herds of one as well as to shares in animals. The Finance Act 2000 introduced new section 82(2), Capital Allowances Act 1990 to the effect that capital allowances cannot be claimed in respect of animals subject to the herd basis.
The rules relating to herd basis are contained in Schedule 5 to the Taxes Act 1988 and are as follows:
The cost of any initial herd (and any subsequent addition to the herd -- subject to the rules below) is omitted for tax purposes. If trading deductions have previously been made in respect of this initial herd, the costs previously relieved in bringing the animal to maturity are brought in as a trading receipt (subparagraphs (2) and (3)).
The subsequent sale and replacement of an animal would give rise to a trading receipt, and the replacement cost is relievable (but only to the extent that the replacement is an animal of equal quality to the first) (subparagraphs (4) and (5)).
If an animal is compulsorily slaughtered and is replaced by an animal of lesser quality, then the trading receipt for any animal should not exceed the deduction for its replacement (subparagraph (6)).
The sale and replacement of an entire herd is treated similarly, i.e. a trading receipt on the sale proceeds and relief on replacement costs up to the number and quality of the herd sold (subparagraph (7)).
The proceeds on a disposal of the entire herd or the substantial reduction of it are not subject to tax. The disposals can take place over the course of a year (subparagraph (8)).
If the above would apply but a replacement herd starts to be acquired within five years of the sale, then the proceeds are subject to tax but the replacement costs may be offset against them in accordance with subparagraphs (4) to (7) (subparagraph (9)).
If the sale was beyond the farmer's control, e.g., compulsory slaughter, and the replacement herd is of a lesser quality, then the trading receipt for any animal should not exceed the deduction for its replacement (subparagraph (9)(a)).
If an animal is sold without replacement then the farmer should bring into account the profit calculated as:
Proceeds less cost of acquiring the animal sold and bringing it to maturity (subparagraph (10)).
If a herd is replaced with another herd and the new herd is smaller (but not substantially smaller) than the old herd, then subparagraph (10) applies to the difference (subparagraph (11)).
Sale proceeds can mean insurance and other compensation receipts on the death or disease of an animal (subparagraph (12)). A substantial reduction is generally regarded by the Revenue to be 20 per cent or more (paragraph 2303b of the Inspector's Manual refers).
Generally, an election for the herd basis must be made by the normal self assessment time limit for making elections (the second 31 January after the year of assessment or two years after the chargeable period for companies) in respect of the period for which the herd is first held. But this is extended in cases where a herd is wholly or substantially slaughtered under Government or local authority orders because of disease. In such cases the time limit is that applicable for the period in which the compensation for the slaughter is to be (or would be) taken into account.
Example 3: Herd basis

Brown commences farming with a herd of ten cows which costs him £1,000. In year 2, he sells one cow for £200 and replaces it with a cow of comparable quality for £150. In year 3, he sells five cows for £1,000 and buys two for £400. In year 4, he sells the remaining herd for £1,500.

Under the conventional basis, Brown will be assessable on the following profits:

Year 2
Proceeds £200 less cost £100
Profit £100

Year 3
Proceeds £1,000 less cost £500 (assuming older cows are sold first)
Profit £500

Year 4
Proceeds £1,500 less cost £950
Profit £550

The total profits of £1,150 can be reconciled with the total receipts (£2,700) less the total costs incurred (£1,550).

Under the herd basis, the assessable profits will be as follows:

Year 2
Proceeds £200 less replacement cost £150
Profit £50

Year 3
There is a substantial reduction in the size of the herd. A profit need only be taken in respect of the replaced animals. However, cost and proceeds Equal £200 each.
Profit nil

Year 4
Herd is disposed of.
Profit nil

The total assessable profit of £50 can be reconciled with the conventional profits as follows:

Profits under herd basis
50

Opening costs not relieved
(1,000)

Final sale receipts not taxed
1,500

Partial disposal receipts not taxed
600


£1,150

This example shows the benefit of adopting the herd basis when prices are rising.


Agricultural buildings allowances
Farmers qualify for capital allowances in the same way as any other traders. However, there is a special régime of capital allowances that is particularly applicable to farmers.
Agricultural buildings allowances are available, under section 123, Capital Allowances Act 1990, in respect of 'any capital expenditure on the construction of farmhouses, farm buildings, cottages, fences or other works'. The person incurring the expenditure must have a 'major interest' in agricultural land at the time the expenditure is incurred.
The 'building' must be used for the purposes of husbandry on that land, and therefore need not be on the land itself. If a building is used both for husbandry and other purposes, then an appropriate adjustment should be made to the expenditure qualifying for agricultural buildings allowances. In the case of a farmhouse, the portion of the expenditure qualifying cannot in any event exceed one third.
A major interest is generally a freehold or leasehold interest or the agreement to acquire such an interest. At the time of writing, the terms applicable to Scottish land law are subject to change -- but the equivalent definitions will apply (Abolition of Feudal Tenure, etc. (Scotland) Act 2000).
The availability of agricultural buildings allowances will be subject to the 'relevant interest' in the land. This is defined in section 125(2), Capital Allowances Act 1990 to be the interest held by the person who incurred the construction expenditure at that time. (If two interests are held by that person at that time, it is the inferior of these interests that is considered to be the relevant interest.)
If the relevant interest becomes merged with another interest, the merged interest becomes the relevant interest.
Operation
Agricultural buildings allowances are given at an annual rate of four per cent of the construction expenditure. They are given to the person who has the relevant interest in that chargeable period.
They are given during the course of the writing-down period which lasts 25 years from the date of the beginning of the chargeable period in which the expenditure is incurred.
If the relevant interest is transferred during the writing-down period, the new owner will qualify for allowances for the remainder of the period.
If the relevant interest is transferred during a chargeable period, the former owner is only entitled to an appropriate proportion of the writing-down allowance. Similarly, if the relevant interest is acquired during a chargeable period of the acquirer, only a proportionate writing-down allowance may be claimed in that period.
Agricultural buildings allowances continue to be available to the person with the relevant interest even if the building ceases to exist.
Example 4: Simple agricultural buildings allowances scheme

Barley builds a barn for £80,000 in 1995. He uses it for his farm (where he owns the freehold). On 1 July 2000, he sells the entire farm to Alfalfa. Barley prepares accounts to 31 December each year; Alfalfa prepares accounts to 30 June. On 1 January 2005, the barn is destroyed in a fire.

Barley's expenditure on the barn qualifies for agricultural buildings allowances. He may therefore claim annual allowances of £3,200. For the chargeable period ending on 31 December 2000, Barley may only claim £1,600 as he sold the relevant interest halfway through the chargeable period. Alfalfa may claim writing-down allowances of £3,200 beginning with the chargeable period ending 30 June 2001. Even though the barn is destroyed, Alfalfa will continue to claim allowances until 2020. In the chargeable period ending 30 June 2020, Alfalfa's claim will be restricted to £1,600 as under section 146(3), the total amount claimed may not exceed the original construction expenditure incurred.


Balancing adjustments
Taxpayers may alternatively treat the transfer or destruction as a balancing event. In such cases, an election should be made by the normal time limit. If the event is the transfer of the relevant interest, any election must be made jointly by both the former owner and the new owner.
Under this system and contained in section 128, taxpayers are required to note the 'residue of unrelieved expenditure'. Subject to any adjustments below, this is equal to the original expenditure less the writing-down allowances taken to date.
The former owner will compare the residue with the sale proceeds or compensation received in respect of the destruction of the building. If the residue is larger, the difference will be given as a balancing allowance. If the residue is smaller, then the difference will be taxed as a balancing charge. However, the charge cannot exceed the allowances given to date to the former owner.
Any subsequent owner will, under section 129(3), be able to claim writing-down allowances equal to the revised residue divided by the length of the remaining part of the writing-down period. It will be noted that in many cases, the new owner's allowances will be based on the new owner's actual cost. However, they will not apply if the former owner has a balancing charge which is restricted under section 128(6).
Buildings bought unused
Special rules exist where a person sells the relevant interest before bringing the building into use (see section 127). In such circumstances, any writing-down allowances already given are withdrawn. Furthermore, the purchaser is deemed to have incurred construction expenditure on the building. Agricultural buildings allowances are then calculated on the basis of:
the lower of the original construction expenditure; and
the net price paid for the interest by the purchaser.
The writing-down period commences at the beginning of the chargeable period in which the purchaser becomes liable to pay for the relevant interest.
Similarly, if the building when it is first used is not used for husbandry, then any allowances already given will also be withdrawn (section 124(2)).
Keith Gordon is a director of ukTAXhelp Ltd and can be contacted by e-mail on keith.gordon@ukTAXhelp.co.uk. The views expressed in this article are those of the author.


Down On The Farm
KEITH GORDON MA, ACA, ATII gives readers an overview of some of the more common issues relating to farming and market gardening.
FARMERS ENJOY A number of tax breaks ranging from the taxation of income to inheritance tax exemptions and a special four per cent VAT rate for those in the flat-rate scheme for farmers. The inheritance tax exemption in particular attracts many wealthy investors to farming as a means of sheltering their estate from inheritance tax. The ability to obtain tax relief on losses – almost invariably at the top rate – makes hobby farming even more attractive. It is for this reason that loss relief can be restricted where there are repeated losses.
The direct tax rules described below apply equally to farmers and market gardeners, and also to both incorporated and unincorporated businesses, except where stated. For convenience, the term farmer is used to cover both occupations.
Under section 53(2), Taxes Act 1988, all farming activities carried on in the United Kingdom form one trade. This means that old losses on one farm can generally be set against future losses on another farm provided that the general rules in section 385 (or section 393 for companies) are satisfied, for the trade has continued.
The Inland Revenue's Inspector's Manual at paragraph 2263 states that an interval between the cessation of trade at one farm and the resumption of farming elsewhere should not be treated as a permanent cessation if the facts do not support the conclusion that a permanent cessation was intended.
Definitions of terms
Section 832(1), Taxes Act 1988 defines several words and phrases used in the Tax Acts, and includes the following:
'farming' is defined as the occupation of land in the United Kingdom wholly or mainly for the purposes of husbandry';
'market gardening' is the occupation of land in the United Kingdom 'as a nursery or garden for the sale of the produce (other than land used for the growth of hops)'.
'Husbandry' is not defined in section 832(1) but it covers all agricultural activities: from the growth of crops to the rearing of animals for their food and by-products.
Farmers' profits
Farmers' profits are calculated under normal rules (subject to an election to apply the herd basis, see below). When computing their assessable income, farmers can in certain circumstances average their profits of two successive years. Farming activities are also subject to certain restrictions on losses.
Averaging rules
The variability of a farmer's profits from one year to another is recognised in tax legislation. As a result, a farmer may choose to average his taxable profits over two years. This enables, for example, a farmer to reduce liability to higher rate tax in a good year when the farm just broke even in the previous year. The provisions relating to the averaging rules are set out in section 96, Taxes Act 1988, and in brief are as follows.
The averaging rules apply to profits on United Kingdom farming. They apply to income tax only, but can be used by farmers who trade alone and those in partnership. Where a farmer is in partnership, there is no requirement for all partners to make a claim under the averaging rules.
The rules apply to the taxable profits in two successive years of assessment, but not if there is little variation between the two figures concerned. Full averaging is available if the lower profits figure (L) in the two years is less than 70 per cent of the higher (H). In such cases the two years of assessment are treated as if the profits in both year were equal to: 1/2 x (H + L).
A tapered averaging is available if L is equal to or more than 70 per cent of H, but less than 75 per cent. In such cases, the profits of the year in which L applies are increased by: 3/4 x (3H – 4L). The profits for the other year are reduced by the same amount.
Tapered averaging means that where L is exactly 70 per cent of H, then full averaging is achieved, and where L is 75 per cent of H then no averaging is available. In other words, the profits in the lower year are increased to: 1/4 x (9H – 8L); and the profits in the higher year are reduced to: 1/4 x (12L – 5H).
Averaging is not available in the first or last year of assessment relating to a trade. This includes deemed commencements and cessations under section 113. The appointment of a new partner or the retirement of an existing partner does not fall within section 113 provided that there is at least one trader in common before and after the change.
Averaging claims must be made in date order, but this does not preclude the second of two years affected being the first of another pair of years to be subject to a claim. In such cases, when applying the rules for the second pair of years, the profits for the first of those two years are as adjusted for the first claim.
If a farmer has made a loss in one of the two years, then the rules are given on the basis that that year's profits are nil. Loss relief continues to be available in respect of the actual loss incurred. The averaging claim takes effect on profits before any loss relief, whether or not the loss arises from farming, but after capital allowances.
Any claim must be made within the normal time limit for claims in respect of the second of the two years.
Effect of self assessment
If a claim is made, the self assessment of the first year is not affected. Instead, an adjustment is made to the liability of the second year based upon the income and rates applicable of the first year, as in paragraph 3 of Schedule 1B to the Taxes Management Act 1970.
As a consequence, payments on account of the second year (which are based upon the results of the first) are not revised to take into account the change in the profits attributed to the first year. This works to the farmer's advantage when profits are rising, but works against the farmer when the second year's profits are lower than those of the first. (The final tax liability in the second year will reflect both the revised profits figures and any adjustment in respect of the first year. This will have a knock-on effect on payments on account due for that and the next year. But on its own, an averaging claim will not affect the payments on account.)
Example 1: Averaging relief claim

Farmer Giles has the following results:

Year
Taxable profit/(loss)

1999-2000
10,000

2000-01
50,000

2001-02
22,000

2002-03
(10,000)

Giles may claim averaging relief for any pair of successive years, but it should be borne in mind that a claim may not be made in respect of an earlier pair of years after a claim has been made for a later pair.

Giles chooses to make a claim in respect of all pairs of years:

Year
Original
Averaging
1999-2000 and 2000-01
Averaging
2000-01and 2001-02
Averaging
2001-02 and 2002-03

1999-2000
10,000
30,000



2000-01
50,000
30,000
28,500


2001-02
22,000

23,500
11,750

2002-03
0


11,750

Notes

Full averaging
Tapered averaging because £22,000 is between 70% and 75% of £30,000
Full averaging – loss relief continues to be available for the loss realised in 2002-03 under normal rules


Limit on loss relief
It is a general rule in tax that loss relief is not available for hobby activities. Section 384, Taxes Act 1988 deals with this in a subtle but effective way by restricting the set off against general income under section 380 of any losses that arise from an activity that is:
not being carried on on a commercial basis; and
not with a view to the realisation of profits in the trade.
The effect of this restriction is that loss relief continues to be available against future profits from this source should profits subsequently arise. The equivalent provision for corporation tax is in section 393A(3).
As mentioned earlier, farming losses are subject to an additional restriction that applies for both income and corporation taxes. The general rule (section 397(1) is that relief under section 380 (or section 393A(1) in the case of companies) is not available if the trade has resulted in losses for five previous years. For the purposes of this test, losses are before deduction for capital allowances.
To avoid this restriction, it is necessary for the farming trade to give rise to profits at least once every six years. If not, then losses are restricted for years (from the sixth) until profits are restored.
There is also a let out, provided by section 397(3), for farms that do have the potential for profit. To qualify, it is necessary that:
the whole of the farming activities in the sixth (or subsequent) year are of such a nature, and carried on in such a way, as would have justified a reasonable expectation of the realisation of profits in the future if they had been undertaken by a competent farmer; and
if that competent farmer had undertaken those activities at the beginning of the loss-making period, one could not reasonably have expected the activities to become profitable until after the end of the year in question.
To paraphrase, the losses must be inevitable (even to a competent farmer) and there must be a reasonable expectation of future profits.
The restriction on loss relief applies to farming and market gardening activities anywhere in the world.
A further temporary concession has been announced (Extra-statutory Concession B55) for 2000-01 and 2001-02. To reflect the depressed state of the farming economy, loss relief will continue to be available to farming businesses.
In 2000-01 (or, for companies, in accounting periods ending in the year to 31 March 2001), loss relief will be available even if it is the sixth consecutive loss-making year. But there must have been a profitable year immediately before the six consecutive loss-making years. There must also be another profitable year in one of the three years preceding that year. This additional rule is designed to prevent hobby farmers from benefiting from the concession.
For 2001-02 (or, for companies, in accounting periods ending in the year to 31 March 2002), the concession applies in the sixth or seventh consecutive loss-making year.
Example 2: Section 397 in action

A farming business last made profits (before deducting capital allowances or adding balancing charges) in 1997-98, but subsequently has made only losses. Relief is available under section 380 (subject to the other rules being satisfied) for the losses arising in 1998-99, 1999-2000, 2000-01, 2001-02 and 2002-03.

Regardless of whether section 380 relief is claimed in these years, relief will be denied for any losses arising after 2002-03 unless there is an earlier year which gives rise to a profit (or the losses are inevitable and there is a reasonable expectation of future profits).


Herd basis
The herd basis is an optional way to calculate profits arising from the sale of livestock. It applies for mature animals only, i.e., those that are able to reproduce.
Without a herd basis election, the acquisition of animals would be reflected as a cost of a sale, and the sale proceeds of the animal would be a trading receipt. Under the herd basis, the initial cost and the final disposal proceeds of a herd are not subject to tax – the disposal proceeds and the replacement costs are subject to tax and deductions in the normal way.
The herd basis may apply to all living creatures (including birds, fish and insects, e.g., bees)). It may be used for herds of one as well as to shares in animals. The Finance Act 2000 introduced new section 82(2), Capital Allowances Act 1990 to the effect that capital allowances cannot be claimed in respect of animals subject to the herd basis.
The rules relating to herd basis are contained in Schedule 5 to the Taxes Act 1988 and are as follows:
The cost of any initial herd (and any subsequent addition to the herd – subject to the rules below) is omitted for tax purposes. If trading deductions have previously been made in respect of this initial herd, the costs previously relieved in bringing the animal to maturity are brought in as a trading receipt (subparagraphs (2) and (3)).
The subsequent sale and replacement of an animal would give rise to a trading receipt, and the replacement cost is relievable (but only to the extent that the replacement is an animal of equal quality to the first) (subparagraphs (4) and (5)).
If an animal is compulsorily slaughtered and is replaced by an animal of lesser quality, then the trading receipt for any animal should not exceed the deduction for its replacement (subparagraph (6)).
The sale and replacement of an entire herd is treated similarly, i.e. a trading receipt on the sale proceeds and relief on replacement costs up to the number and quality of the herd sold (subparagraph (7)).
The proceeds on a disposal of the entire herd or the substantial reduction of it are not subject to tax. The disposals can take place over the course of a year (subparagraph (8)).
If the above would apply but a replacement herd starts to be acquired within five years of the sale, then the proceeds are subject to tax but the replacement costs may be offset against them in accordance with subparagraphs (4) to (7) (subparagraph (9)).
If the sale was beyond the farmer's control, e.g., compulsory slaughter, and the replacement herd is of a lesser quality, then the trading receipt for any animal should not exceed the deduction for its replacement (subparagraph (9)(a)).
If an animal is sold without replacement then the farmer should bring into account the profit calculated as:
Proceeds less cost of acquiring the animal sold and bringing it to maturity (subparagraph (10)).
If a herd is replaced with another herd and the new herd is smaller (but not substantially smaller) than the old herd, then subparagraph (10) applies to the difference (subparagraph (11)).
Sale proceeds can mean insurance and other compensation receipts on the death or disease of an animal (subparagraph (12)). A substantial reduction is generally regarded by the Revenue to be 20 per cent or more (paragraph 2303b of the Inspector's Manual refers).
Generally, an election for the herd basis must be made by the normal self assessment time limit for making elections (the second 31 January after the year of assessment or two years after the chargeable period for companies) in respect of the period for which the herd is first held. But this is extended in cases where a herd is wholly or substantially slaughtered under Government or local authority orders because of disease. In such cases the time limit is that applicable for the period in which the compensation for the slaughter is to be (or would be) taken into account.
Example 3: Herd basis

Brown commences farming with a herd of ten cows which costs him £1,000. In year 2, he sells one cow for £200 and replaces it with a cow of comparable quality for £150. In year 3, he sells five cows for £1,000 and buys two for £400. In year 4, he sells the remaining herd for £1,500.

Under the conventional basis, Brown will be assessable on the following profits:

Year 2
Proceeds £200 less cost £100
Profit £100

Year 3
Proceeds £1,000 less cost £500 (assuming older cows are sold first)
Profit £500

Year 4
Proceeds £1,500 less cost £950
Profit £550

The total profits of £1,150 can be reconciled with the total receipts (£2,700) less the total costs incurred (£1,550).

Under the herd basis, the assessable profits will be as follows:

Year 2
Proceeds £200 less replacement cost £150
Profit £50

Year 3
There is a substantial reduction in the size of the herd. A profit need only be taken in respect of the replaced animals. However, cost and proceeds Equal £200 each.
Profit nil

Year 4
Herd is disposed of.
Profit nil

The total assessable profit of £50 can be reconciled with the conventional profits as follows:

Profits under herd basis
50

Opening costs not relieved
(1,000)

Final sale receipts not taxed
1,500

Partial disposal receipts not taxed
600


£1,150

This example shows the benefit of adopting the herd basis when prices are rising.


Agricultural buildings allowances
Farmers qualify for capital allowances in the same way as any other traders. However, there is a special régime of capital allowances that is particularly applicable to farmers.
Agricultural buildings allowances are available, under section 123, Capital Allowances Act 1990, in respect of 'any capital expenditure on the construction of farmhouses, farm buildings, cottages, fences or other works'. The person incurring the expenditure must have a 'major interest' in agricultural land at the time the expenditure is incurred.
The 'building' must be used for the purposes of husbandry on that land, and therefore need not be on the land itself. If a building is used both for husbandry and other purposes, then an appropriate adjustment should be made to the expenditure qualifying for agricultural buildings allowances. In the case of a farmhouse, the portion of the expenditure qualifying cannot in any event exceed one third.
A major interest is generally a freehold or leasehold interest or the agreement to acquire such an interest. At the time of writing, the terms applicable to Scottish land law are subject to change – but the equivalent definitions will apply (Abolition of Feudal Tenure, etc. (Scotland) Act 2000).
The availability of agricultural buildings allowances will be subject to the 'relevant interest' in the land. This is defined in section 125(2), Capital Allowances Act 1990 to be the interest held by the person who incurred the construction expenditure at that time. (If two interests are held by that person at that time, it is the inferior of these interests that is considered to be the relevant interest.)
If the relevant interest becomes merged with another interest, the merged interest becomes the relevant interest.
Operation
Agricultural buildings allowances are given at an annual rate of four per cent of the construction expenditure. They are given to the person who has the relevant interest in that chargeable period.
They are given during the course of the writing-down period which lasts 25 years from the date of the beginning of the chargeable period in which the expenditure is incurred.
If the relevant interest is transferred during the writing-down period, the new owner will qualify for allowances for the remainder of the period.
If the relevant interest is transferred during a chargeable period, the former owner is only entitled to an appropriate proportion of the writing-down allowance. Similarly, if the relevant interest is acquired during a chargeable period of the acquirer, only a proportionate writing-down allowance may be claimed in that period.
Agricultural buildings allowances continue to be available to the person with the relevant interest even if the building ceases to exist.
Example 4: Simple agricultural buildings allowances scheme

Barley builds a barn for £80,000 in 1995. He uses it for his farm (where he owns the freehold). On 1 July 2000, he sells the entire farm to Alfalfa. Barley prepares accounts to 31 December each year; Alfalfa prepares accounts to 30 June. On 1 January 2005, the barn is destroyed in a fire.

Barley's expenditure on the barn qualifies for agricultural buildings allowances. He may therefore claim annual allowances of £3,200. For the chargeable period ending on 31 December 2000, Barley may only claim £1,600 as he sold the relevant interest halfway through the chargeable period. Alfalfa may claim writing-down allowances of £3,200 beginning with the chargeable period ending 30 June 2001. Even though the barn is destroyed, Alfalfa will continue to claim allowances until 2020. In the chargeable period ending 30 June 2020, Alfalfa's claim will be restricted to £1,600 as under section 146(3), the total amount claimed may not exceed the original construction expenditure incurred.


Balancing adjustments
Taxpayers may alternatively treat the transfer or destruction as a balancing event. In such cases, an election should be made by the normal time limit. If the event is the transfer of the relevant interest, any election must be made jointly by both the former owner and the new owner.
Under this system and contained in section 128, taxpayers are required to note the 'residue of unrelieved expenditure'. Subject to any adjustments below, this is equal to the original expenditure less the writing-down allowances taken to date.
The former owner will compare the residue with the sale proceeds or compensation received in respect of the destruction of the building. If the residue is larger, the difference will be given as a balancing allowance. If the residue is smaller, then the difference will be taxed as a balancing charge. However, the charge cannot exceed the allowances given to date to the former owner.
Any subsequent owner will, under section 129(3), be able to claim writing-down allowances equal to the revised residue divided by the length of the remaining part of the writing-down period. It will be noted that in many cases, the new owner's allowances will be based on the new owner's actual cost. However, they will not apply if the former owner has a balancing charge which is restricted under section 128(6).
Buildings bought unused
Special rules exist where a person sells the relevant interest before bringing the building into use (see section 127). In such circumstances, any writing-down allowances already given are withdrawn. Furthermore, the purchaser is deemed to have incurred construction expenditure on the building. Agricultural buildings allowances are then calculated on the basis of:
the lower of the original construction expenditure; and
the net price paid for the interest by the purchaser.
The writing-down period commences at the beginning of the chargeable period in which the purchaser becomes liable to pay for the relevant interest.
Similarly, if the building when it is first used is not used for husbandry, then any allowances already given will also be withdrawn (section 124(2)).
Keith Gordon is a director of ukTAXhelp Ltd and can be contacted by e-mail on keith.gordon@ukTAXhelp.co.uk. The views expressed in this article are those of the author.

 

Issue: 3794 / Categories: Comment & Analysis