Farmers wanting to step down from the industry are being urged to consider five financial options before choosing to take the government's exit payment.
NFU Mutual has highlighted 'five financial considerations' for farmers after Defra recently unveiled lump sum payments of up to £100,000 for those wanting to quit.
The government has not yet confirmed how the proposed lump sums for exiting farming in England will be taxed.
However, advisers at NFU Mutual have urged farmers to ‘look before you leave’, as there are other tax considerations to take into account when choosing to step down.
Sean McCann, chartered financial planner at the rural insurer said: “It’s important for farmers to consider the other tax impacts of leaving the industry.”
Farmers who choose to sell in order to leave industry
Mr McCann explained that selling land and buildings could trigger a capital gains tax charge.
"The tax is payable on the difference between the market value when you sell and the value when you acquired it - or 31st March 1982 if acquired before that date.
“A top rate of 20% is payable on land and buildings and 28% on residential property other than your main home.
“It may be possible to claim ‘Business asset disposal relief’ - previously known as Entrepreneurs’ relief - which allows the first £1m of lifetime gains to be taxed at 10%.
“If reinvesting some or all proceeds into a new trading business it may be possible to claim ‘Roll over relief’ which defers CGT on the sums reinvested.”
Selling land and building could also mean bigger inheritance tax bills, Mr McCann added.
“Agricultural land and buildings may qualify for Agricultural Property Relief (APR) which can mean that the agricultural value is free from Inheritance tax.
“If you’re using it in your business any development value may qualify for Business Property Relief (BPR) meaning that may also be exempt from inheritance tax.
“If you sell, the proceeds won’t benefit from APR or BPR and will be subject to inheritance tax.”
Farmers who choose to rent out land and buildings to leave industry
If farmers rent all their land out on a farm business tenancy, they won't qualify for APR on their farm house.
This means that it will be included in their estate when it comes to assessing inheritance tax, Mr McCann explained.
“If you have land buildings with development potential, you may still qualify for APR on the agricultural value.
"However, as they are no longer used by you in a trading business the enhanced development value will not qualify for BPR, meaning it will be subject to inheritance tax.”
Some farmers may choose to use the exit payment to set up a diversified business, but there are a number of potential inheritance tax traps to look out for.
“If a piece of land or a building stops being used for agricultural purposes it will no longer qualify for APR," Mr McCann said.
“BPR is available for ‘trading’ businesses but not ‘investment’ businesses. Common diversifications on farms that are likely to be deemed ‘investment’ activities include letting buildings for storage, workshops or offices and holiday lets.
“If your diversified business is likely to include trading and investment activities it’s important to take advice to ensure your family don’t end up with a large and unexpected tax bill in the future.”
If a farmer choosing to take these exit payments doesn't sell but simply gifts their farm land or buildings to the next generation, they may trigger a Capital Gains Tax bill.
"However, it may be possible to defer any Capital Gains Tax on the gift by claiming ‘Holdover relief’," Mr McCann explained.
“If the farmer dies within 7 years of gifting the land and buildings, the family may still be able to claim APR if the they have continued to farm it and were still doing so at the time of the farmer’s death.
“If the farmer chooses to exit the industry by letting the land out on a farm business tenancy, they may still qualify for APR on the agricultural value meaning the agricultural value would be exempt from inheritance tax."
As part of their succession plan, some farmers may choose to pass some or all of the exit payment to their non-farming children.
He added: "While the children won’t face an income tax liability on the gift, should the farmer die within seven years, the gift will be assessed for inheritance tax.”
Tax-efficient ways of using the lump sum
For those who choose not to invest in a new business venture there are a wide range of options, Mr McCann explained.
“Pensions are one of the most tax efficient ways to invest. For every £80 you pay in HMRC add an additional £20. If you pay 40% income tax, you can claim up to an additional £20 back via your tax return.
“We are still awaiting clarity from HMRC on how the lump sum exit payment will be treated. If it is treated as taxable income in the year it’s received, this may push more farmers into the 40% tax band.
“From age 55, you can choose when you take some or all of the money out of a pension, and 25% of the fund can be taken tax free, with any other withdrawals subject to income tax.
“Any money left in a pension on death can normally be passed on free of inheritance tax. Many farmers choose to invest in pensions as a form of succession planning, building up a fund that can be left to non-business inheriting children.”
ISAs are also a tax efficient way to hold cash or share based investments, as any income or growth generated is free of UK income tax and capital gains tax.
“You can invest up to £20,000 each tax year and you can normally access your fund whenever you need," Mr McCann said.
“Others may wish to help out family members with Junior ISAs or Lifetime ISAs.”