The sale of an asset for which there is a profit between the value that the asset was acquired at and the disposal value or open market value (if sold/transferred for a value which is less than open market) can give rise to a liability to Capital Gains Tax (CGT).
The rate of CGT payable is dependent upon the individual tax payer’s income tax position and is effectively treated as a top slice of income and capital gains made. Where the top slice would, if it were income, be charged to income tax at the 40% or even the highest rate of income tax, then the CGT rate is 28%. Where the top slice methodology would give rise to income being taxed at the basic 20% rate, then until such time as the capital gains made/income received figure breaches the 20%/40% cut off figure, then the capital gain will be taxed at the lower 18% rate.
However, on a disposal of certain business assets the effective rate of capital gains tax can be lowered to 10% if the tax payer is eligible for Entrepreneurs’ Relief. Entrepreneur’s Relief (‘ER’) is available for gain up to £10,000,000 of “lifetime gain” per individual.
The rules for successfully claiming ER are complex and there is a particular difficulty where a business is carried on by an individual either trading as a sole trader or in partnership with other individuals. Of course many farmers choose to operate their business in precisely these business models. Aside from situations where the farming business of the individual sole trader or the farming partnership ceases on the sale of the whole of the farming business, the sale of an asset from the business is not likely to be eligible for ER and so the usual CGT rates (and more likely the full rate of 28%) could be payable on the gain arising from the sale. This is a common problem for farmers.
The recent case of William S G Russell v HMRC is instructive and the decision was published October 2012. Mr Russell farmed in partnership. He and his partners had sold off 6.72 hectares for a sum of £1.2 million.
The total land farmed prior to the sale was 21.65 hectares and the land sold represented 35% of the total farmed land. The profits from the farming enterprise had been modest in recent years. The profits had declined since the date of the disposal of 6.72 hectares. There was evidence that there was no significant change in the way the partnership carried on the farming business before and after the sale. The Revenue accordingly rejected the claim for ER on the basis that it was a mere sale of an asset of the underlying business. The Revenue’s case was that without other factors such as the nature and extent of the farming after the sale being wholly different from the nature and extent of the farming activities before the sale, it was not a disposal of the business or a distinct and severable part of the overall farming business.
In Mr Russell’s case, he accepted that there was no difference in the way the farm was run before or after the sale of land. There was simply a reduction in the profit received for the farming activities carried on. The tribunal’s comments are helpful.
“After the sale of the land Mr Russell and his brothers continue doing exactly what they were previously doing, only for less money”.
The point to take from this case is that farmers and their advisors cannot simply assume that ER can be successfully claimed. It may be possible to restructure the affairs of a business before a sale. The rules of ER are perhaps odd and perhaps unfair in some ways because if a farmer owns shares in a farming company and simply sold a portion of the shares, then in principle that sale could be eligible for ER. Simply selling a few acres of land as a sole trader or as a partnership will not, in many cases, be eligible.
It is also important to ask whether the land is part of the partnership’s assets or held by the partners outside the partnership, as different rules can apply.
Any farmer planning to realise significant capital gains now or in the near future should take advice immediately so as to try to minimise their tax liability.
The availability of “roll over relief” should not be discounted although, of course, the implicit capital gain will still be an issue for the future. Likewise, the use of certain types of financial products which act as CGT deferral can also assist in appropriate cases.
For further information please contact Ed Walter from our Tax and Trust team at our Sevenoaks office on 01732 440855 or email firstname.lastname@example.org or Nick Fagg from our Rural Business team at our Uckfield office on 01825 761555 or email email@example.com or Richard Cripps from our Commercial Property team at our Sevenoaks office on 01732 440855 or email firstname.lastname@example.org