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The Farming Partnerships

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Julie Butler - Expert Author

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The Farming Partnerships - 100% BPR As Opposed To 50% BPR

16 April 2012

Recent inheritance tax cases such as Balfour (Earl of) v HMRC [2010] UK UT 300) and McCall (PN McCall & BJA Keenan (PR of Mrs McClean) v HMRC (2009) STC 990) have shown the importance of Business Property Relief (BPR) and the hunger for HMRC to try and deny this relief when it appears the correct conditions have not been met.

The farming partnership does have the fall back of Agricultural Property Relief (APR) at agricultural value and also 50% BPR for an asset owned by a partner provided the asset is used in the partnership.  However, Balfour showed the importance of BPR where there are rental properties and where there is an investment business integrated into the main trading business.  Balfour followed on from the finding of Farmer (Farmer’s Executors) v IRC [1999] STC (SCD) 321) where BPR was achieved on 22 let cottages.  The value of the rental property at stake was high and there was a lot of inheritance tax relief at risk.  Likewise, McCall showed the importance of BPR for development land as the land involved in the case was worth well over £4m whereas agricultural value was only £165,000.  APR was not enough; BPR was needed to shelter hope value (the difference between market value and agricultural value).

With land prices having increased by approximately 100% between 2005 and 2010 and development opportunities resulting in values returning since the apparent crash of 2008, there are large values to protect.  As a tax planning point every farm should understand what its current value is in terms of not just agricultural value but full market value.

Farmland used by the partnership

If a partner owns property personally (i.e. not on the partnership balance sheet) which is occupied or used by the partnership, 50% of the value of the property will be excluded from the calculation of inheritance tax when that partner dies.

There are many tax advisers who argue that the simple inclusion of the assets on the partnership balance sheet is not enough to prove that they are partnership property and eligible for 100% relief.  When it comes to the availability of BPR at the rate of 100% for land in a partnership case, it is assumed that the question will come down to whether the land is a ‘partnership asset’, albeit one that appears to be ‘owned’ by just one of the partners.  It is assumed that if the land is ‘partnership property’, then the value of the land will be included in the value of ‘the business or an interest in the business’, qualifying for relief at the rate of 100%.  This is an approach followed in paragraph IHTM 25104 of the HMRC IHT Manual.  If it is not a partnership asset, the land will only qualify for relief at the rate of 50% under section 102(1)(c) IHT Act 1984.

Proprietary interest v beneficial interest

Protection of the 100% relief can be obtained through the drafting of the family farming partnership agreement and this should be drawn up so that whilst the partnership remains in force, the land continues to be a partnership asset.  This means the original owner does not have a “proprietary interest” in the land.  The objective will then be achieved.  If an asset is to be held as partnership property but allocated wholly to one partner the draftsman’s approach will have to be to ensure that none of the other partners, except the intended ‘owner’, have any “beneficial interest” in the asset. 

In Miles v Clarke [1953] 1 A11 ER 779 there was a dispute about what was partnership property.  Harman J found that the only term agreed by the parties was that profits should be shared equally.  He rejected guidance from the accounts because of errors in the way in which they were drawn up, and laid down the following principle ‘No more agreement between the parties should be supposed than is absolutely necessary to give business effect to that which has happened’ (see [1951] 1 A11 ER at page 782, letter a).  Applying this principle, the trading stock was a partnership asset, but the lease of the premises held in the name of only one partner was not. 

Proving partnership assets

When land is included on the balance sheet so that the owner has a beneficial interest but not a proprietary interest, there is still the need to prove that the land is a partnership asset.  Case law suggests that there is an evidential burden to be surmounted, and also that the courts may be reluctant to allow it to be surmounted with the aid of accountancy evidence.  In Barton v Morris [1985] 1 A11 ER 1032, a man and woman, who were unmarried but who lived together, purchased a farm which they held as joint tenants.  They lived at the property and carried on a partnership, without a written partnership agreement.  The woman died in an accident.  The question was whether the farm had become a partnership property (severing the joint tenancy) or whether the partner became solely entitled by survivorship.  The High Court held that even though the farm was shown as a partnership asset in draft accounts, it had not been made partnership property.  This point is reinforced by an earlier decision, Miles v Clarke (see above).

The importance of correct drafting of the partnership agreement

A number of partnerships operate without a written Partnership Agreement, which has obvious dangers as it is important to set out the terms upon which the partners agree to carry on business together.  This should go beyond such matters as profit sharing, for example to specify what should happen in the future if there is a dispute or a partner leaves or dies.  The importance of the drafting of the partnership agreement is therefore to lay down terms specifying what is to happen when the partnership ceases, or the land ceases to be partnership property.  For example, if the land is sold, how will the sale proceeds be treated?  Presumably the ‘landowner’ partner will have been credited with the value of the land, in his capital account, which should be adjusted to take account of any profit or loss realised, by reference to the book valu16 April 2012e.  On the partnership ceasing, the agreement may provide for the land appropriated to the landowner partner or towards his capital entitlement. 

100% BPR for land which to a great extent may be regarded as beneficially owned by just one of the partners will obviously require a carefully drawn partnership agreement.  Not necessarily a deed, as set out by Hoffman LJ in IRC v Gray, but a detailed written agreement which defines the position on partnership assets.

A set of accounts signed by the parties may well be regarded as evidence of agreement between the partners on basic trading concerns, such as the division of the profits shown in the annual profit and loss account.  However, accounts unsupported by a detailed written agreement cannot suffice by themselves, to provide the evidence of the detailed and intricate agreement as to farmland ownership and need to ensure that the land is effectively beneficially owned by just one of the partners.

Persuading HMRC of partnership assets and 100% relief

If the drafting problems can be overcome, it is possible to persuade HMRC that an asset, apparently ‘owned’ by just one of the partners is partnership property and therefore eligible for 100% relief.  The undisputed facts found by the FTT in the Balfour case suggest that in the context of IHT this can be achieved.

Option to purchase

In the event of a death, partners often want to make arrangements which require the surviving partners to buy their share of the partnership.  This can result in a loss of BPR as there is a binding contract for sale.

It is therefore important to ensure that there is no such purchase obligation in the partnership agreement (or elsewhere).  The better approach is for each of the surviving partners to have an option to buy the deceased partner’s interest in the business.  The funding of the purchase price on exercise of the option can be funded in advance by means of a life assurance policy on the life of each partner, held within a trust arrangement.  The trust needs to be carefully drafted so that the policy proceeds pass to the correct persons to ensure that those proceeds are free of inheritance tax and other forms of tax.

Wills

A properly prepared 16 April 2012partnership agreement needs to be supplemented by an appropriate Will for each partner.  In the first place this is to avoid the nightmare of intestacy but also so that BPR can be preserved on the death of a partner so that there is consistent interpretation between the Will and the partnership agreement.

Investments introduced

The above has assumed that the partnership asset on w16 April 2012hich BPR is sought is farmland and buildings, which is farmed by the partnership.  Different considerations could apply in the case of, for example, investment property being brought on to the balance sheet.  In such a case, there could well be a question of whether there was just a single business or, as HMRC sought to argue in Balfour, two separate businesses, one being a ‘trading’ business qualifying for relief and the other an ‘investment business’ excluded from relief by section 105(3) IHTA 1984.

With diversification a large number of the farms include investments which can be protected by BPR because they are part of the business and always have been part of the business.  In the cases of Balfour and Farmer all the investment assets (the let property) had evolved from traditional farming assets as part of the business.  In Farmer where there had been previous buildings for livestock, farm workers cottages etc, it would be inappropriate to try and introduce investment assets and then try and claim 100% BPR thereon.

There are a lot of partnerships where land and property used in the partnership are not included in the accounts.  That might just be an oversight on behalf of the accountant who has drafted the balance sheet or it could be a misunderstanding of the partnership agreement.  Regardless, a complete review does need to be undertaken of all partnership assets and assets owned personally.

Action Plan

For tax planning purposes all the farm assets should be valued at both agricultural value and market value as previously suggested.  There should be what is effectively a BPR “audit” to see if BPR would be achieved, and that is in terms of both the 100% and 50% relief availability.  Also the nature of the transaction and whether it would be included in the business as in Balfour and Farmer or qualifying as a business instead of a grazing agreement as in McCall.  Many have argued that the recent furnished holiday let case of Pawson (Mrs N V Pawson’s Personal Representative v HMRC [2012] UK FTT 51) has “lowered the bar” for BPR with regard to the degree of services in order to achieve BPR.  It is understood HMRC have appealed.  Before partnership agreements are updated (or even drafted for the first time), it should be fully understood what is required both in terms of what the partners want and what is the tax efficient inclusion of assets.  It is important to establish who owns what property, what reliefs can be achieved and what protection there could be when BPR is needed at the 100% rate.


About the Author

Supplied by Julie Butler F.C.A. Butler & Co, Bennett House, The Dean, Alresford, Hampshire, SO24 9BH.  Tel: 01962 735544.  Email; j.butler@butler-co.co.uk, Website; www.butler-co.co.uk

Julie Butler F.C.A. is the author of Tax Planning for Farm and Land Diversification (Bloomsbury Professional), Equine Tax Planning ISBN: 0406966540, and Stanley: Taxation of Farmers and Landowners (LexisNexis).



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Article Published/Sorted/Amended on Scopulus 2012-07-19 10:10:09 in Tax Articles

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