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Tax Bulletin Special Edition - June 2005

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HM Revenue and Customs -Tax Authorities

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June 2005

Contents

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Introduction

This article sets out our views on the main points arising from the Single Payment Scheme. It has been prepared with the benefit of input from the National Farmers Union, the Institute of Chartered Accountants in England and Wales, the Institute of Chartered Accountants of Scotland, the Country Land and Business Association, the Agricultural Law Association and the Scottish Rural Property & Business Association. After giving briefly the background and an overview of the Scheme it deals in turn with:

  • income tax charges
  • the corporate intangible assets regime
  • capital gains tax
  • inheritance tax
  • value added tax

There is a glossary of the main terms used in the article at Appendix 1. Appendix 2 reproduces, with permission, guidance on accounting issues arising from the Single Payment Scheme.

During the process of analysing the EU regulations for the purposes of this article we had to contend with a reform that was still evolving and indeed is continuing to do so. As a consequence this article represents our view as at May 2005. In future months the most up to date position will be available within HMRC published guidance material as indicated at the commencement of each section.

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Background

The Common Agriculture Policy (CAP) of the European Union (EU) has undergone many changes in its lifetime. The latest reform package was finally agreed on 26 June 2003. The most notable change is the introduction of full decoupling. At the time of writing the decoupled Single Payment Scheme (SPS) will replace all of the following direct aid schemes but it is possible others will be added as time goes by:

  1. Arable Area Payments Scheme
  2. Beef Special Premium
  3. Dairy additional payments
  4. Dairy Premium
  5. Extensification Payment Scheme
  6. Hops Income Aid
  7. Seed Production Aid
  8. Sheep Annual Premium Scheme
  9. Suckler Cow Premium Scheme
  10. Slaughter Premium Scheme
  11. Veal Calf Slaughter Premium Scheme

It is worth noting that farmers who claim SP can also participate in other schemes including a range of agri-environmental schemes as well as new production linked schemes for energy crops, proteins and nuts.

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Overview of the reforms

Direct payments to farmers are no longer linked to production, hence the term "decoupled". In effect this means that a farmer can cease to produce agricultural products altogether and still receive financial support. However, in order to receive the full Single Payment (SP) farmers must comply with a series of standards, collectively called Cross Compliance conditions, that include a range of existing statutory management requirements in areas such as environmental, public, animal and plant health and animal welfare as well as aspects that cover good farming and environmental practice. Failure to comply can result in penalties ranging from nominal amounts to 100% of the SP in serious or deliberate cases.

There is a one off opportunity in 2005 to receive payment entitlement (PE). Subject to other conditions being satisfied, PE is expected to provide income support for the next 8 years. After 2005 anyone who has not established entitlement but wishes to receive SP will have to buy, lease or otherwise acquire PE from another farmer. PE will be fully tradable but only within a region (of which there are 6 within the UK, England having been divided into three separate regions).

Each single payment covers a calendar year. It is funded from savings made from the disbanded schemes and payments are subject to a number of reductions (modulation, national reserve, and financial discipline), the overall effect of which will likely increase over the period and hence result in a decrease in the annual value of the SP. While the basic governance of the scheme is found in EU regulations there is sufficient latitude within these to allow for regional variations in its implementation. The differences do not in our view affect the tax treatment. But for completeness and to aid understanding the UK variations are mentioned below:

The Welsh system is based solely on claims in the reference period. In other words, the claims that each farmer made during the reference period divided by the number of hectares (ha) declared in 2005 form the basis of the amount the farmer is entitled to per ha. As a result each farmer will have bespoke PE values.

Scotland adopted the same approach but reduced the SP of those that were beef producers in the reference period by 10%. This money will be used to fund the Scottish Beef Calf Scheme. This is a production related scheme but is subject to the same cross compliance conditions as the SP.

In England a flat rate payment system was selected, though its full implementation will be delayed until 2012. In the meantime there will be a sliding scale where an ever reducing part of the SP will consist of an historic component. Additionally, England has been divided into 3 regions, broadly corresponding to moorland, hill land and lowland with a different flat rate component paid in each. Farmers that have a claims history in the reference period and register in 2005 receive both a historic and a flat rate component to the SP. Those with no history and no national reserve entitlement that register a holding in 2005 will receive a SP consisting of the flat rate component only, though because of the sliding scale this will increase year on year until by 2012 this will be the whole of the SP.

Finally in Northern Ireland the system adopted is known as the "static vertical hybrid model". In short, the SP here consists of a historic and a flat rate component that will remain in the same proportions throughout.

The SPS has a number of features that mean payments may go to people other than those traditionally regarded as farmers. For example:

  • PE are tradable. Original allocations will generally go to tenants but landlords will, in principle be able to acquire them from tenants; and
  • the EU definition of farmer would allow someone to claim SP for grazing horses even though this may not be a farm in the traditionally accepted sense of the word.

There are a number of different types of PE that may be allocated to farmers. These include:

  • Ordinary PE to which are attached the basic terms and conditions.
  • Set aside entitlements: In addition to ordinary conditions, land must be set aside. These entitlements must be used before ordinary entitlements can be used.
  • Special entitlements: different conditions apply, notably there must be a continuing level of livestock production.
  • Authorised entitlements: allow farmers to grow negative list crops, broadly (soft) fruit, vegetables and potatoes.

To receive SP the farmer must first hold PE and then match each against an eligible hectare of land that is at the farmer’s disposal for a minimum consecutive period of 10 months. To secure full payment the farmer must also comply with a series of cross compliance conditions. With the exception of PE that was allocated from the national reserve as a result of special circumstances (in which case tighter restrictions apply) if PE is not used within 3 years it is taken to the national reserve.

It is worth noting that PE is not permanently linked to the land. For those with land it is one of the components that allow entry to the SPS. For example the PE may be matched against land owned by the farmer in year one and a different parcel of land in year 2, which could even be land rented in. If a farmer had more PEs than eligible hectares the farmer can keep all the PEs by rotating them as long as they are used at least once every 3 years. PEs may be sold or otherwise traded with or without land (the latter subject to certain restrictions). Note there is a requirement that when PE is being leased it is leased with land. But if the land were rented for 11 months at a time, the actual PEs leased with a particular field could change from year to year.

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The basic charge (Income Tax Issues)

The permanent HMRC guidance on the topic will be at BIM55125 onwards. This section explains our current (May 2005) view but you should refer to the permanent guidance for the latest information.

All SP receipts are chargeable to income tax (subject to the usual exemptions, for example, for charities). The basis of charge will depend on the circumstances under which they are received. It is worth being aware of these, as the differences in treatment can be significant.

Traditional farmer

The most straightforward situation is that of ordinary commercial farmers who continue to farm as they have for many years in that they grow and harvest crops and/or rear farm animals. This is what someone on the Clapham omnibus would call a farmer. Such a person continues to satisfy the statutory definition of farming for tax purposes and receives the subsidy for farming in accordance with the SPS rules. As a consequence sums receivable are chargeable as revenue trade receipts for income tax purposes.

SP without production

Under the SPS it is possible to receive an income without production by keeping the land in Good Agricultural and Environmental Condition (GAEC). Where there is no actual production then there can be no occupation for the purposes of husbandry and therefore no farming trade. Whether the farmer has actually ceased to farm for tax purposes will be a question of fact. One must look at the intention together with the evidence supporting the stated intention. There are several main possibilities.

First, where only part of the holding is no longer used for production then the farm as a whole will likely continue to be worked and the farming trade continue. Similarly, where there is no production on the whole of the farm but this is a temporary measure, for example while changes are being made, then HMRC will accept the farming trade continues. However, if a return or claim is made that production has ceased only temporarily, then HMRC would expect to see the farm infrastructure maintained.

Second, where there is a permanent cessation of all production then the trade will also have ceased. If there is no trade then the SP will be chargeable under Schedule D case VI or Chapter 8 of Part 5 of Income Tax Trading and Other Income Act 2005 (ITTOIA).

Third, there may be a new trade in place of farming. If there is no farming trade for tax purposes but it can be shown that the land occupied is still managed on a commercial basis and with a view to the realisation of profits then that occupation will still constitute a trade under s.53(3) ICTA 1988 or s.10 ITTOIA 2005. This is a different trade from farming. So, for example, if unused losses existed at the change then they would not be available to relieve against profits arising in the new trade. The onus will very much be on the land occupier to show that these conditions are satisfied and that trading status is consequently justified. However, where the person so asserting was previously a profitable commercial farmer then while the potential profitability of the activity will still need to be established, HMRC will make the presumption (rebuttable) that the farm will continue to be organised and run on a commercial basis.

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Non farmers

The simple receipt of SP is not evidence that a person is carrying on a trade of farming for tax purposes. The difference between the way entitlement to SP is defined and the way farming is defined for tax purposes needs to be appreciated. For example, land that is used for grazing horses or ponies kept for the leisure purposes of the SP recipient is eligible for the SP provided all the other conditions are satisfied. If the occupier keeps the land in GAEC then SP may be received. But that does not mean a trade is being carried on. In these cases the charge to tax will arise under schedule D case VI or Chapter 8 of Part 5 of ITTOIA 2005.

In summary, SP may be taxable under:

  • schedule D case I or s.9 ITTOIA 2005 (farming),
  • schedule D case I or s.10 ITTOIA 2005 (non farming trade), or
  • schedule D case VI or Chapter 8 of Part 5 of ITTOIA 2005 (non-trading).

Accountancy treatment

Following consultation with HMRC the Institute of Chartered Accountants of Scotland and the Institute of Chartered Accountants in England and Wales have published guidance for their members on accounting issues arising from the SPS. This has been reproduced, with their permission, at Appendix 2. It explains the accounting principles that need to be applied to the recognition of SP in farmers' accounts.

Deductions

The basic rule for the deduction of expenses against the SP for a trade is the same regardless of the statute under which the charge is raised and is laid down in s.74 ICTA 1988 and Chapter 4 of Part 2 of ITTOIA 2005. (In practice the same rule also applies, so far as relevant, for non-trading SP income under Case VI and Chapter 8.) In broad terms, no expense is allowed unless it is laid out wholly and exclusively for the purposes of the trade. The problem here is where there is an alternative purpose such as keeping ponies or horses for leisure purposes then by definition there is dual purpose and expenditure will fall to be disallowed. If it can be shown additional expenditure has been wholly and exclusively laid out to secure the SP then such can be set off to reduce the tax charge but this is likely to be rare.

The SPS provides for the imposition of penalties where the farmer fails to comply with the cross compliance conditions. However, because they are imposed by restriction on the SP payable there should never be a need to include a penalty as a deduction in the accounts. Even in the rare circumstances where SP has been paid out and a restitution claim is lodged by the department administering the SP and the accounts have been signed off then the appropriate means of dealing with this would be by prior year adjustment.

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Farming: stock valuation: BEN 19

Following representations it has been decided not to revoke BEN 19, but to monitor its relevance. However, it is worth noting that the SP, with the exception of the Scottish Beef Calf Scheme (SBCS) is not linked to any particular crop, product or expense and should not be taken into account in any calculation of the cost of stock. The SBCS element should be accounted for in accordance with BIM55430.

Leasing

Where PE is leased by one person to another the EU regulations specify that it must be accompanied by an equivalent portion of land. The correct analysis points to the income for the land being chargeable under Schedule A or Part 3 of ITTOIA 2005 and the income for the PE under schedule D case VI or Chapter 8 of Part 5 of ITTOIA 2005. Where agreements do not specify the rental amounts appropriate to each it will be necessary to apply an apportionment based on market values.

In situations where PEs are handed over to landlords for nil consideration under the terms of a lease then, depending on the circumstances of the handover, there may be a premium charge arising under s.34(5) ICTA 1988 or Chapter 4 of Part 3 of ITTOIA 2005.

Corporate Intangible Assets regime

Where it is correct under generally accepted accounting practice for a company to recognise PEs as intangible fixed assets and the company is subject to corporation tax the intangible assets regime (Schedule 29 FA 2002) will determine their treatment for the purposes of corporation tax. Where PE is acquired for continuing use in the business we would expect it to be accounted for as an intangible fixed asset. Options to acquire or sell PEs should also be dealt with by the intangible assets regime, so long as the PE would be a fixed asset of the business.

Where PEs have been granted for no consideration then there will be no expenditure to be taken into account under the intangible assets regime as the cost of acquiring the asset.

Where PEs are held as intangible fixed assets then SP receipts arising from those PEs will be taxable credits within the regime.

Where previous quota which were within the regime have come to an end, and so are no longer recognised in the accounts, there will have been a realisation of the assets which may give rise to an allowable debit within the regime.

On the disposal of PEs within the regime the company may be able to make a roll-over claim into another asset within the regime. Similarly a gain on realisation of other assets within the regime may be able to be rolled over into the acquisition of PEs within the regime.

Further information about the intangible asset regime for companies can be found in the Corporate Intangibles Research and Development Manual on the Inland Revenue website.

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Capital Gains Tax (CGT)

The permanent HMRC guidance on the topic will be incorporated in the CG Manual. Gains arising from transactions in PE will be chargeable to capital gains tax following normal capital gains rules in the Taxation of Chargeable Gains Tax Act 1992 (TCGA).

As noted already, PE held by a company chargeable to Corporation Tax will be an intangible asset for the purposes of Schedule 29 Finance Act 2002.
What is the asset?

PE is a chargeable asset for capital gains purposes. In relation to an originating statutory claimant PE came into existence on 1 January 2005, the date from which SP became payable. PE is not linked to a particular parcel of land and does not form part of the land for capital gains purposes. As it is a separate asset that was not derived from any pre-existing asset its base cost is nil in relation to an originating statutory claimant.

PE is not a wasting asset within the definition of section 44 TCGA. A wasting asset is one with a predictable life of less than 50 years at the time of acquisition and currently there is no clarity as to whether the SPS will be renewed in 2012 or not.

Transactions carried out before 1 January 2005 involving a disposal of a future entitlement to PE will be treated as a disposal of an asset in the form of a right to future PE rather than a disposal of PE itself.

When is PE a business asset for capital gains purposes?

Whether PE is a business asset for capital gains purposes will depend on the facts of each case. Broadly, if the income from PE is charged to income tax as the profits of a trade under sections 9 or 10 of ITTOIA 2005 then PE is likely to be a business asset for capital gains purposes.

A right to future PE existing before 1 January 2005 is a non-business asset for capital gains purposes. Composite transactions involving the disposal of farming land and a right to future PE entered into before 1 January 2005 must be treated as separate disposals in relation to the land and the right to future PE for the purposes of calculating chargeable gains or allowable losses.

Transfers of PE to landlords at undervalue

Where, under the terms of a tenancy agreement, a tenant transfers PE to a landlord at undervalue, the market value of the PE should generally be substituted for the disposal proceeds in accordance with sections 17 and 18 TCGA where the parties are either connected or are acting otherwise than at arm’s length.

There may be occasions when an agreement to transfer PE at undervalue is a genuine arm’s length transaction, for example where the tenant has no interest in receiving SP and is not conferring a gratuitous benefit on the landlord. It would not be necessary to substitute market value for the actual consideration in these cases. Whether or not a case falls into this category will depend upon the individual facts.

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Roll-over relief

Where PE is used for the purposes of an unincorporated trade which is subject to income tax (broadly speaking, a farming trade or a trade based on the occupation of land) acquisitions and disposals of PE from 22 March 2005 will be eligible for roll-over relief under sections 150 - 154 TCGA. The Finance Act 1993, Section 86(2), (Single Payment Scheme) Order 2005 introduced a new class of asset, Class 7A, "Payment entitlements under the single payment scheme" to which roll-over relief applies under section 155 TCGA.

Hold over Relief

Hold over relief under section 165 TCGA will be available where the PE transferred is used for the purposes of an unincorporated trade.

Taper relief

The normal taper relief rules will apply to disposals of PE, depending on the use to which the PE is put. PE used for the purposes of an unincorporated trade (see above) will be a business asset under paragraph 5 Schedule A1 TCGA for taper relief purposes. For a farmer who is allocated PE on the basis of their historic subsidy record, the holding period begins from 1 January 2005.

Other subsidies

Quotas that ceased before 1 January 2005 are now worthless and negligible value claims may be made. A negligible value claim may result in an allowable loss available to set against chargeable gains of the same or a later tax year where the quota had been acquired on purchase.

Milk quota, though subject to review continues to exist and, as for PE, it is not a wasting asset under section 44 TCGA because it is not possible to say that milk quota has a predictable life of less than 50 years.

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Inheritance Tax (IHT)

General

The permanent HMRC guidance on this topic will be incorporated in the IHT manual.

As with CGT, PE is subject to the normal IHT rules. So the following references to "transfers" include the most common occasion when an IHT charge arises, i.e. the transfer that is deemed to take place on death, where the value transferred at that time for IHT purposes is equivalent to the value of the deceased’s estate immediately before death.

Transfers before 1 January 2005 of a farming business, or an interest in a farming business, whose value reflects the expectation of future PE should be valued for IHT purposes with the benefit of that expectation. Transfers of PE on or after 1 January 2005 (whether before or after actual establishment) are liable to IHT as any other asset.

Agricultural Property Relief (APR)

APR can apply to "agricultural property" only. This is defined in section 115(2) IHTA 1984 as agricultural land or pasture (including woodland and certain agricultural buildings). So PE itself, being an asset which is separate from land, cannot qualify for APR. (This will of course not affect the availability of APR for any other asset which does qualify as "agricultural property".)
APR applies to agricultural property which has been either occupied by the transferor for agricultural purposes for the two years immediately before the transfer, or owned by the transferor throughout the seven years immediately before the transfer and throughout that period has been occupied for agricultural purposes whether by the transferor or by another (section 117 IHTA).

Agricultural land which is taken out of production can still qualify for APR (including GAEC land) because section 117 IHTA does not require the land to be in production either continuously or at a specific time (though there must be an intention or expectation that the land will be back in production at some time in the future). So, for example, agricultural land set aside to rotational, or even permanent, fallow can still qualify as agricultural property within the definition of section 115(2) IHTA 1984 and as occupied for the purposes of agriculture within the meaning of section 117 IHTA.

Land used for grazing leisure horses does not satisfy the "occupied for the purposes of agriculture" test and so cannot qualify for APR.

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Business Property relief (BPR)

Land which formerly qualified for APR but which no longer does so (for example, because it ceases to be occupied for agricultural purposes) may nonetheless qualify for BPR if it is an asset of a trading business which satisfies the normal conditions of the relief.

BPR is available for transfers of "relevant business property" which the transferor has owned as such throughout the two years immediately before the transfer. "Relevant business property", which can qualify for BPR at 100 per cent, includes certain categories of business (or an interest in a business, for example a partnership interest) and some types of shares and securities. So in the normal case where the transferor is a farmer who has been farming for at least two years, PE (whether in expectancy pre-1/1/05, or on or after that date regardless of whether PE has actually been established) will qualify for 100 per cent BPR as an asset of the business, on the assumption, which will normally be the case, that the resulting payment will be used in the business or be required for future use in the business. PE will still qualify for BPR where the owner has put farmland out of production, for example into set-aside in order to receive SP, provided the farmer is still carrying on a business on a commercial basis, and provided the nature of the business remains essentially that of a trading concern rather than one that consists of dealing in land or making or holding investments.

As with any asset, the transfer of PE by someone who is not carrying on a trading business will not qualify for BPR. Similarly, the transfer of PE as an individual asset, rather than the business itself, or an interest in the business, will not qualify for BPR.

Valued Added Tax (VAT)

The permanent HMRC guidance on the topic will be incorporated in the V series of the VAT guidance.

The Single Payment does not represent consideration for any supply between the farmer and the state and is, therefore, outside the scope of VAT. However, as PE is transferable either with land or on its own, there are situations in which a VAT liability will arise.

If PE is sold without land then VAT will be due at the standard rate on the sale. If PE is transferred with the underlying land in a leasehold arrangement, the PE will follow the liability of the land transfer, provided the acquisition of the land is the principal driver behind the transaction. Where PE and land are sold together as part of a single transaction, the VAT liability will depend upon the actual circumstances of the sale but it is likely that two supplies will be seen, each with their own liability. It is advisable that the vendor consults with the National Advice Service (0845 010 9000) to confirm the VAT treatment of the transaction at the earliest opportunity.

Where a farm business is sold, including the PE, to a new owner who intends to carry on the farming business, then the sale may treated as the Transfer of a Going Concern (TOGC) provided all the relevant conditions are met. If the sale fails to qualify for TOGC treatment then the sale of the PE will be taxable as described above.

Where the SP is the only income received, and the farmer has no intention of pursuing taxable business income, there will be no entitlement to VAT registration with the knock-on effects that no input tax can be recovered and any VAT registration will be cancelled.

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Appendix 1 - Glossary of Terms

Agricultural Property. Agricultural land or pasture and includes woodland and any building used in connection with intensive rearing of livestock or fish if the woodland or building is occupied with agricultural land or pasture and the occupation is ancillary to that of the agricultural land or pasture; and also includes such cottages, farm buildings and farmhouses, together with the land occupied with them, as are of a character appropriate to the property.

Cross Compliance Conditions. These set out standards and requirements that farmers have to meet as a condition of receiving their Single Payment. They are divided into:

  • Statutory Management Requirements (SMR), involving compliance with a range of European regulatory requirements covering the environment, food safety, animal and plant health and animal welfare, and
  • Good Agricultural and Environmental Conditions (GAEC). These are a set of requirements developed by individual member states and vary slightly between England, Scotland, Wales and Northern Ireland.

Farmer. For SP purposes this is defined in Regulation (EC) No 1782/03 as someone who exercises an agricultural activity and this covers all the usual farming activities but also keeping the land in good agricultural and environmental condition. The definition should also be taken to include growers of fruit and vegetables.

Farming. For income tax purposes this is defined as the occupation of land wholly or mainly for the purposes of husbandry, but does not include market gardening which has a separate definition.

Financial Discipline. The process by which from 2007 EU Farm Ministers will determine what percentage reductions are required to keep EU spending within budget.

Historic Basis. The method used to compute the value of PE based on the average of actual claims during the reference period of the person farming.

Modulation. The mechanism whereby a percentage of direct aid (subject to a lower threshold limit) is removed and recycled into Rural Development spending. UK regions will be subject to EU compulsory and member state voluntary modulation.

National Envelope. Is a sum of money taken from the reference amount and set aside to support a particular sector of farming. The only region to use the national envelope is Scotland and it is used there to support the beef industry.

National Reserve. As a consequence of the transition to the Single Payment, farmers in certain situations may find themselves at a disadvantage for a variety of reasons. The National Reserve, funded by a percentage cut in all farmers’ PE is a fund used to supplement PE to those disadvantaged or allocate PE to new entrants.

Negative list crops. The negative list crops are strictly the products referred to in Article 1(2) of Regulation (EC) No 2200/96 and potatoes, other than those intended for manufacture of potato starch. In this article the term has been used to denote fruit, vegetables and potatoes (fvp).

Payment Entitlement (PE). PEs are a requirement to participate in the SPS. They do not grant any automatic right to payment. A farmer with PE applying to join the SPS is further obliged to satisfy certain conditions before payment can be made and indeed full payment is subject to cross compliance. There a number of different types or 'flavours' of entitlement. The basic or ordinary PE is amended to become:

  • Set aside entitlement. Must be used before other entitlement. Land used to meet set aside entitlement must be withdrawn from agricultural production, including grazing for the duration of the set-aside period and be managed in accordance with the set-aside management rules. Organic farmers are exempted.
  • Special entitlement. Are given to farmers with no eligible land or if the PE (arising from certain of the historic schemes) is more than 5000 euros. Unlike ordinary entitlements, special entitlements have a production criterion.
  • Authorised entitlements. Are allocated to farmers who have grown negative list crops in the reference period and allow SP to be paid when land is used for growing fvp.

Reference Period. The 3 year period consisting of calendar years 2000 to 2002.

Region. A geographical area within the EU within which the SPS is administered. There are 6 in the UK. Scotland, Wales and N. Ireland are one each and England has been divided into 3. Land already categorised as severely disadvantaged (SDA) above the moor line, SDA below the moor line and the rest.

Regional Average or Flat Rate basis. The method used to compute the value of PE based on the average of claims made by all farmers within a member state in the reference period divided into the total area registered in 2005.
Single Payment (SP). A payment to farmers under the Single Payment Scheme.

Single Payment Scheme (SPS). The Single Payment Scheme introduced by EU regulation 1782/2003.

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Appendix 2 - Guidance On Accounting Issues Arising From The Single Payment Scheme

Guidance on accounting issues arising from the Single Payment Scheme, issued in May 2005 by The Institute of Chartered Accountants of Scotland and the Institute of Chartered Accountants in England and Wales.

This Technical Release provides general guidance and does not purport to deal with all possible questions and issues that may arise in any given situation. No responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this guidance can be accepted by the Institutes.

Introduction

  1. The purpose of this Technical Release is to set out guidance on accounting issues arising from the:

Single Payment Scheme (SPS) (Footnote 1)

This Technical Release (Footnote 2) reflects the law at 29 April 2005 and accounting standards (Footnote 3) in issue at that date.

The Common Agricultural Policy

  1. The basic principles on which the Common Agricultural Policy (CAP) was built were set out in the Treaty of Rome in 1957. From the mid 1960s and throughout the 1970s financial assistance was provided for the restructuring of farming and to subsidise production. By the 1980s, the EU had to contend with almost permanent surpluses of major farm commodities. As a result, in the 1990s, important reforms were agreed which involved reducing support prices and compensating farmers by paying them direct aids. Production limits helped reduce surpluses. Farmers had to look more to the market place, while receiving direct income aid, and to respond to the public’s changing priorities. This shift of emphasis in the CAP entered a new phase with agreement in 1999 on the so-called 'Agenda 2000' reforms.
  2. The SPS is part of the CAP Reform arrangements that were agreed in June 2003. The SPS will be subject to a review in 2007. It is possible that it may then be extended or amended. It is always a possibility that a new subsidy scheme may be introduced or subsidies dropped altogether.

The Single Payment Scheme

  1. The new regime provides for a Single Payment (SP) to replace most existing farm subsidy schemes.
  2. Unlike the previous subsidy, the SP is de-coupled in that payment is not dependent on the farmer maintaining any specified level or type of production. However, in order to receive the full payment, the farmer will have to meet a number of Cross-Compliance conditions which include specified environmental conditions and animal health and welfare standards.
  3. The operation of the SPS will differ slightly in the separate jurisdictions of

Scotland, England, Wales and Northern Ireland (Footnote 4), but is sufficiently similar for the accounting implications to be addressed in this single guidance statement (Footnote 5).

  1. Eligible farmers will be able to establish entitlements to the SP using forms circulated in spring 2005, thus essentially receiving an intangible asset known as the Payment Entitlement (PE). Once definitively established (at around the turn of the year), the PE will be tradeable (subject to restrictions) and can be sold or leased. There will be various classes of entitlement, with differing rates of payment within each class.
  2. The period to which an SP claim relates follows the calendar year from 1 January to 31 December. Payments are expected to be made within the period from 1 December in the year of claim up to 30 June in the following year.

9. A farmer’s entitlement to the SP needs to be formally established by application by 16 May 2005. (Claims will be accepted up until 10 June 2005 but will be subject to late claim penalties.) It is only when all entitlements have been established that the actual value of each entitlement will be calculated and notified to farmers.

10. A farm becomes entitled to the SP for a calendar year if:

  1. a claim is made by 15 May in the year of claim (except where this date falls on a weekend);
  2. the PE and the qualifying farm land are held for the whole of a chosen basis period (of at least ten months) – the Eligibility condition; and
  3. the specific qualifying conditions relating to the care of the land, animal husbandry etc are maintained for at least the chosen ten month basis period and for any additional period in which the land is available to the farmer in the calendar year of claim – the Cross- Compliance conditions.

11. The ten month basis period can commence at any time between 1 October prior to the year of claim and 30 April within the year of claim: if the farmer does not elect a specific period, the basis period is taken to run from
1 February to 30 November in the year of claim. It is not possible to have an overlap of chosen basis periods for two consecutive years of claim. The farmer cannot elect to have different ten month periods for different parts of the farm. There must be a common period applied to the whole farm.
[In cases where the farm includes land taken in let, a recent change to the legislation has been made at EU level. It is understood that farmers who use rented land can elect to divide the farm into two parcels and have a different ten month basis period for each. The Scottish Executive has indicated its intention to implement this change in 2005 and it is anticipated that it will be implemented in the other jurisdictions in 2006. An update to this Guidance Note will be issued once more details of the amendment to the legislation have been ascertained and the accounting implications assessed.]

12. Failure to comply with the Eligibility condition would result in a total loss of SP, although it should be noted that failure to occupy part of a holding would lead to a loss of subsidy only on that proportion of the claim. Failure through negligence to comply with any of the Cross-Compliance conditions would normally be dealt with by a reduction in SP of between 3 to 5%, building to 15% for repeated non-compliance. This penalty may be reduced to 1% where minor breaches have been identified. The authorities may decide to issue a warning letter for only very minor and technical infringements. Intentional non-compliance would result in a minimum 20% reduction to the SP (although a penalty could be reduced to 15% in less serious non compliance) and may even result in exclusion from the SPS the following calendar year. In extreme cases, eg gross animal cruelty or deliberate use of land for an environmentally destructive activity, it is possible that the whole SP might be lost, or required to be returned. In addition, it should be noted that enforcement agencies may also consider pursuing criminal action in cases of serious non-compliance where Cross-Compliance standards are reflected in law.

13. Non-compliance with the Eligibility and Cross-Compliance conditions will be identified at inspections by various bodies (Footnote 6). Although the inspection regimes are still under development at the time of writing, it is understood that:

  1. approximately 5% of farms will be inspected each year in relation to satisfying the Eligibility test (ie re the ten month basis period);
  2. approximately 1% of farms will be inspected each year on each relevant aspect of the Cross-Compliance conditions (by the relevant authority for each condition), although reported non-compliances identified via inspections undertaken by the various enforcement agencies (outside of the 1% selection) might also incur cross-compliance penalties;
  3. both inspection regimes will be risk based;
  4. any non-compliance with the Cross-Compliance conditions discovered during an inspection will result in application of a penalty for that year of claim. Other than for serious non-compliance, penalties are unlikely to be applied retrospectively;
  5. any penalty arising from non-compliance with the Cross-Compliance conditions will be applied to the whole of the farm’s claim and not only in relation to the acreage subject to the non-compliance.

14. It is therefore unlikely that an inspection will be made of an individual farm in any one year of claim. If an inspection does take place, this might occur during the chosen ten month basis period or at some other time during the SP year of claim. If the SP had already been paid for the year of claim and the qualifying conditions were found not to have been met, there would be some clawback of the appropriate part of the amount of SP paid.

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Recognition of SP income

SSAP 4

15. In the UK, accounting for government grants is governed by SSAP 4 "Accounting for Government Grants". Paragraph 23 requires that, if a grant is made to finance the general activities of an enterprise over a specific period (as the SP is), it should be recognised in the Profit and Loss Account of the period in respect of which it is paid. However, paragraph 24 requires that SPs should not be recognised in the Profit and Loss Account until the conditions attached to the grant have been complied with and there is reasonable assurance the grant will be received.

Triggering recognition

16. SSAP 4 requires that recognition does not take place until there is both compliance with the relevant conditions for receipt of the SP and reasonable assurance as to receipt.

17. The conditions are set out in paragraph 10 above. Condition (a) is necessarily satisfied first. Condition (b) is satisfied at the end of the chosen ten month basis period. Condition (c), in theory, could be regarded as not satisfied until the end of the year of claim, or the end of the basis period if later. Therefore, under a strict application of SSAP 4, the conditions might only be said to have been satisfied at the later of:

  • midnight on 31 December in the year of claim; and
  • the end of the chosen ten month basis period.

18. However, it is difficult to ascertain when compliance by a farmer with the Cross- Compliance conditions could be said to be reasonably certain. It has been suggested that most of the Cross-Compliance conditions are manageable and achievable for the majority of farms and, indeed, these will normally be complied with as a matter of course. Moreover, it is understood that less than 10% of farms will be subject to inspection in any one year of claim. Therefore, for the vast majority of farms not subject to inspection in the year of claim, admission of non-compliance will essentially be voluntary:

  1. in the main, farmers will be unaware of unintentional non-compliance (by definition), unless this is identified by them, their advisers, accountants or auditors, or other third parties during the course of the year. If the farmer reports such non-compliance, then the appropriate penalty will be suffered (3 to 5% of the SP for that year, possibly rising to 15% for repeated unintentional non-compliance);
  2. in cases of intentional non-compliance, it would seem unlikely that farmers would wish to report this to the authorities or to their accountants or auditors and, in the absence of an inspection or the discovery of non-compliance by the accountants or auditors or other third parties, this would be likely to remain undiscovered.

19. Furthermore, other than in cases of major intentional non-compliance, subsequent inspections are unlikely to result in penalties being applied retrospectively. Even after the end of the calendar year of claim or the ten month basis period, if later, it is possible that unintentional non-compliance which had existed during the year of claim may subsequently be discovered. For a diligent and honest farmer, however, the penalties for any such non-compliance subsequently discovered are unlikely to be applied retrospectively.

20. For practical purposes, it would therefore be the case that, once the ten month basis period had been completed, the Cross-Compliance conditions could be assumed to be satisfied for a year of claim unless:

  1. an inspection has taken place during the ten month basis period (or any part of the calendar year of claim prior to that ten month period) and discovered non-compliance; or an inspection has taken place (or is to take place) before the end of the calendar year of claim if this is later than the end of the ten month basis period; or
  2. there is other evidence of non-compliance.

21. Given the likely achievability of the Cross-Compliance conditions and the limitations of the inspection and penalty regimes, condition (c) does not seem to be significant to the timing of the recognition of the SP or for determining the amount recognised.

22. Accordingly, it is recommended that the trigger for recognition of the SP should be the end of the ten month basis period for the year of claim.

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Recognition of SP

23. SSAP 4 requires the SP to be recognised in the Profit and Loss Account of the calendar year in respect of which it is paid. Unless some other basis seems more appropriate, this would be recognised evenly on a time basis. [Example 1 in Appendix B illustrates a simple case – where, by the end of both the financial year and the calendar year, the conditions for receipt of the grant have been met and there is reasonable assurance that the grant will be received.]

24. However complications arise where the conditions are not met until after the end of the financial year. The question then arises as to whether the SP should be recognised in the accounting period during which the ten month basis period ends or whether it should be recognised in the calendar year to which it relates.

25. Paragraph 24 of SSAP 4 is quite clear in stating that"…a government grant should not be recognised in the profit and loss account until the conditions for its receipt have been complied with…". Under FRS21 "Events after the Balance Sheet Date", events that provide evidence of matters that existed at the balance sheet date are adjusting events and the entity should adjust the amounts recognised in its financial statements or recognise items that were not previously recognised. The relevant condition for receipt of the SP is to hold the land for the whole of the chosen basis period, and the situation at the balance sheet date was that this condition for receipt had not yet been complied with.

The end of the ten month period is therefore not an adjusting post balance sheet event. [See Example 2 in Appendix B.]

26. If a farmer retains the same basis period and accounting period each year, each set of annual financial statements will include 12 months of SP.

27. However, an anomaly can arise when the farmer changes the ten month basis period, with two years of SP being recognised in the same financial statements. [See Example 3 in Appendix B.] This situation gives rise to questions as to the consistency of accounting treatment and whether the financial statements for the years affected actually give a true and fair view. Paragraph 15 of FRS 18 "Accounting Policies" states that "…if in exceptional circumstances compliance with the requirements of an accounting standard…is inconsistent with the requirement to give a true and fair view, the requirements of the accounting standard…should be departed from to the extent necessary to give a true and fair view…". The general understanding is that the true and fair override should only be used to override an accounting standard in the special circumstances of an individual entity that has a different situation from most other entities. Paragraph 16 of FRS 18 states that "an entity will not depart from the requirements of an accounting standard…where a true and fair view can be achieved by additional disclosure". Therefore, other than in exceptional circumstances, the matter should be dealt with by complying with SSAP 4 and making appropriate disclosures in the notes to the accounts.

Provision for Non-Compliance with the Cross-Compliance conditions

28. Once recognition has been triggered, 100% of the SP for the year of claim should be recognised as receivable. Given the nature of the Cross-Compliance conditions and the limitations of the inspection and penalties regimes, it would normally be acceptable for 100% of the SP to be recognised as receivable at the end of the ten month period, even if this occurs before the end of the calendar year of claim.

29. Recognition should only be deferred where there are reasons for believing that the farmer will not be able to comply with the conditions attached to the grant.

30. Any provision to repay the grant (in whole or in part) should only be established to the extent that repayment is probable.
Early Receipt of SP

31. Paragraphs 6 and 27 of SSAP 4 address the circumstances where the SP has been received by the farmer prior to the accounting year end. If the accounting year end is prior to the end of the ten month basis period, then the SP received would need to be carried forward in the balance sheet as deferred income/creditor until the end of the ten month period. If the accounting year end is after the end of the ten month basis period, the SP received would be recognised in the Profit and Loss Account (on a time basis) and any provision to repay the grant (in whole or in part) should only be established to the extent that repayment is probable.

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Recognition of the PE as an Asset

Initial Recognition

32. The PE is an intangible asset which is created by the filing of the first claim after 1 January 2005. This entitlement would appear to have a useful life whilst the SPS is in operation as described here or if some other subsidy regime is introduced with qualification based on previous SP eligibility (Footnote7).

33. FRS 10 "Goodwill and Intangible Assets" covers the accounting treatment of intangibles and defines them as non-financial assets:

a) with no physical substance;
b) which can be separately identified; and
c) which can be controlled by the entity through legal or custody rights.

FRS 10 specifically includes licences and quotas in its definition of intangible assets. A PE is similar to these, which indicates that it should be regarded as an intangible asset.

34. It is not clear whether FRS 10 would regard the PE as a "purchased" or an internally developed intangible asset, as it shows characteristics of both. A purchased intangible asset should be capitalised at cost or, if acquired as part of an acquisition of a business, at fair value (based on a readily ascertainable market value). If the PE is deemed to be "purchased", then the "purchase" cost is zero.

35. An internally developed asset may be capitalised only if it has a readily ascertainable market value (FRS 10 paragraph 14). FRS 10 defines such a market value as being where:

a) The asset belongs to a homogeneous population of assets which are equivalent in all material respects; and
b) There is an active market, evidenced by frequent transactions for that population of assets.

In that event the credit side of the double entry would be to deferred income, in accordance with SSAP 4, and this deferred income would subsequently be amortised to the profit and loss account for each year over the period to 2012 on the same basis as the amortisation of the intangible asset (and these would therefore cancel out to zero).

36. Criterion (a) is satisfied but it is unlikely that criterion (b) could be satisfied at the inception of the SP scheme.

37. On this basis, the PE should not be recognised as an asset (or should be recognised at nil cost).

Purchase of a PE at a subsequent date

38. If a PE is purchased at a subsequent date, it would normally be carried at cost in the balance sheet under intangible fixed assets. Fixed assets are defined in the Companies Act as "assets…which are intended for use on a continuing basis in the company’s activities". Therefore the PE will be held as a fixed asset if it is intended to be held so as to match with eligible land and generate entitlement to annual SP. Although not addressed by FRS 10, if the PE is merely held for transitional reasons or for trading, it would be
recognised as a current asset at the lower of cost and net realisable value.

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Revaluation

39. A PE held as a fixed asset may be revalued if it has a readily ascertainable market value. In such cases, the revaluation would be taken to an intangible asset revaluation reserve. Any transfer from this reserve to the Profit and Loss Account Reserve by way of amortisation or on disposal, would be by way of transfer between reserves and would not impact on the Profit and Loss Account.

Amortisation and Impairment

40. If the PE is not initially recognised as a fixed asset, amortisation is not an issue. However, if the PE is initially recognised as a fixed asset or if a farmer purchases a PE as a fixed asset, then this will become a matter for consideration.

41. FRS 10 requires that an intangible asset must be amortised over its useful life (a period of up to 20 years) or be subject to annual impairment reviews. The initial carrying value or purchase price of the PE would therefore need to be amortised on a straight line, or some other more appropriate basis, over the period from inception or date of purchase to the end of the asset’s useful life or, if sooner, the termination of the SPS.

42. However, if the farmer’s circumstances changed such that land to support an SP claim is no longer held, then the carrying value of the PE should be reviewed and, if appropriate, an impairment write down made.

Disposal

43. On disposal of a PE obtained as a result of the filing of the first claim after 1 January 2005, a profit or loss on sale would arise representing the difference between the sale proceeds and the book value (ie nil or amortised initial carrying value) at the date of sale.

44. On disposal of a purchased PE, a profit or loss on sale would arise representing the difference between the sale proceeds and the book value (ie the amortised purchase cost) at the date of sale.

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Appendix A - Legislation

The general rules for the operation of the SP Scheme are laid down in European Council (EC) Regulation 1782/2003 and Commission Regulations 2237/2003, 795/2004 and 796/2004.

The implementing legislation in the UK at 29 April 2005 is as follows:

 
Scotland  
SI 2004 No 518 The Common Agricultural Policy Schemes (Cross-Compliance) (Scotland) Regulations 2004
SI 2005 No 218 The Common Agricultural Policy Single Payment and Support Schemes (Integrated Administration and Control System)
Regulations 2005
SI 2005 No 143 The Common Agricultural Policy Single Farm Payment and Support Schemes (Scotland) Regulations 2005
SI 2005 No 117 The Agricultural Subsidies (Appeals) (Scotland) Amendment Regulations 2005
 
England  
SI 2004 No 2689 The Common Agricultural Policy Single Payment and Support Schemes (Appeals) (England) Regulations 2004
SI 2004 No 3196 The Common Agricultural Policy Single Payment and Support Schemes (Cross-Compliance) (England) (Regulations) 2004
SI 2004 No 3385 The Common Agricultural Policy Single Payment Scheme (Set-Aside) (England) Regulations 2004
SI 2005 No 218 The Common Agricultural Policy Single Payment and Support Schemes (Integrated Administration and Control System) Regulations 2005
SI 2005 No 219 The Common Agricultural Policy Single Payment and Support Schemes -Regulations 2005


 
Wales  
SI 2004 No 3280 The Common Agricultural Policy Single Payment and Support Schemes (Cross-Compliance) (Wales) (W284) (Regulations) 2004
SI 2005 No 45 (W4) The Common Agricultural Policy Single Payment Scheme (Set-Aside) (Wales) Regulations 2005
SI 2005 No 218 The Common Agricultural Policy Single Payment and Support Schemes (Integrated Administration and Control System) Regulations 2005
SI 2005 No 360 (W29) The Common Agricultural Policy Single Payment and Support Schemes (Wales) Regulations 2005


 
Northern Ireland  
SR 2004 No 512 The Common Agricultural Policy Support Schemes (Hardship Notification) (Northern Ireland) Regulations 2004
SR 2005 No 6 The Common Agricultural Policy Single Payment and Support Schemes (Cross-Compliance) (Northern Ireland) (Regulations) 2005
SI 2005 No 218 The Common Agricultural Policy Single Payment and Support Schemes (Integrated Administration and Control System) Regulations 2005


Note: Two Statutory Rules are still to be published.

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Appendix B- Examples

Example 1

Consider a farmer with an accounting year end of 31 December and a ten month basis period ending on 31 August 2006 for the 2006 year of claim. The farmer has lodged the claim by 15 May 2006. It is envisaged that the farmer will meet the Eligibility and Cross-Compliance conditions and that the SP will be received.

No SP would be recognised up to 31 August 2006. At that date, a receivable of 100% of the SP would be recognised, with eight twelfths taken to the Profit and Loss Account at that time. The remaining four twelfths (of 100% of the SP) would be taken to deferred income to be released over the remaining four months of the calendar year. Thus, by 31 December, 100% of the SP would have been recognised.

Example 2

Consider a farmer with an accounting year end of 30 November and a ten month basis period ending on 31 January 2006 for the 2005 year of claim. The farmer has lodged the claim by 16 May 2005. It is envisaged that the farmer will meet the Eligibility and Cross-Compliance conditions and that the SP will be received.

Subject to a valid claim being made by 16 May 2005, the 2005 SP claim is therefore triggered on 31 January 2006. All of the SP for 2005 would be recognised in the accounting period in which the 10 month basis period ends ie in the financial statements for the year ending 30 November 2006.

Example 3

Assume the farmer in Example 2 then changes the ten month basis period so that the 2006 claim period ends on 30 November 2006. Subject to a valid claim being made by 15 May 2006, the 2006 SP claim is therefore triggered on 30 November 2006. All of the SP for 2006 would be recognised as a receivable in the accounting period in which the ten month basis period ends ie in the financial statements for the year ending 30 November 2006.
However, only 11/12 of the 2006 SP would be included in the Profit and Loss Account for the year ended 30 November 2006. That Profit and Loss Account would also include the whole of the 2005 SP.

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Content

The content of Tax Bulletin Special Edition gives the views of our technical specialists on particular issues. The information published is reported because it may be of interest to tax practitioners. Publication will be six times a year, and include a cumulative index issued on an annual basis.

  • You can expect that interpretations of the law contained in the Bulletin will normally be applied in relevant cases, but this is subject to a number of qualifications.
  • Particular cases may turn on their own facts, or context, and because every possible situation cannot be covered, there may be circumstances in which the interpretation given here will not apply.
  • There may also be circumstances in which the Board would find it necessary to argue for a different interpretation in appeal proceedings.
  • The Bulletin does not replace formal Statements of Practice.
  • The Board’s view of the law may change in the future. Readers will be notified of any changes in future editions.
  • All the names used in examples and illustrations are imaginary and have no relation to real persons, living or dead, except by coincidence

Nothing in this Bulletin affects a taxpayer’s right of appeal on any point.

Footnotes

  1. The scheme is called the Single Farm Payment Scheme in Scotland, but the Single Payment Scheme in England, Wales and Northern Ireland.
  2. The SPS is part of the package of measures agreed under the heading of Common Agricultural Policy Reform. See Appendix A for details of implementing legislation in the UK.
  3. This Technical Release addresses the accounting treatment under
    UK GAAP.
  4. In Scotland and Wales, the administrations have opted for payments based solely on the individual historic entitlement (IHE), while England’s scheme is a dynamic hybrid model, including elements of both IHE and regionalised area payments (RAP). Northern Ireland has adopted a static hybrid scheme where the proportion paid on IHE and RAP will remain the same.
  5. See paragraph 11 for details of differences between the jurisdictions concerning the 10 month basis period.
  6. In Scotland, the Scottish Executive Environmental and Rural Affairs Department (SEERAD), the Scottish Environment Protection Agency (SEPA) and others and the equivalent authorities in England, Wales and Northern Ireland.
  7. Entitlements may be lost and revert to the national reserve if not utilised according to the SPS usage rules.

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