For farmers and owners of agricultural estates, Agricultural Property Relief (“APR”) and Business Property Relief (“BPR”) are extremely valuable reliefs from Inheritance Tax, together worth over £1 billion each year.
BPR can apply to assets that do not qualify for APR as long as certain conditions are met. Where BPR applies, the value of gifts made either in one’s lifetime or on death are reduced by either 50% or 100% depending upon the type of property. BPR does not, however, apply to a business consisting “wholly or mainly of making or holding investments”. When considering which parts of a diversified estate’s business are eligible for BPR, the 2010 Balfour case remains the leading authority. The Balfour case related to the availability of BPR to the Whittingehame estate of the late Lord Balfour.
The estate covered 1,907 acres and comprised:
- 2 in-hand farms;
- 3 let farms;
- 26 let cottages;
- 2 let commercial units;
- parks; and
- sporting rights.
The Executors claimed that the estate was managed as one composite business, with Lord Balfour presiding over all business decisions. On Lord Balfour’s death, the Executors therefore claimed BPR in full against the value of his partnership interest in the business. HMRC contended that as the estate included a large number of rental properties, the partnership was not undertaking a qualifying business activity and was instead predominantly “making or holding investments”.
The question for the Tribunal to consider in this case was whether the balance of trading and investment activities tipped towards investment and therefore whether BPR should be denied. The Tribunal found in favour of the taxpayer and held that Lord Balfour’s partnership interest qualified for 100% BPR. The key criteria they considered in reaching their decision was whether the business was:
- a single composite business of farming and estate management (in which case BPR would be available on the whole estate including the ancillary investment assets such as rental cottages); or
- two separate businesses (in which case BPR would only be available in respect of the trading activities).
The Balfour case remains good news for agricultural businesses who engage in some investment activities (such as renting out properties) in addition to their main farming activities, as it means that BPR can potentially be claimed on ALL the assets within the business. Given the importance in the Balfour case of the existence of a single composite business, landowners may want to review their management structure and implement a single business plan across the whole estate. They should also prepare consolidated management accounts, run a single bank account and payroll and ensure that different board meetings are not held to discuss separate trading and investment strategies.
Once a single composite business has been established, it is necessary to determine which activity is dominant (trading or investment) by looking at the turnover, profit and time spent by employees of the business. For BPR purposes, when considering whether the business is ‘wholly or mainly’ investment or ‘wholly or mainly’ trading, this is considered to be a 50% test. However, this is at odds with the test used in the Capital Gains Tax legislation which looks at whether there is ‘substantial’ trading, generally considered to be an 80% test.
This issue was considered by the Office of Tax Simplification’s IHT review in July 2019 who recommended that the government should consider whether it continues to be appropriate for the level of trading activity for BPR to be set at a lower level than that for CGT reliefs. Since then, the Government has not demonstrated any willingness to take this debate forward. However, this is something that professional advisers are keeping an eye on. Farmers and owners of agricultural estates should review their IHT position regularly to ensure that any investment activities remain ancillary to the trading activities.
Whilst it can seem attractive to include as many investment assets as possible within a mixed estate to maximise the availability of BPR, this does create significant risks. Firstly the level of investment activities carried out may cause BPR to be denied on all of the assets within the business (including the trading assets). This risk is heightened with above-inflation increases in house values and rental income in recent years. There are also wider commercial factors such as whether it is prudent to house various trading and investment assets within the same business entity and expose investment properties to the financial risks associated with operating a trading business such as farming.
With this in mind, and with the possibility of the 80:20 rule applying to BPR in future, it is worth considering as to whether it is desirable to shift some investment assets outside of the existing business (to ensure that BPR is preserved on the bulk of the business assets) or whether the level of trading activities should be increased by, for example, offering B&B (trading) instead of holiday lets (investment) or full livery (trading) instead of DIY livery (investment). There are nevertheless wider commercial issues in play which will inevitably override IHT considerations. If you would like to discuss how BPR applies to you or would like an IHT review of your business, please contact Chris George.