Capital gains tax: relief on development land
13 February 2015
Fiona Graham and Sara Maccallum discuss entrepreneurs' relief from capital gains tax on development land
Given the pressing need for large-scale housebuilding in the UK, many estates and farm owners may be considering selling off parcels of land to developers. A sale of land will give rise to a charge to capital gains tax (CGT) but, depending on the circumstances of the sale, the taxpayer may benefit from entrepreneurs' relief.
Entrepreneurs' relief was introduced in 2008 and is available to individuals (and in some cases trustees) who realise qualifying gains. The effect is to reduce the rate of CGT payable on certain disposals to 10% up to a lifetime limit, currently £10m. Without the benefit of entrepreneurs' relief, CGT is generally payable at 28%, although an 18% rate applies to basic rate taxpayers.
This translates into a maximum tax saving of £1.8m for each individual and a husband and wife each have their own individual lifetime limit. The relief is therefore of considerable value and should always be considered on the sale of businesses and/or assets.
Entrepreneurs' relief is available on assets in the following categories:
- assets used in the business in a disposal of the whole or part of a business that an individual has owned (whether individually as a sole trader or in partnership with others) for at least one year prior to the date of disposal. The disposal must be of the business and not just of the assets used in the business. In a business carried on by a partnership, the relief will only apply on the sale of partnership assets where they represent a sale of the whole or part of the partnership business
- assets that were in use in a business when it ceased, provided that they were owned by the individual (or partners) for at least 1 year and the disposal of the assets takes place within 3 years of the cessation of the business.
Much like the old CGT retirement relief (which was replaced by taper relief), entrepreneurs' relief is designed to benefit taxpayers whose businesses are brought to an end or those selling their businesses.
It will be available where a farming business ceases and the whole of the farmed land is sold off to a developer. It is not designed to benefit sales of specific assets, such as disposals of discrete parcels of development land, which is the scenario more usually encountered in practice.
Entrepreneurs' relief is often an issue for farming businesses and a number of cases have come before the courts.
The most recent case (following in the line of retirement relief cases such as McGregor v Adcock and Mannion v Johnston) is Russell v HMRC, in which a farmer sold approximately 35% of farmland to a developer and claimed entrepreneurs' relief.
A key factor was that, after the sale of the land, the taxpayer carried on farming much as before, albeit on a smaller area and the court found the sale was merely of a business asset. The courts will consider the activities of the business before and after the sale and if the post-sale business continues in the same manner, the disposal is unlikely to benefit from the relief.
It may remain possible to claim entrepreneurs' relief on the sale of land. However, a basic condition is that the taxpayer needs to have been in business and to have owned the relevant assets for a year prior to disposal. Once a piece of land for development has been identified, the key, in planning terms, is that a separate farming business (distinct from any business operating over the wider land) is set up to farm that area of land.
This could be achieved by establishing a new family farming partnership to operate as a distinct farming business on the relevant land. Once the partnership is up and running, the taxpayers might then apply for planning permission themselves or perhaps enter into an agreement with an agent or developer to fund the planning fees and costs.
The partnership farming business would need to operate for at least 12 months for entrepreneurs' relief to be available, after which point its trade could be brought to an end and the land sold. The land would need to be sold within 3 years of the cessation of the partnership's business.
Any developer or landowner must have in mind the ever-evolving and more pervasive HMRC anti-avoidance provisions, including those in the recent General Anti-Abuse Rule. Those can trip up some even innocuous planning strategies
It is critical that a genuine farming business is set up and that the partners can show that they are involved together in farming the land, rather than simply receiving rents from it (which would not qualify as a business for entrepreneurs' relief purposes). The new trading partnership should be evidenced by a partnership agreement and the land earmarked for development would need to be held as a partnership asset and shown in the partnership's accounts as such.
Financial accounts should be prepared to record the trading activities and the partners should meet to review performance and strategy. The partnership should be registered with HMRC for income tax and should register for value added tax on the basis of its farming activities. Given the scrutiny given by HMRC to claims for entrepreneurs' relief, it is crucial that the separate business activity of the farming partnership is clearly evidenced.
Alternatively, if the land is already farmed by a third party farmer, the owner will need to discuss whether they can be brought into any partnership or, alternatively but less ideal, agree to a contract farming arrangement, which should bear all the hallmarks of an arrangement where both farmer as well as landowner bear the risks of the farming business.
There may be other ways in which to obtain entrepreneurs' relief. For example, an individual who farms as a sole trader might consider ceasing to trade and transferring their farming business to a company. A sale of the land to a developer within 3 years of the cessation of trade should then qualify for the relief. There will be other tax concerns to consider on the transfer of a business to a company and the facts of each case will need to be examined.
Of course, tax planning arrangements must not be implemented with just the one tax in mind. Farmers and landowners should not forget how such arrangements interact for income tax, stamp duty land tax, VAT, and inheritance tax (IHT).
For many generations, the IHT reliefs offered to farmers have been widely used, so as to preserve farms and land holdings and protect them from forced sales due to death duties.
Therefore, when looking to secure the 10% CGT rate, the landowner should, where possible, also aim to continue to secure that valuable IHT relief. If a partnership or contract farming structure is invoked, that is likely to secure 100% relief from IHT on death or any gift, by virtue of business property relief; but care needs to be taken in introducing the partnership or other structure and often a new 2 year ownership period will be required before the relief is available.
Once the land is converted into cash any IHT relief will be lost unless the proceeds are reinvested into a further qualifying asset within a certain period. The owner may be resigned already to losing their relief on that land given the likely imminent development and then sale. However, they should look carefully at crafting any option agreement with the developer so as to ensure that does not prejudice the IHT relief in the interim, prior to sale.
Any developer or landowner must have in mind the ever-evolving and more pervasive HMRC anti-avoidance provisions, including those in the recent General Anti-Abuse Rule. Those can trip up some even innocuous planning strategies.
The landowner should also consider their wider succession planning and may wish to implement a gift to their children or a trust to 'bank' the inheritance tax relief and the increase in value prior to effecting any entrepreneurs' relief planning. Succession, wills and gifting strategies need to be borne in mind together with concerns with asset protection, the risks of bankruptcy and ravages of divorce.
Fiona Graham and Sara Maccallum are Partners in private client and tax at law firm Boodle Hatfield