Big relief

  • Author : Matthew Woods
  • Date : November 2010
ABOUT THE AUTHOR: Matthew Woods is partner and joint head of the Landed Estates Group at Withers LLP

The Upper Tax Tribunal1 has upheld the decision in the First Tier Tribunal that the diversified activities of a Scottish landed estate satisfied the wholly or mainly trading test. This meant that the entire estate qualified for 100 per cent business property relief (BPR) from inheritance tax (IHT) following the death of the Fourth Earl of Balfour. The facts of the case are unusually complicated, but there are a number of useful pointers to be drawn from the decision.

The brief facts

Lord Balfour held a liferent in the Whittingehame Estate, a Scottish estate comprising a little less than 2,000 acres. Under the terms of the trusts, Lord Balfour was entitled to the rent from the let properties and the profits from managing the in-hand properties. In respect of the in-hand properties, he was also responsible for any losses that were incurred. Lord Balfour was given specific power to grant leases of limited duration, but which could subsist beyond his lifetime, and his consent was required in relation to the sale of land. These powers were granted against the backdrop of a wish to preserve the Estate for successive generations.

The Estate was a typical rural estate and comprised of in-hand and let farming, residential and commercial lets, grazing, forestry, a private water supply and shooting. From September 1999, Lord Balfour operated the business activities effectively as a sole trader before he became the freehold owner of the Estate in November 2002. From November 2002 until the date of his death in June 2003, Lord Balfour continued to run the business activities, but in partnership with his nephew.

Single composite business – two sets of accounts

One of the grounds of contention was whether two businesses were being operated; one comprising the in-hand farming operation and the other comprising the remaining activities. If it could be shown that there was a separate business comprising only of non-trading activities, then BPR would have been restricted. Some of the evidence was not helpful to the executors as there were two sets of accounts, separate VAT registrations and separate bank accounts prior to the establishment of the partnership between Lord Balfour and his nephew in November 2002.

The facts are unusually complicated, but there are a number of useful pointers to be drawn from the decision

However, what was hugely influential, at both the First Tier Tribunal and the Upper Tax Tribunal was Lord Balfour’s active role and involvement in the management of the Estate. It was clear from the evidence that, whatever the accounting and administrative arrangements, the Estate was, in fact, managed by Lord Balfour as a single composite business. It was accepted by the Upper Tax Tribunal that as Lord Balfour had the right to continue farming the in-hand farms, it was a necessary consequence that separate accounts needed to be kept. It was determined that the First Tier Tribunal was entitled to find that separate accounts did not in itself create two separate businesses. Although this may be helpful in other similar situations, it would be prudent advice, wherever possible, for owners of a diversified estate to have one set of accounts to support the fact that there is a single composite business. Separate management accounts can be kept to deal with different aspects of that composite business but these should still demonstrate that there is an integrated business plan.

Trust property

What was crucial to the conclusion that there was a single composite business and that BPR was available at a rate of 100 per cent was the earlier decision in Finch2. This case makes it clear that BPR is available at a rate of 100 per cent where trustees make property available to a life tenant, who uses that property in his sole trader business. Lord Balfour fell within the parameters of this case, which enabled him to satisfy the two-year ownership requirement and for the property to qualify for relief at the higher rate. It seems clear from the decision in Finch that this analysis will only apply to an interest in possession that satisfies the requirements of s49(1A) Inheritance Tax Act (IHTA) 1984. This means that the position would have been different if the interest was one that arose after 22 March 2006, unless it was a transitional serial interest or an immediate post death interest under a will. What is also clear is that if Lord Balfour had been operating the business prior to November 2002 in partnership with another party, BPR would have been restricted to 50 per cent.

There are many similar family arrangements where trust assets are used in a partnership operated between the life tenant and other family members. These arrangements should be reviewed carefully and consideration given to the trustees becoming partners so that BPR is available at 100 per cent rather than 50 per cent. Historically, there has been a reluctance for professional trustees to expose themselves to trading risks. However, it should be possible to deal with liability concerns with a limited liability arrangement and the tax rewards are significant. A similar review should take place if the life tenant does not have a qualifying life interest under s.49(1A) IHTA 1984 as, again, BPR may be restricted to 50 per cent.

Investment business

Having satisfied itself that the First Tier Tribunal was entitled to find that there was a single composite business, the Upper Tax Tribunal considered whether the First Tier Tribunal was entitled to conclude that the business was one that was wholly or mainly trading. It will have come as a great relief and comfort for many owners of diverse rural estates that it was accepted that the First Tier Tribunal was entitled to do so and endorsed the general principles set out in the case of Farmer 3 more than ten years earlier.

Although the factual matrix in Balfour is complicated, the decision is helpful as it confirmed that there is no single test to determine whether a business is or is not wholly or mainly trading. Although factors such as acreage, turnover, profit, expenditure, capital value and time spent by employees and management are all relevant indicia to consider, the Upper Tax Tribunal agreed that it is matter of more general assessment and impression as to where the preponderance of business activity lies. In the case of Farmer, the investment activities were more profitable, but it was held that the business was mainly a trading activity. In Balfour, the capital values were in favour of an investment business, but it was accepted that the First Tier Tribunal was entitled to attach little weight to this factor.

What is clear is that the case supports the principle that BPR can be available even if it is not possible to ‘tick’ all of the boxes on the various factors listed above. Clearly, if it is possible to satisfy all of the indicia when looking at a diverse rural business, this will be the safest position as it will make it more difficult for HMRC to deny relief. If this approach is considered sensible, it may be better to aim for a business where, say, 70 per cent of the activities are trading by reference to the various indicia as this should iron out any market fluctuations between the different aspects of the business.

Let properties

It is worth highlighting that let properties will almost always fall on the investment side of the equation. It was accepted that the First Tier Tribunal had made an error in treating these as part of the trading activities when reaching its decision. However, the Upper Tax Tribunal concluded that this error was not material as, in particular, the acreages split between the two categories were approximately equal. Similarly, although the capital value of the let properties indicated an investment activity, as the long-term policy of the estate was to retain the land, it was accepted that market values were not a weighty factor. Although this is helpful if market fluctuations result in the capital values of the investment activities predominating, it would be unwise to rely on this factor being irrelevant in all circumstances.

Historical use of properties

One factor that was remarked on in the First Tier Tribunal was the historical use of the let cottages. These had previously been part of the faming enterprises or had housed full-time estate workers but were no longer required for these purposes. A similar point was made in the earlier case of Farmer. Clearly this helps to demonstrate that the trading and investment activities of the business were, at least previously, part of the same integrated business and, in Balfour, it was clear that the use of the let properties was for the overall benefit of the Estate. One wonders whether HMRC could and would draw a distinction if the let properties had no previous association with the trading activities? If a distinct trading business is merged with a distinct and unrelated investment business, there must be a risk that the new business will still be treated as two separate businesses unless it is possible to show that they are truly integrated.

Concluding comments

Although agricultural property relief remains a valuable relief for owners of rural property, it has limitations for diversified landed estates and is no longer as effective a tax shelter as it used to be. BPR is wider in scope and, with the correct planning, can provide greater protection for a traditional landed estate from inheritance tax. The case of Balfour is a useful reminder of the complexities of BPR and potential problem areas, but also the rewards if you get it right. Owners of a diversified estate should be encouraged to carry out a regular audit to ensure that there are no nasty surprises in the future as each case will turn on its own particular facts.

Revenue and Customs Commissioners v Brander [2010] UKUT 300 (TCC)
Fetherstanhaugh & Others (Finch) v IRC [1984] STC 261
Farmer’s Executors v IRC [1999] STC (SCD) 321


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