The question of Inheritance Tax and the need for stringent legal advice and tax planning to minimise it is a major concern to those who may be likely to face IHT at some time in the future.
One of the country's leading experts in the field is Alan Neal, managing director and finance partner of Midlands firm MFG Solicitors.
He is also a Chartered Tax Adviser, a member of the Society of Trust and Estate Practitioners (STEP) and clerk to the General Commissioners for Income Tax for the Kidderminster Division.
Alan Neal has special expertise in the agricultural sector.
In this article he provides an insight into a case of fundamental importance to farmers and those involved in agriculture and rural businesses – if they are not to lose the benefit of important IHT reliefs.
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Mr Farmer and Mr Giles were the appropriately named executors of Frederick Farmer, who died in 1998 having run his West Country farm in hand for many years.
Frederick had diversified for good commercial reasons and had let a number of his buildings for non-agricultural uses.
The farm had remained unchanged during the eight years before Frederick Farmer's death when the estate comprised about 449 acres of land, of which 274 were arable and 60 acres grassland.
The farmhouse, farm buildings and incidental land extended to about nine acres. There was woodland of 98 acres and rented properties comprising about eight acres.
Home Farm had been run as one business with all income and expenses going through a single trading account and recorded as such in the audited accounts.
This meant the business comprised not only the income from the farming but also the rental income from the various investment properties.
At the time of Frederick's death there were 23 separate tenancies but only one of these, a cottage let to a former farm worker, was actually related to the farming business.
The Inland Revenue was determined to tax the non farming assets which had arisen as a result of diversification.
The taxpayer claimed Business Property Relief (BPR) for Inheritance Tax (IHT) purposes across the enterprise.
The Inland Revenue had denied BPR on the non farming assets and was claiming that these were investments subject to IHT.
The taxpayer considered Home Farm as one overall business – notwithstanding the fact that there were elements of it that were pure investment.
The Inland Revenue wanted to look at the individual aspects of the enterprise to examine which qualified for BPR.
The Special Commissioner found in favour of the taxpayer and came up with five tests that she said needed to be applied to ascertain whether or not there was a single business entity to which BPR could be applied.
• The capital test – This involves comparing the value of the capital assets used in the business as against the capital value of the investments.
• The turnover test – this involves looking at the turnover produced from the farming business as against the turnover produced from the rents of other investment income.
• The net profit test – this involves looking at a similar comparison of net profit.
• The employee involvement test – an assessment needs to be made as to the amount of time spent by employees on the one hand in the farming business, and on the other, looking after the investment properties.
• The overall view of the activity test – this requires one to stand back and take an objective view of the position as a whole rather than looking at the constituent parts.
The Special Commissioner decided that in the Farmer case the taxpayer's argument passed all five tests.
One does not need to tick all of the boxes in such cases but most must be satisfied and the fifth is critical.
What worked particularly in favour of the taxpayer here was that despite diversification everything had been dealt with through a single business account and run as one business.
It was also important that all of the properties being let out for investment had formerly been used for farming business but diversified for financial and profit reasons.
There were no new investment properties that had not previously been used within the farming business.
The farming profits and rental income had been paid into a single business account and the costs of running the farm and all outgoings in respect of the let premises had been financed from it.
BPR was given on all assets because the elements that were investment rather than business were in overall terms not significant.
If the Special Commissioner had found the non farming investments were significant then tax would have been paid on an element of them.
The word "significant" is usually defined for tax purposes as more than 20 per cent.
Comparison should be made between Agricultural Property Relief and BPR.
APR is given on the agricultural value of land, buildings, cottages and farmhouses, whereas BPR is given on business assets.
Inevitably in a farming or rural business situation the two can overlap since land, buildings and cottages could qualify both for APR and BPR.
If both are available, APR is considered before BPR and insofar as APR is not available then BPR can apply.
"There are two potentially important aspects of this. APR is only given on the agricultural value.
This has to be a hypothetical value which presupposes that the particular agricultural property can only be used in perpetuity for agricultural purposes.
BPR is given on the full market value. Consequently if one owns a barn with planning permission for conversion to residential use, APR can only be given on the value of the barn as a barn, whereas BPR can be given on the full market value if it also qualifies as a business asset.
APR is restricted to agricultural property but BPR is given in a wider context and can include incidental assets used within the overall business even if they are not actually being used for agricultural purposes - as in the Farmer case.
The critical issue for the taxpayer was to obtain BPR on the non agricultural assets and hence relief on the full market value.
We have just settled successfully a case for a client where we have used the five-point Farmer test though we were not able to satisfy all five.
The critical issues that were apparent in both cases were that the businesses were run as one entity without separation of activities.
Interestingly in the case that we have settled the farm was being run through a contract farming arrangement and not being farmed in hand.
It was a significant difference between the two cases.
However, the contract farming arrangement did provide for an element of financial risk for both farmer/landowner and contractor and we were able to prove from both verbal and documentary evidence that the farmer/landowner was significantly involved in the day to day decision making in relation to the contract farming.
It is absolutely critical that planning is done in advance – and at least two years in advance – as there is a time qualification requirement for both APR and BPR.
For example, if a farmer has diversified but set up separate business accounting records and the entities traded are under separate names, or possibly in different formats such as a partnership or company, then that would be fatal to a Farmer argument.
If you are thinking of diversifying, or if you have diversified, you need to take advice on the structuring of the business to ensure that reliefs are maximised and come within the Farmer case.
We are in the process of acting for a number of clients where we are advising on the restructuring of business entities to ensure that Farmer tests are complied with.
For further advice, please contact Alan Neal or Gary Priest at MFG Solicitors' Halesowen Office on 0845 5555321.
