Farm diversification tax and finance guide
Farm diversifications are a great idea for anyone looking to make use of assets, shore up the farming business or provide economic security, but the financial side is complex, which is why involving an accountant is so important. Philip Kirkpatrick and Oliver Bond offer their top finance tips to setting up a farm diversification.
From the start of any diversification project, finances need thorough planning to get budgeting and cash flow right. The short- and long-term reasons for diversifying will affect choice of business structure – and therefore tax obligations – so it’s important to set it up right from the start – a complex field to navigate.
Purpose of diversification
Any diversification must of course have the potential to be profitable. But different types of enterprise will affect both the existing farm business and potential tax burden in different ways, so it’s important to consider those from the start.
What are you aiming to achieve? This might be to provide a steady income for when the farm goes through a difficult period, to make the most of any assets that aren’t providing a return, or to deliver off-farm income for things like succession. The first thing an accountant should do is play devil’s advocate to understand why the landowner is diversifying and whether it will be profitable.
The number one reason for a new venture failing is lack of cash flow. It’s advisable to involve an accountant as soon as you’re committed to the idea, as they will be able to point out the areas of opportunity and risk while also helping to budget, cash flow forecast and assess the project’s affordability. It might take a while before the project makes a profit so it will need cash to keep it running.
Farmers and landowners may fund smaller projects themselves, but larger projects are likely to need bank funding. The application will need a thorough cash flow budget to be evaluated by the bank.
When borrowing money, there are often two major pitfalls that borrowers fall foul of:
- Not borrowing enough – delays and unforeseen costs are normal for a new venture. Consider how you would fund the project if costs were to increase by 10-15%
- Unrealistic loan term – debt costs money, therefore most people wish to pay it off as quickly as possible and this typically hits cash flow hard. Cash flow is key and you should be doing everything you can to maximise it in the early years, so consider spreading debt repayments over a longer term. Banks will often allow you to repay loans quicker (watch out for early repayment charges on some loans) however, asking for additional finance when the business is struggling can be difficult.
Ask your bank about interest-only periods as this is a great way to preserve cash flow in the first six-12 months.
Other financing options like grants should also be explored. Though it might be difficult in the current environment as EU funding has been withdrawn, there are still often grants supporting diversification, particularly for accessing new markets, job creation and technological advancements.
Be aware that grant money isn’t usually awarded until the project is completed, so initial funding will have to be sourced elsewhere.
Whatever your diversification, considering whether it should be structured as part of your existing business or as a separate entity is important, particularly for tax purposes.
Once you know the answer to that question, you can consider what type of entity the business should be – sole trader, partnership, limited company, and limited liability partnership being the most common examples.
Limited companies and limited liability partnerships can be useful to ring-fence the business away from other assets or businesses, providing an extra degree of financial protection for the main farm.
- VAT – There are three main questions to consider in relation to VAT:
- What is the VAT treatment of the output from the diversification, and will the customers be able to reclaim any VAT charged?
- What will the input VAT be on any capital costs to develop the diversification and can these be reclaimed or reduced?
- What impact will the diversification have on the farm’s existing VAT registration?
Depending on the answers to the above questions, it may be better to ringfence the diversification as a separate entity, so it exists outside the farm VAT registration.
VAT will impact the finances of the diversification and therefore it should be considered at an early stage and factored into your business plan.
- Inheritance Tax (IHT) – Farming property and businesses can potentially benefit from both Agricultural Property Relief (APR) and Business Property Relief (BPR), making them relatively tax efficient assets for IHT purposes.
However, when you take some of those farming assets and use them for non-farming purposes, APR will no longer be available and you will be reliant upon BPR. Therefore, it’s important to understand whether or not the new enterprise will qualify for BPR. If it doesn’t qualify, then it could be exposed to IHT at 40%.
It’s possible for the diversification to sit under the umbrella of your existing business and this could allow BPR to be spread over the diversification as well. However, this is a highly specialist area and advice is needed from your accountant as it could equally jeopardise the BPR position of the existing business.
- Capital Gains Tax (CGT) – This is relevant for those aiming to sell or transfer the diversification in the long run. It’s key from the offset to know the eventual aim, to understand which CGT reliefs are available in the event of a sale, gift or transfer. However, be aware that these will be restricted if the diversification is not deemed to be ‘trading’ by HMRC.
Consider transferring the asset before it’s developed into a diversification, as removing it from agricultural production could limit the reliefs available.
- Tax on profits (Income Tax or Corporation Tax) – Depending on how the business is structured, Income Tax or Corporation Tax will be payable upon the profits the new enterprise generates.
Understanding what you want to do with those profits (reinvest in the business, spend etc) and what rate of tax could be charged on them will likely be key to determining how the enterprise should be structured and ought to be considered at an early stage.
In addition, a point often overlooked is whether any of the capital costs incurred on developing the new enterprise can be offset against business profits. For example, most people think they can’t claim on building conversion costs but this isn’t always the case. There is often a significant amount of tax relief available on building or converting a furnished holiday let and this relief can significantly reduce or eliminate tax on profits in the first few years.
Other points to consider
- Planning permission – most diversifications will require planning consent which could directly impact VAT
- Insurance – the existing policy might not cover the diversification
- PAYE – relevant if the diversification is employing people
- Stamp Duty – not normally an issue but in the event of property transfer or sale it applies, particularly if debt is attached to the property.