Farmers and their families will most likely be aware of the important Inheritance Tax (IHT) reliefs currently available on the value of their businesses. Agricultural Relief (AR) and Business Relief (BR) can relieve the full value of the farming operation, and it has long been recognised that the policy objective behind these reliefs is to prevent the breaking up or sale of farms (and other businesses) on the death of their owners.
AR is available on the agricultural value of farmed land, buildings, woodlands or pasture, as well as farm cottages and farmhouses which are “of a character appropriate” to the property. The agricultural property must have been held, and used for agricultural purposes, for at least two years if owner-occupied, or seven years if occupied by someone else.
The rate of AR is 100 per cent of the agricultural value if the owner farms himself or the land was let since 1 September, 1995, when the Agricultural Tenancies Act came into force, and 50 per cent relief otherwise. Commonly, value not relieved by AR may instead be covered by 100 per cent BR on the basis that the business of farming is a trade.
Following consultation, the Office for Tax Simplification (OTS) published an initial report in November last year, setting out their views on various issues and complexities associated with the current IHT system. Among the issues raised were AR and BR and the lack of clarity and consistency in applying the rules.
Concerns were also raised as to whether the availability of these reliefs led taxpayers to hold on to farms and other businesses until death, rather than transferring them to the next generation during their lifetime. Evidence suggests the reliefs were generally operated in a straightforward way with only a few specific areas requiring simplification, including relief for furnished holiday lettings, lack of clarity on AR in the case of partially retired farmers, and the administrative burden of claiming the reliefs.
It is perhaps surprising then that the most recent report from the OTS on IHT reform, published on 5 July, explores the possibility of complete withdrawal of AR and BR, tempered by the suggestion that this significant change could be coupled with a global reduction in the rate of IHT, although the level of reduction is unclear.
Even if the reliefs are not removed entirely, the OTS has recommended aligning the accepted definition of what constitutes trading as opposed to investment between the different taxes. At the moment, a business is regarded as “wholly or mainly trading” for IHT (and therefore BR) purposes based on a 50 per cent test. The Capital Gains Tax (CGT) equivalent “substantial” trading test is a more restrictive 80:20. While the OTS could have suggested upwards alignment of the CGT test, they recommended that the appropriate test for IHT is lowered. Many landowners who have diversified their business activities in recent years, while being careful to remain on the right side of the 50 per cent BR test, may soon find themselves on the opposite side of this line.
A major area of uncertainty for an ageing farming population is the criteria for AR availability on the farmhouse itself, when the farmer reduces his involvement in the day-to-day running of the business and is forced, possibly due to ill-health, to move out of the house. A welcome suggestion in the latest report is that the tests should be simplified and more transparent. How exactly this will be effected has not been explained.
It remains to be seen whether any of these OTS proposals will be implemented. But farmers and other business owners should be mindful of their potential impact on the succession and taxability of their estates by seeking advice from specialist advisors.
Lisa Tait is tax senior manager at Anderson Anderson & Brown