Changes to the tax regime post-coronavirus: 10 ways the rural sector could be affected
Part 1 - five key areas where we think change is likely to happen.
Part 2 - five radical changes that could potentially happen.
The Office for Budget Responsibility (OBR) has estimated that the coronavirus pandemic will increase government borrowing by almost £300bn in 2020-21. For context, provisional figures for 2019-20 show HMRC’s total tax take was £634.7bn across all taxes. There is a general consensus that the wide-ranging support measures that the Government has put in place are necessary, but the debate about how this is paid for will undoubtedly run for many years. Whether we will see increases in headline rates of tax or drastic changes in the tax regime remains to be seen. But what is almost certain is that targets that have been in the Government and HMRC’s sights for some time will seem even more appealing.
Why should this matter more to the rural sector than other parts of the economy? Reform of the capital taxes regime is clearly on the agenda following the Office of Tax Simplification report in 2019 and the All Party Parliamentary Report this year. Changes to Entrepreneur’s Relief (ER) in March’s Budget and any changes to the inheritance tax (IHT) regime in particular could have a significant impact on rural businesses. The ability to pass the business down the generations tax free through both Agricultural and Business Property Relief (APR and BPR, respectively) and capital gains holdover relief is not just a nice to have – rural businesses need this to remain sustainable, with the alternative being selling assets or taking on debt to pay large tax bills.
What change might we see and what impact would it have? Below are five key areas where we think change is likely to happen and in a second article, we consider some more radical changes that could happen.
1) Either IHT relief or CGT uplift, but not both?
Both reports noted a change to capital gains tax (CGT) ‘base cost uplift‘ on death. Currently, an individual inheriting farmland receives it at market value for tax purposes, regardless of what the deceased paid for it. This forms their ‘base cost’ for CGT purposes when they come to sell the asset. At the same time, APR or BPR will likely mean no IHT will have been paid. The impact of these two measures means a very lightly taxed asset in the hands of the recipient, particularly if it is sold shortly after inheritance.
An ‘either or’ approach seems likely. If IHT relief is claimed, then the uplift for CGT purposes is not available and the recipient is taxed on the disposal from the date the deceased acquired the asset (or March 1982 if later). Where a family intends to continue farming for many generations to come, this may not matter too much but it would be a significant change nonetheless and one which would likely have an impact on when assets are passed on to future generations, as it may remove the incentive for the older generation to hold on to assets so that they pass on death.
2) Switch to 80 per cent trading rule for BPR?
Also noted is the introduction of a tighter trading test for BPR. Those operating diversified or mixed businesses should be aware of the principles behind the Balfour case and the impact that carrying on certain non-trading activities such as lettings can have on the availability of BPR.
In broad terms, the operations need to be at least 51 per cent trading in nature for BPR to be available. These reports propose a stricter 80 per cent trading test to replace the current 51 per cent test to bring IHT in line with CGT. Many farms and estates may struggle to meet this criteria, resulting in higher IHT bills. Where non-trading income streams are supporting the business, this could have a significant impact on the long-term sustainability of the business as a whole.
3) Smart use of Entrepreneur’s Relief now vital
ER, which provides for a 10 per cent rate of CGT on certain capital disposals, has already been dramatically reduced in scale, with the £10m lifetime limit reduced to £1m in the 2020 Budget and we may see this go further still. This change will impact families looking to exit their business, alongside those who had made arrangements for valuable assets, such as development land, to be held in a manner which would enable them to benefit from Entrepreneur’s Relief. Maximising the ER allowances amongst family members is now key.
4) Tighter rules on farm houses?
As recent tax changes have shown, residential property is an easy target, particularly where it is not the taxpayers’ main residence and given property values, a potentially fruitful one for HMRC. We might see a targeted approach on let properties within a rural business to bring them in to charge to IHT, which would otherwise have qualified for BPR under Balfour.
The benefit of this for HMRC is that it draws a very clear line, without the need to raise enquiries in to claims for BPR for mixed estates. Whether such a change would be on all let property, rather than just those not occupied by farm workers, would be critical – there is still a clear need to have workers living on the farm for the good running of the business and anything which makes this more difficult would be unwelcome.
5) Or perhaps farmhouses?
There is normally at least some relief from IHT for the main farmhouse on death – although as ever, the rules are complex and the extent of relief often hangs on whether the farmhouse is of a “character appropriate” to the farming operations. Add in the complexity of whether the occupants are still working and one could easily envisage HMRC taking the view that a more straightforward approach is needed, that brings rural businesses in line with other taxpayers. For most, the Residential Nil Rate Band means that, for a married couple, if your house and the rest of your chargeable estate is less than £1m, there shouldn’t be any IHT to pay – there may be a view that this fairly generous relief would be sufficient for most rural businesses, with more valuable properties likely to belong to those more able to take the burden of an IHT charge.
So what does this mean for rural businesses now? For those considering change, whether driven by internal or external factors, now may be a good time to move forwards with those plans while the landscape is known.
If your rural business needs support during these challenging times, whether on long-term succession matters or more day-to-day matters, get in touch with a member of the rural team.
We previously considered 5 changes we thought were likely to the capital taxes regime and their impact on rural businesses, driven by the need to pay for the cost of the coronavirus pandemic. However, one of the most widely used phrases in recent months is that “we are living in unprecedented times” (second in popularity to “you are on mute”, when on a Zoom call). It is therefore possible that we see more revolutionary change in the next few years.
This can be framed by reference to the Office of Tax Simplification report in 2019 and this years’ All Party Parliamentary Group Report – the first of which contained recommendations that seemed, on balance, understandable and generally fair and the second of which went right back to the drawing board and proposed a fundamental reshaping of the capital taxes regime. If change looked more like the APPG report, we would be in a very different situation to where we are now.
What might this more fundamental change look like? Below are five areas where we think change could happen.
1) End of the road for APR and BPR?
These reports propose a wholesale review of the APR and BPR regime, perhaps even a complete removal of the reliefs with the introduction of a lower rate of IHT instead. Such a change, which may seem unlikely, would have a fundamental impact on many rural businesses. Whilst it is likely that there would be some provision for payment of the IHT in instalments over a number of years, it would still be a significant cost to businesses ill-placed to afford it, which could mean land sales or taking on debt.
2) Introduction of a wealth tax
A number of European countries currently have a wealth tax, often focussed around residential property but with some taxing all wealth. Such a tax, if aimed at the very wealthy, could be politically popular – the issue would be that even relatively modest farms could be of sufficient value to fall into this bracket.
One of the issues with a wealth tax is the level of administration required, which the APPG recognise in their report – land agents and valuers would be kept very busy. Putting this aside, such a change would be an unwelcome drain on cash for rural businesses, where wealth is tied up in illiquid assets.
3) PET cemetery
Currently, a gift of any size to an individual will (subject to some exceptions) fall out of the donor’s estate and be free of IHT, provided they survive 7 years from the date of the gift– these are termed Potentially Exempt Transfers (PETs). This tends to encourage those with the resources and willingness to make large gifts to children or grandchildren to do so as early as possible.
The APPG report proposes a relatively generous annual allowance for making gifts, with any amounts above this subject to an immediate tax charge. This has the benefit to the government of accelerating tax receipts, whilst still allowing for relatively generous support from parents and grandparents to the younger generation albeit more restrictive than the current regime.
4) Sales of development land set for higher tax rates?
It’s possible we will see a targeted approach that sets higher rates of tax on disposals of agricultural land for development, where the value per acre is many times greater than the agricultural value. Given the changes that have already happened to Entrepreneurs Relief and the debate about why income is taxed much more heavily than capital, this may not be as unlikely as it seems. This may not be an immediate change and may only come to pass with a change of government.
5) The “lifestyle” farmer in the firing line?
If we hope that the Government recognises the need for the tax system to support rural business, this may leave “lifestyle farmers” as a clear target. It is unfair to make generalisations, but for many “lifestylers” the day-to-day farming will be contracted out and their involvement in the business will be very limited – with a combination of the favourable IHT regime and the joy of country living being a greater drive than a desire to make a return on the farming operations. We have precedent for rules based on the level of time devoted to a business for income tax purposes – drawing up legislation to catch a particular type of farmer would be possible, but care would need to be taken to make sure unintended targets do not end up in the firing line
What we hope we have demonstrated over this and our previous article is that the potential for change in the capital taxes regime is great and the direction of travel is unlikely to be favourable for rural businesses.
If you are considering change in your rural business, get in touch with a member of the rural team to discuss the actions you should be taking now