The Agricultural Weasel Problem
Farmers say that around 70,000 farms will be affected by the restrictions on inheritance tax relief in Rachel Reeves’ Budget. The government and their cheerleaders say it will only be a tiny minority, just a few hundred.
Who is right, and how do they get such widely different ‘facts’? The answer I think is a combination of the difficulty of trying to govern by statistics, a sadly too common lack of understanding of how the tax system works in practice, and a bit of abuse of language, especially a little weasel word that is being loaded (deliberately or otherwise) with more weight than it can support.
The Government Line
HMRC statistics suggest that only around 500 farms a year currently claim the Agricultural Property Relief (APR) exemption from inheritance tax on over £1 million of assets.
Since APR will still be given in full on the first £1 million, they assume that only those 500 will pay the tax once APR is restricted.
And, as has been pointed out by the government’s supporters, possibly not even all of them will have to pay, because some clever tax planning can reduce that number further.
That is the basis of the government’s claim, much repeated by its supporters. At first sight it looks like it has a sound basis in official statistics, but look more closely and it starts to look more dubious.
Generations
The first point is that inheritance tax happens roughly once a generation, so 500 a year means there are around 15,000 farms that can be expected to have to pay the tax.
For them it will be a huge problem. A viable farm needs a lot of land, and land values (on which inheritance tax will now be charged) are very high, but farms make very low profits. The inheritance tax bill can therefore be completely out of proportion to the profits generated by the farm to pay it. And this matters; 85% of farmers own all or some of their land, with purely rented farms only a small minority, so almost all farms will be having to pay inheritance tax on land that has a high value but which they cannot sell without harming the business.
On some calculations therefore, funding each inheritance tax bill could wipe out the entire future profits for that generation. That is unsustainable, and so farms will have to be broken up or sold.
And of course it is the real working family farms that will be hit by this, while the small uncommercial ‘hobby farms’ will mostly be protected by the £1 million exemption.
But 15,000 is still a lot fewer than the farmers’ estimate of 70,000. Where’s the difference?
Out of Date Statistics
One problem of trying to govern by statistics is that they are always out of date.
The government’s ‘500’ claim comes from HMRC’s inheritance tax statistics, which of course are for those farmers who have already died. But if the average farm size is growing (as economic pressures and increased mechanisation mean larger farms are needed to sustain a viable business), that is unlikely to have fed through yet to the older generation who have been dying off and appearing in HMRC’s statistics.
And the statistics (yes, another set of them) do suggest that this has happened; since 2000 the number of farms has fallen by about a third, while the total area farmed has remained fairly constant, in which case the average size of farm has grown substantially. This will mean that a much higher proportion of current farmers will be hit by inheritance tax than would have been the case for those, mostly older, farmers who have died in the last few years.
Complex Relief
Another problem is a lack of understanding (even, it seems, in the Treasury) of just how complicated these inheritance tax reliefs are.
Just because someone has a farm does not mean that it was exempt from inheritance tax. The definition of what qualified for Agricultural Property Relief is so convoluted that a lot of farm assets, and a lot of the value, did not qualify. However there is another inheritance tax relief, Business Relief (‘BPR’) which covers businesses in general, not just farms, and has a different definition of what assets qualify.
Some farm assets qualify for APR but not BPR, some qualify for both, some qualify for BPR but not APR, particularly since farms have been encouraged to diversify. Land used for grazing for a horse livery business, for example, or a barn used for non-free-range chickens, or rooms let for Bed & Breakfast, are common farm business assets that are unlikely to qualify for APR but might, depending on the circumstances, qualify for BPR. And there are complex valuation rules for APR that mean, even where a field qualifies, its full value might not. Also farm equipment does not qualify for APR but might for BPR, an important consideration when a combine harvester can cost £1 million.
On most farmers’ deaths therefore, the inheritance tax return is a hodgepodge of different reliefs – APR, BPR, the residence nil rate band, and others. But the Budget reforms restricted APR and BPR together, leaving just a single £1 million threshold to be shared between the two.
Farms with more than £1 million of assets therefore will not all show up in the statistics as claiming more than £1 million of APR. A farm claiming £900 thousand of APR and £900 thousand of BPR, for example, would not be one of the ‘500’, but at £1.8 million would be well over the new combined threshold and would see nearly half its value hit by a costly inheritance tax bill.
So from those same government statistics:
The roughly 400 farms a year claiming £500,000 to £1 million of APR are highly likely to be over the £1 million threshold, once BPR is included;
Of the roughly 400 other farms a year claiming £250,000 to £500,000 of APR, it is likely that many will be over the £1 million threshold once BPR is included, although this will depend on the type of farm (with some more machinery-intensive than others) and location (as to how much of the land value qualifies for APR).
Even some of the nearly 500 farms a year that claim under £250,000 of APR could actually be over the £1 million threshold, once BPR is included, particularly if they have followed government advice and diversified into related businesses that, although still rural and probably farming-related, do not meet the strict tax definition of ‘agricultural property’.
So the government’s ‘500 farms a year’ could easily be 1,200, at a rough guess. That would be something like 36,000 farms over a generation, which is over half way to the farmers’ estimate of 70,000. But where are the others?
The Weasel Word
I think the other affected farms are being hidden behind that little weasel word, “affected”.
A lot of commentators, and HM Treasury, calculate the number who might have to ‘pay’ the tax, but then switch to referring to that as the number who will be “affected” by it. But the two are not the same.
Even if only 15,000 farms a generation will have to pay inheritance tax (and, as we have seen above, it is likely to be more than that), many more still will be affected by it.
This is because anything handed on while the older generation are still alive isn’t subject to inheritance tax at the time. It only becomes taxable if the donor dies within seven years. So long as ‘grandad’ (or whoever) survives seven years, there is never any inheritance tax, with or without APR, and so those farms won’t show up in the much-quoted HMRC APR statistics.
But even if they still don’t have to pay any inheritance tax under the new rules, they will still be affected by it because of that 7-year rule.
Currently the younger generation doesn’t need to worry about inheritance tax, because even if there is a death in 7 years, most of the value will be exempted by APR. But it won’t be under the new rules. Instead the threat of inheritance tax hangs over the farm for seven years, in case the older generation dies within that time.
So what does the younger generation do, having been given the family farm? Worry for 7 years, knowing that everything you’re working for may be taken off you to pay a tax bill? Take out expensive life insurance that the farm can’t afford? Cut back on essential investment to keep money back to cover the potential tax?
Even if those families still don’t have to pay any inheritance tax under the new rules, they are still affected by it, and a death at the wrong time could flip them into a tax bill that, after the Budget, could lose them their farm, home and livelihood.
Yes, there is all sorts of planning that can be done, and it is interesting to hear government figures suggesting tax planning as a way to mitigate the harshness of their own reforms. Lifetime gifts are common (although they are difficult; thanks to the ‘gift with reservation of benefit’ rules, the older generation will often have to entirely give up their livelihood and home to qualify); husband-and-wife lifetime trust schemes were used in the past and may come back into fashion (but they are fiddly to operate, split up ownership of the farm, and of course rely on being married with a still-living spouse); partnerships can start to pass some of the value to the younger generation while also getting them more involved in running the farm (but that has to be a genuine partnership, and you don’t have to listen to The Archers to see the potential for intergenerational disagreements there); some farms incorporate and hand on shares in tranches (but the additional APR restrictions on farming companies makes that difficult); etc. etc. But tax planning is complicated and there are all sorts of traps that the ill-advised can fall into.
More importantly, all of that comes at a cost - not just professional and legal fees but also changing plans, awkward split ownership structures, and the time and effort to plan, implement and operate complex arrangements.
Who is affected
All of these seriously affect those farms, and their families, even if they still don’t actually have to pay the tax and so aren’t included in the government’s ‘500’ statistic.
For some, the result will be 7 years of stress and worry. For others, 7 years of underinvestment as they save to be able to cover an inheritance tax bill that might fall on them. For others it will be costly legal fees and the strain of operating a complex structure – with the risk of a huge tax bill if you get it wrong.
But in whatever way, all of these will be affected by the Budget’s tax changes, many significantly so. The government, and expert commentators, who should know better, should not be ignoring that.
500 or 70,000?
So how many farms will be affected by the Budget changes? Trying to put some rough figures on it:
the government’s much-quoted ‘500’ a year is really 15,000 a generation;
the APR/BPR split can easily take that up to something like 35,000;
ongoing farm consolidation, making HMRC’s statistics out of date, could add, say, 20% to that, taking it to 42,000 farms that are likely to have to pay the tax;
then the many others who, through lifetime gifts and tax planning, do not actually pay the tax but are still seriously affected by the costs of doing so and the hoops they have to jump through to escape it; if a third of farms are taking proper tax advice, that takes the total to 63,000 affected farms.
These are only rough figures, but they make the farmers’ estimate of 70,000 affected farms, arrived at from different but respectable data, look very reasonable. Certainly the true figure is much more likely to be around the 70,000 level than it is to be just 500.
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Richard Teather is a chartered accountant who, along with twenty years’ academic experience in tax law and policy, has advised businesses, business organisations and governments around the world.
The opinions expressed here are his own and do not necessarily represent those of any firm or organisation with which he is connected.
This blog post concerns the possible effects of tax reform and policy; it is not and should not be regarded as advice. Tax planning is highly complex and carries many risks, so should not be undertaken without specific, personalised advice.