Julie Butler and Libby James investigate how farm business tenancies (FBTs) and contract farming arrangements (CFAs) will be affected as we move from the EU’s common agricultural policy to a new farm support system, with reference to inheritance tax and capital gains tax.
Farm business tenancies (FBTs) are under the spotlight for survival. Following the reduction and eventual loss of the basic payment scheme (BPS) subsidy, many farm tenants may be concerned about their ability to pay their rents, particularly if their business has also been adversely affected by the current COVID-19 pandemic.
When FBTs were introduced in 1995 they were heralded as the ‘saviour of farming’, attracting 100% agricultural property relief (APR). However, it is fair to say that since then they have lost their shine and many are calling for reform. Not only has farming profitability dropped, but the realisation that they do not qualify for business property relief (BPR) or business capital gains tax (CGT) reliefs has prompted a move to contract farming arrangements (CFAs) for greater tax efficiency and involvement by the landowner. Baroness Rock, a member of the Rural Economy Committee, is a strong advocate for FBTs, but is also calling for change, believing that they should last for 10 years or more and benefit from the same tax reliefs as CFAs.
A period of transition
As a reminder, we are currently in what is known as the agricultural transition period. This marks a move away from the EU’s common agricultural policy to a new farm support system, the details of which are still unknown. From 2021, direct support payments under the BPS, which are currently paid based on the amount of land farmed, are gradually being reduced and will be phased out completely by 2027.
A new scheme in England, known as the environmental land management (ELM) scheme, is being developed as a replacement, based on sustainable land management and animal health and welfare improvements, as well as reduced carbon emissions.
There is a range of treatments of the BPS within an FBT. Where the BPS belongs to the tenant, there have been cases where the BPS has been greater than the rent, so the tenants are effectively farming the land for free. Alternatively, if the landlord retains the BPS, they receive a steady income, the land is looked after and the tenant can then enjoy cost-effective farmland, especially where economies of scale are available if they add this to other land.
However, with the removal of BPS, it is generally considered that rent for an FBT where the tenant owns the BPS will reduce over time. However, unlike Agricultural Holding Act 1986 tenancies, the rent for an FBT does not need to reflect what the holding is capable of earning. As such, it may be harder for these tenants to argue for an immediate rent reduction in line with reducing subsidies.
Fight for flexibility
Some advisers have suggested that FBT tenants could instead look to negotiate better terms to their tenancies, such as allowing more scope for diversification, succession, building usage, etc, rather than requesting a rent reduction. If the drafting of the FBT allows for flexibility – such as mechanisms to substitute provisions should the original provisions no longer be commercially applicable – this will clearly help both landlord and tenant navigate the tricky changes ahead.
APR and change
Generally, FBT tenants are not able to diversify into non-agricultural income streams because, by definition, they must be farming. Furthermore, with the majority of FBT terms averaging just three years, it is unlikely that tenants will invest in setting up new revenue streams, even those necessary to meet the new requirements of the proposed ELM scheme. From an inheritance tax (IHT) perspective, this is obviously a positive for landlords with regard to the availability of APR, particularly given that reliefs for let property are somewhat rare.
That said, the definition of ‘agriculture’ is difficult, especially when there are so many marginal activities in the changing landscape of farming. Even if tenants did carry out the required environmental activities under the new ELM scheme, would they be deemed ‘agriculture’ and still qualify for APR?
From the tenant’s perspective, the IHT position of FBTs holds little sway. The Tenant Farmers Association has long been trying to gain the ear of the government to review the taxation system, supported by Baroness Rock. In order to encourage FBTs with longer terms, it has been calling for 100% APR to be applied solely to FBTs with a life of 10 years. It will be interesting to see how this plays out.
Uncertain times
Landowners and farmers entering into FBTs will undoubtedly be concerned about the possible impact of the proposed ELM scheme, both in commercial and tax terms, given that details are evolving and will continue to do so over the next few years.
For landlords, particularly in relation to existing FBTs, the concern may be that there is no certainty that they will be able to get future rights to subsidies back at the end of the tenancy because the new terms introduced by the changes will not be referred to in the majority of agreements.
Landlords and tenants will need to adapt as the new ELM system evolves. The key is to draft agreements as flexibly as possible during such periods of rapid and significant change, to ensure that all parties with either existing or potential FBTs are protected.
There will be a need for an in-depth review of the interaction of the legal and tax considerations. With Tax Day 2021 proving silent on any potential changes to IHT and CGT reliefs, there could be a strong desire for many landowners to switch to CFAs to take advantage of the BPR that can be available if conditions are met. This would tie into comments of Baroness Rock calling CFAs and similar arrangements “thin façades of trading activity to gain tax advantage” and the need to give FBTs an equal playing field.
These are challenging times for the farming landlord and tenant alike, and there will be much concern about the legal protection and tax direction of the FBT. All tenancy agreements must be reviewed and updated as further clarity is gained to ensure they are still meeting both the commercial and tax goals, which will keep the professional farm advisers busy.
About the authors
Julie Butler FCA, Joint Managing Partner, and Libby James ACA CTA, Tax and Accounts Associate, Butler & Co