Given the pressing need for large scale house building in the UK, many estates and farm owners may consider selling off parcels of land to developers. A sale of land will inevitably give rise to a charge to capital gains tax (CGT) but, depending on the circumstances of the sale, the taxpayer may be able to benefit from a valuable relief from CGT known as entrepreneurs' relief.
The legislation governing entrepreneurs' relief was introduced in 2008 and is available to individuals (and in some cases, trustees) who realise qualifying gains. The effect of the relief is to reduce the rate of capital gains tax (CGT) payable on certain qualifying disposals to 10% up to a lifetime limit, currently of £10 million of gains. Without the benefit of entrepreneurs' relief, CGT is generally payable at 28%, although a lower 18% rate applies to those who pay income tax at the basic rate. This translates into a maximum tax saving of £1.8 million for each individual and, importantly from a tax planning perspective, a husband and wife each have their own individual lifetime limit. The relief is therefore of considerable value and its availability should always be considered on the sale of businesses and/or assets.
Entrepreneurs' relief is available on the disposal of assets falling into the following categories:
- assets used in the business comprised in a disposal of the whole or part of a business that an individual has owned (whether individually as a sole trader or in partnership with others) for at least one year prior to the date of disposal. It is important to note that the disposal must be of the business and not just of the assets used in the business. In the context of a business carried on by a partnership, the relief will only apply on the sale of partnership assets where they represent a sale of the whole or part of the partnership business; and
- assets that were in use in a business when the business ceased provided that the assets were owned by the individual (or partners) for at least one year and the disposal of the assets takes place within three years of the cessation of the business.
Much like the old CGT retirement relief (which was replaced by taper relief), entrepreneurs' relief is designed to benefit taxpayers whose businesses are brought to an end or those selling their businesses. It will clearly be available where a farming business ceases and the whole of the farmed land is sold off to a developer. It is not designed to benefit sales of specific assets, such as disposals of discrete parcels of development land by farmers (which is the scenario more usually encountered in practice). As such, the availability of entrepreneurs' relief is often an issue for farming businesses and a number of cases in which farmers have claimed entrepreneurs' relief on the sale of land have come before the courts.
The most recent case of this kind (following in the line of retirement relief cases such as McGregor v Adcock and Mannion v Johnston) is Russell v HMRC, in which a farmer sold approximately 35% of this farm land to a developer and claimed entrepreneurs' relief. A key factor in this case was that, after the sale of the land, the taxpayer carried on the farming activity much as before, albeit on a smaller area and this led the court to find that the sale was merely of a business asset rather than the sale of a business. The courts will consider the nature and extent of the activities of the business before and after the sale and if the post-sale business continues to be carried on effectively in the same manner, the disposal is unlikely to benefit from the relief.
Despite the limitations of the relief, it may remain possible to structure matters so that entrepreneurs' relief is available on the sale of land. Given, however, that a basic condition of the relief is that the taxpayer needs to have been in business and to have owned the relevant assets for a year prior to disposal, consideration needs to be given to potential tax planning options well in advance of a potential sale.
Once a specific piece of land for development has been identified, the key, in planning terms, is that a separate farming business (distinct from any business operating over the wider land) is set up to farm that area of land. This could be achieved by establishing a new family farming partnership to operate as a distinct farming business on the relevant land. Once the partnership is up and running, the taxpayers might then apply for planning permission themselves or perhaps enter into an agreement with an agent or developer to fund the planning fees and costs. The partnership farming business would then need to operate for at least 12 months for entrepreneurs' relief to be available, after which point its trade could be brought to an end and the land could then be sold. For entrepreneurs' relief to be available, the land would need to be sold within three years of the cessation of the partnership's business.
It is critical to the analysis that a genuine farming business is set up and that the partners can show that they are together involved in the business of farming the land, rather than simply receiving rents from it (which would not qualify as a business for entrepreneurs' relief purposes). In this regard, the new trading partnership should be evidenced in detail by a partnership agreement and the land earmarked for development would need to be held as a partnership asset and shown in the partnership's accounts as such. Financial accounts should be prepared to record the trading activities of the partnership and the partners should meet to review performance and strategy as any business would. The partnership should be registered with HM Revenue & Customs for income tax and should register for value added tax on the basis of its farming activities. Given the scrutiny given by HM Revenue & Customs to claims for entrepreneurs' relief on sales of development land by farmers, it is crucial that the separate business activity of the farming partnership is clearly evidenced.
Alternatively, if the land is already farmed by a third party farmer, the owner will need to discuss if he can be brought into any partnership or, alternatively but less ideal, agree to a contract farming arrangement which should bear all the hallmarks of an arrangement where both farmer as well as landowner bear the risks of the farming business.
There may be other ways in which to obtain entrepreneurs' relief on a disposal of land. For example, an individual who farms as a sole trader might consider ceasing to trade and transferring his farming business to a company. A sale of the land to a developer within three years of the cessation of his trade should then qualify for the relief. There will clearly be other tax concerns to consider on the transfer of a business to a company and the specific facts of each case will need to be examined in detail to find the most appropriate solution.
Of course one must not implement tax planning arrangements with just the one tax in mind: here CGT and the 10% rate. Farmers and landowners not forget how such arrangements interact for income tax, Stamp Duty Land Tax, VAT and then generally for inheritance tax (IHT). For many generations the IHT reliefs offered to farmers have been much appreciated, and widely used, so as to preserve farms and land holdings and protect them from forced sales due to death duties. Therefore when implementing any structure looking to secure the 10% CGT rate, the landowner should, where possible, also aim to arrange his affairs so as to continue to secure that valuable IHT relief. If a partnership or contract farming structure is invoked, that is likely to secure 100% relief from IHT on death or any gift, by virtue of Business Property Relief; but care needs to be taken in introducing the partnership or other structure and often a new two year ownership period will be required before the relief is available.
The landowner needs to be aware that once the land is converted into cash any IHT relief will be lost unless the proceeds are reinvested into a further qualifying asset with a certain period. It may be that the owner is already resigned to losing his relief on that land given the likely imminent development and then sale. However he should look carefully at crafting any option agreement with the developer so as to ensure that does not prejudice the IHT relief in the interim, prior to sale.
Also any developer or landowner must also have in mind the ever-evolving and more pervasive HMRC anti-avoidance provisions, including those in the recent General Anti-Abuse Rules. Those are a topic too long for inclusion in this article but can trip up some even innocuous planning strategies.
Alongside any tax planning, the landowner should also have in mind his wider succession planning and given the imminent loss of IHT relief on development, he may wish to implement a gift to his children or into a trust for them so as to "bank" the Inheritance Tax relief and the anticipated increase in value prior to effecting any entrepreneurs' relief planning. Succession, Wills and gifting strategies therefore need to be bourne in mind together with "softer" aspects such as concerns with asset protection, the risks of bankruptcy and ravages of divorce.
This article originally appeared in the RICS Land Journal (December 2014 to January 2015).