The increasing appeal of rollover relief for landowners and farmers
Julie Butler and Fred Butler examine the growing attraction of rollover relief.
The Spring Budget and the reduction of the lifetime limit for entrepreneurs’ relief (ER) for capital gains tax (CGT) from £10m to £1m has placed more focus on the advantages of rollover relief. ER has been renamed business asset disposal relief (BADR).
However, rollover relief was already increasing in popularity prior to this, to the extent that it has created a class of buyer in the business property market – the rollover buyer, especially in the farming market. The COVID-19 pandemic has, at the time of writing, effectively closed down the residential property market. However, the farmland property market is still relatively active and rollover deadlines of 36 months after exchange have to be achieved.
The land agents and farm property press classify rollover buyers as those purchasing farms and seeking rollover relief for CGT from development gains. The gain from the development of houses on the whole or part of a farm can be rolled over into another qualifying business asset, which is often a farm.
The tax adviser acting for the rollover buyer has to be careful that the sale does indeed qualify for rollover relief and does not become caught in any income tax traps such as slice of the action schemes (eg, where the landowner benefits from the developer’s profits, a deal involving the landowner taking houses as part of the deal which can vary in value, and so on). Rollover buyers can also be those seeking to shelter any business gains into the purchase of a farm.
Many tax advisers consider that it is a combination of the positive general tax reliefs on a farm purchase, (eg, the potential inheritance tax (IHT) relief and possible option for claiming input VAT and income tax losses), combined with the strong role of rollover buyers that had been keeping farm sales prices strong.
The property development potential for landowners and farmers has been very positive. The generic aims of farmers owning potential development land are generally to maximise the use of rollover relief and BADR. Careful structuring with these tax savings in mind can reduce the tax payable to 10% or that gains can be rolled over into other business assets so that all potential CGT liability is deferred. Because death is not a chargeable event, it is possible to erase potential CGT liabilities at that point.
In practice, the CGT mitigation strategy is often a mix of these two reliefs, and this is likely to continue with the reduction in the BADR lifetime limit. For example, part of the gain may be subject to a claim to BADR while the balance might be rolled over into new property or into improvements to those parts of the farm that remain after the development. However, this can be quite complex given the requirement for a cessation of the trade to qualify for BADR.
Replacement property relief for IHT
With many farms or parts of them being sold for development, the replacement property provisions and occupation test must be considered for IHT. The replacement property relief for IHT increases the incentive of the rollover buyer to find more farmland. With the elderly farming population in the UK replacement property relief is attractive, but conditions must be met, especially if death should occur soon after purchase.
The occupation conditions of replacement property relief are relaxed if the agricultural property transferred has replaced other agricultural property. The two-year occupation test is treated as satisfied if the two (or more) properties concerned were occupied by the deceased or transferor for the purposes of agriculture for an aggregate period of at least two of the five years immediately before the transfer (s118(1), IHTA 1984). The seven-year ownership condition is treated as satisfied if the properties were both owned by the deceased or transferor and occupied (by them or another) for agricultural purposes for an aggregate period of at least seven of the 10 years immediately before the transfer (s118(2)). Further, the agricultural property relief (APR) must not exceed the relief that would have been available had the claim not been made. In other words, the claim is limited to the amount of relief available on the original holding. The need to be able to claim business property relief (BPR) as well as APR is of key importance for the replacement property occupation rules.
Once again, the Spring Budget, or more correctly the lead-up to the Budget with the considerations of the All-Party Parliamentary Group (APPG) and the Office of Tax Simplification (OTS) will have a big impact here. One suggestion of the APPG was removing APR and BPR and replacing the 40% rate of IHT with a lower rate between 10% and 20%. Both the APPG and OTS also suggested scrapping the CGT uplift on death.
However, as there were perhaps surprisingly no changes to IHT in the Spring Budget, rolling over gains into farmland is still very attractive, perhaps even more so as people take advantage of the reliefs in anticipation of changes in the Autumn Budget!
CGT strategy links with hope links
With the current advantageous rates of CGT of 0%, 10% or 20% on sales of potential development land, the decision for the farmer or landowner to develop the land themselves can have associated tax risks compared to a direct sale that would achieve CGT reliefs.
Rollover relief represents the 0% rate of CGT. BADR is at the 10% rate of CGT and from 1 April 2016 there has been the 20% rate of CGT that applies to the sale of land to developers. Claiming ER has historically been complex and has pushed a lot of farmers/landowners towards the category of rollover buyers. With a reduced BADR lifetime limit of only £1m, rollover will have an even greater attraction.
The landowner must consider the integration of IHT and CGT in relation to the potential development land. Legal advisers must ascertain the exact ownership – often what the landowner understands to be the ownership structure might not be mirrored by the legal interpretation.
When considering IHT relief on potential development land, if the landowner should die before the land is sold to the developer, the relief on the development potential (hope value) at the date of death must be considered. If the land is part of a farming partnership that is trading and the land is used in the trade, BPR should be achieved on the hope value. The question is whether the land is partnership property or is simply used by the farming partnership. Potential development land that is not partnership property achieves only 50% BPR (s104(1) and s105(1)(d), IHTA 1984). The Foster case (Foster v Revenue and Customs Commissioners  UKUT 251(LC)) must be considered in terms of quantifying the hope value.
Where the farm is operated as a partnership, but the land is owned by one or more partners personally (although as mentioned this is not normally advisable for IHT purposes), if BADR is the more immediate goal, it may be helpful to set up this kind of structure in advance. The planning is to structure the sale of the land as an “associated disposal” where there has been a “material disposal” of a business. For a partner, a material disposal is relatively easy to achieve because a reduction in the partner’s interest in a partnership share will be recognised as a disposal of part of the business.
Finance Act 2015 indicates broadly a 5% reduction in a business interest as being sufficient to qualify as a withdrawal. This opens the way for the partner to dispose of the land as an “associated disposal” qualifying for BADR. The disposal must be made “as part of the withdrawal of the individual from participation in the business”, but HMRC accepts that this refers to equity participation and not time spent. However, with the reduction in the BADR lifetime limit the associated disposal advantage perhaps becomes less attractive.
Rather than have the complexity of meeting all the BADR requirements and the reduced lifetime limits, a rollover relief claim on a new farm is one way for non-farming children to inherit the family assets tax efficiently. Their task will then be to sell the farm rather than be given cash from the initial sales proceeds after the claim for BADR. It could be the rollover buyer minimises CGT through rollover and then passes the new farm to the next generation using holdover relief for CGT, provided all the conditions are met.
Rollover buyers and improving the farm
Rollover relief is allowed on farm improvements provided that they are incurred 12 months before and 36 months after the date of disposal. There can be complications as to what qualifies as improvements, (ie, the difference between improvements and repairs) and improvements that don’t qualify in some circumstances, (eg, let cottages and the farmhouse).
Recording farm improvements might seem a simple case of good bookkeeping, but the property that has been upgraded must be identified clearly. Some farms have many property units and types and it is important to understand exactly when and where the expenditure has been incurred.
For example, improvements to residential let cottages rather than farm buildings will not be allowed for rollover purposes. HMRC may also enquire into whether the cost has been incurred on repairs or improvements (see Pratt v HMRC  UKFTT 416 (TC) and Cairnsmill Caravan Park v HMRC  UKFTT 164 (TC)).
In Pratt, a farming partnership claimed a deduction for the cost of resurfacing the driveway at its farm. HMRC rejected the claim on the basis that this was capital expenditure, but the First-tier Tribunal allowed the partnership’s appeal, holding that it was revenue rather than capital expenditure.
Similarly, in Cairnsmill, a partnership operated a caravan park. It claimed a deduction for the cost of resurfacing part of the park. The previous grass surface was replaced by a hardcore surface. The First-tier Tribunal allowed the partnership’s appeal against HMRC’s claim that the expenditure was capital and successfully agreed that the expenditure was a repair.
Rollover buyers and the farmhouse
From a tax perspective, the disposal of bare land can be linked with a grand farmhouse and let cottages. The eligibility of the farmhouse as an asset against which a claim can be made for rollover relief is the subject of much debate. It has been known for tax advisers to try and claim full rollover relief on the purchase of the farmhouse, however there should be restrictions to only the business elements of the working farmhouse in rollover relief terms.
The sale of the farmhouse can qualify for main residence relief for CGT which must be explored when the farm is sold and can help mitigate this lack of potential rollover relief into the ‘new’ farmhouse on the purchase of the new farm.
Rollover and tree planting
There has been a surge in demand for low value bare land for rollover purposes. For example, land that is difficult for efficient food production is purchased to plant trees on, thus taking advantage of the potential for future subsidies and keeping the environmentalists happy. Such a strategy is particularly key in Scotland, which is very focused on subsidies for tree planting.
The availably of BPR after two years on the newly acquired land and expenditure on planting the new trees is also making this very attractive. The woodland needs to be deemed commercial, though there is little guidance from HMRC as to the definition of this, simply that it has to be commercial woodlands rather than more usual definitions of what defines a commercial business. Business/woodland management plans are essential to prove the woodland is deemed commercial especially if the purchaser requires BPR as part of replacement property relief.
Some rollover buyers use buying agents so that they remain anonymous to the vendor, as their presence can be a signal for an increased sales price. It is anticipated that there will be many more farms and parts of farms coming up for sale as siblings cannot afford to buy out other siblings on the death of parents and farming partners.
Following the Spring Budget, it is key for tax advisers to explore all the CGT reliefs and qualifications in respect thereof for both the vendor and the rollover buyer. The UK currently has the lowest rates of CGT since its introduction in 1965.
The most favourable 0% rate associated with rollover relief and subsequent IHT replacement relief endorses this power as a strong tax relief and a creator of a very influential class of buyer in the farming market.
The Spring Budget change to BADR only serves to reinforce this and many argue that the rollover buyer just became even more attractive and powerful.
About the authors
Julie Butler, Joint Managing Partner, Butler & Co, is a practitioner and author specialising in farming and equine tax
Fred Butler, Tax Manager, Butler & Co