The Tractor Tax

Inheritance Tax (“IHT”) is levied on the value of the estate of the deceased or on a gift made by the deceased less than seven years before death, that is to say a potentially exempt transfer (“a PET”).

Transfers to a spouse or civil partner are exempt (“the spousal exemption”). After the deduction of the applicable nil-rate band, the IHT which is payable depends on the nature of the assets in the estate or given during the lifetime.

At present, nearly all of the assets used in a working farm will attract either agricultural property relief (“APR”) or business property relief (“BPR”) at 100 per cent. This means that no IHT is payable at all on the transfer of these assets. Agricultural land attracts APR, while farm equipment, machinery and livestock attracts BPR. The reliefs are mutually exclusive, but the test is broadly the same. Agricultural land will attract APR at 100 per cent if it was occupied by the owner or his or her civil partner for two years before the transfer or occupied by someone else for 7 years. Farm business assets attract BPR if such assets were in use not more than two years before the transfer.

APR is limited to the “agricultural value” of the asset. For many farms, the major issue with HMRC was the value of the farmhouse. This has to be “of a nature and size appropriate to the farming activity that is taking place”. This is often a matter of fact and degree. HMRC will not accept a manor house as being appropriate for a hobby farm.

Aside from the requirement for recent use or issues relating to the farmhouse, the applicability of APR or BPR at 100 per cent on all or the vast majority of farm assets has meant that many farmers have never needed to (or wanted to) take tax planning advice.    

From April 2026 100 per cent APR and BPR on any transfer by death or lifetime transfer will only apply to the first £1million of assets. Thereafter, APR and BPR will be at 50 per cent. IHT is payable at a rate of 40 per cent.

It is important to set out specifically what was said in the budget (taken from the official transcript)

“From 2026, the first £1m of combined business and agricultural assets will continue to attract no inheritance tax at all ….

…. but for assets over £1m, inheritance tax will apply with 50% relief, at an effective rate of 20%

            This will ensure we continue to protect small family farms …

            …. and three-quarters of claims will be unaffected by these changes.”

The dots do not represent omitted passages. They record the manner in which the budget speech was delivered.

Clearly, the £1 million figure applies to the whole assets of the farm and not to the interest of a spouse or civil partner in the same.

Although this change does not apply solely or even mainly to tractors, it has been referred to imaginatively as “the tractor tax”. In reality, it applies primarily to land. Farm equipment and machinery are depreciating assets. Land is not. The Good Lord is not making any more of it.

This article is aimed at farmers who own their own farms. However, I have to note that recent reports indicate that institutional landowners are terminating farm business tenancies at an alarming rate in anticipation of the new regime. Whether any political pressure can be put on the Government in this regard is unclear. This seems to be an example of the law of unanticipated consequences.

The Chancellor of the Exchequer has stated that the “effective” threshold for IHT on farms could be as high as £3 million. It is difficult to see how this figure has been calculated. The single transferable nil-rate band still applies. Where one spouse or civil partner dies and does not use up their nil rate band for IHT, the balance can be used by the second spouse or civil partner to die. The single transferable nil rate band is now £650,000 (with a higher figure for a dwelling-house), so the “effective” threshold could be said to be £1.65 million. However, the nil rate band of the first to die can only be used by the second if the marriage or civil partnership was ended by death. Insofar as the Government has considered this in assessing the burden on farmers, it fails to take into account the record rate of divorce in the farming community. The individual nil rate band is only £325,000 and there are many “small family farms” with assets of over £1.325million.

As far as it is possible to tell, the Government has not made any sensible estimate of the yield from this alteration to IHT. In reality, it is impossible to do so. We are moving from a regime where farmers have generally not taken tax planning advice to one in which they will be foolish not to do so. The effect of simple and non-aggressive tax planning will probably reduce any anticipated yield significantly. In reality, IHT will fall on farmers who have not planned ahead or who have been unable to do so.

Tax planning is not only applicable during the lifetime of the farmer. Section 142 of the Inheritance Tax Act 1984 enables dispositions on death to be varied by the beneficiaries up to  2 years after death. In particular, assets can be directed to a spouse or civil partner so as to take advantage of the spousal exemption. This procedure requires a deed which is signed by all adult beneficiaries or the approval of the Court if there are minors. Farming family relationships can often be difficult, but if there is enough IHT to be saved, this is likely to be undertaken extensively in the future.

Aside from making full use of the spousal exemption and any transferable nil-rate band, the most obvious form of tax planning which could be used is merely for the farmer to give an interest in the farm or its land to children during his lifetime and hope to survive for seven years. However, many farmers can be loathe to give up assets in this way as control is lost. Sometimes, more subtle routes are required.

To date, partnership has not generally been viewed as part of farming tax planning due to the availability of 100 per cent APR or BPR. However, partnership does enable value to be transferred between generations gradually over time in a manner which other forms of business association do not. In this regard, I am referring to a genuine partnership with a child involved in the business. Where land and other farming assets are partnership property, no partner has an interest in any specific asset. The interest is merely in the net assets as manifested in the capital  account. The capital account represents an interest in assets. Where a partner admits a child as a partner, the agreement will not create a PET unless the initial capital account of the child is credited with part of the value of the property transferred into the partnership. If the farmer is credited with the full value of the property transferred by him into the partnership as his initial  capital account, then there is no gift. The partnership agreement can  give the child a significant share of the profits of the business moving forward. As capital profits follow income profits, the child will receive a share in the increase in the value of the partnership property from the time of his or her admission. In addition, if the farmer has drawings which exceed his share of profits, this will over time reduce his capital account naturally. As a partner has no interest in individual assets, the only interest which can be transferred on death is this capital account. Accordingly, this natural reduction will reduce the IHT.

What is stated above also applies where there is already a partnership between farmer and child and the profit share of the child is merely increased.

In principle, this arrangement will also work with an LLP. However, LLPs are not designed to accumulate or hold assets. The arrangement does not work with a company as any share given to a child which has a right to participate in profits will be treated as being a gift.