Retirement - planning ahead is essential

An article written by David Webb, partner at our Oundle office

The farming community have long had a reputation for continuing to work well past normal retirement age, and it was not uncommon to see sons in their fifties before father passed over the reigns to them, or at least took them into partnership! More recently however this appears to have changed, and farmers of my father’s generation have made pension arrangements outside the farm to enable them to retire in their sixties and either pass on the farm to their children, or, in more and more cases, particularly in small or tenanted farms, to sell up when it becomes apparent the children don’t wish to carry on.

The relatively high profits during the seventies and eighties, combined with high tax rates, encouraged investment in tax efficient pensions. These proved good investments for those retiring until the last two years, thus enabling them to be financially independent from the farm.

At the same time that these farmers were able to retire with an income independent from the farm, the capital tax regime encouraged them to pass on the farm to the next generation. High base values for agricultural land in 1982, together with high indexation allowances from that time resulted in negligible Capital Gains Tax liabilities in many cases, and gains could in any case be held over if the land was gifted.

Those retiring over the next ten to twenty years are unlikely to be in the same situation however. With falling investment returns, less profits to shelter, and no spare cash to invest, today’s farmers are much less likely to be financially independent from the farm when they reach retirement age. Could we therefore again be moving towards the situation where the farming unit has got to support more than one generation, with farmers reaching retirement age still needing a continuing income from the farm. If so, what problems might arise, in addition to the obvious one of there being insufficient income to support both generations? There are a number of potential pitfalls in relation to the availability of the valuable 100% reliefs for Inheritance Tax for Agricultural Property and Business Property. These reliefs become increasingly important as the transfer of property is postponed, as it becomes less likely that the transferor will survive the seven years from the date of the gift that is required for full exemption.

There are currently many farm partnerships where the land is owned by one partner, normally father, but farmed by the partnership, with no formal tenancy agreement, and probably no partnership agreement. If the tenancy commenced before 1st September 1995, and there is no clause in the partnership agreement enabling the “landlord” to obtain vacant possession of the land within 24 months of his death, it is likely that the Inland Revenue will limit any claim for Agricultural Property Relief to the 50% rate available for tenanted property outside the provisions of the Agricultural Tenancies Act 1995. The same situation could arise if father had ceased to be a partner but continued to let the land to the partnership, perhaps at a nominal rent to provide him with some retirement income.

Where there is a partnership agreement, in particular an old agreement, care should be taken to ensure there is not a binding agreement for the deceased’s share of the partnership to be sold to the remaining partners, as this can result in no relief being available at all. Similarly, if father retires from the partnership, but leaves his capital in the business as a loan, perhaps to draw on to provide income in retirement, the loan is not eligible for Business Property Relief, even if left to one of the partners in his will. However, if the capital had been gifted on retirement, or if father had remained a partner, 100% relief should be available. On capital of £100,000 the Inheritance Tax could be £40,000!

The Inland Revenue are also looking very carefully at whether Agricultural Property Relief is available on the farmhouse, which is often a very valuable asset of the farm. A house must be “of a character appropriate to the (agricultural) property” to qualify for relief. If father gifts most of the farmland to the next generation, but keeps the house and a small area of land, is the house still of a character appropriate to the remaining land? Probably not, in which case relief is lost, which on a house worth £500,000 would cost £200,000 in Inheritance Tax. Similarly, problems arise if the house and land are gifted, but father stays in the house, as the gift is then a “gift with reservation of benefit”, which makes the gift ineffective for Inheritance Tax purposes.

Agricultural Property Relief is only available on the agricultural value of the property. This is not normally a problem where the deceased is still a partner in the business, as any difference is eligible for Business Property Relief, although the conditions for 100% relief are tighter. If however a number of buildings have been developed and let out, it should be borne in mind that the letting of property is not a business for Tax purposes, and relief may well not be available, unless it can be argued that it is a minor part of the business as a whole.

Finally, a cautionary word of warning in the case where property eligible for either Agricultural or Business Property Relief has been gifted during father’s lifetime. The gift does not escape Inheritance Tax until seven years have elapsed, and, on death within seven years, relief is only available if the property has continued to qualify in the hands of the donee for the appropriate Agricultural or Business Property relief throughout the period between the gift and death. Development of part of the property during this period, or its sale, for example, could prove very costly.

The longer therefore that financial circumstances require farmers to retain their farming interests, the more important it becomes to obtain good tax planning advice to ensure that as much benefit as possible is obtained from the available Inheritance Tax reliefs. Your accountant and solicitor should both be involved in giving specific advice whenever your wills or partnership agreements are reviewed, which should be done on a regular basis. Let us just hope these reliefs remain available!