Splitting a farm business: Tax, legal and practical matters

It is usually a difficult decision to divide a business built up over generations, but for farmers who do so, the result can be strong, separate operations that allow those involved to take control or give the next generation opportunities to build up equity.

Specialist agriculture and property tax adviser Joanne Wright, a partner at accountant Ellacotts, says a common reason for farming partnerships splitting is that partners have different interests regarding the future direction of the business.

Another is the retirement or death of a partner, triggering a split as part of succession planning.

See also: Partnership and collaboration advice on fwi.co.uk

“An example is where the core farming business is left to one partner and another part to a family member outside of the partnership,” says Mrs Wright.

The key to an amicable split is open conversations and involving professionals as early as possible.

What do the partners want to achieve from the split?

Partners should have a crystal clear vision of what they want to achieve from the change – and what they are prepared to accept, because getting a deal agreed might mean one of the partners having to accept concessions.

Attaining an equal split of assets and liabilities may not be possible, says Mrs Wright.

“The aim is really for an equitable and fair solution for all, which does not necessarily mean dividing assets up equally,” she says.

For example, when part of a business is being separated to a non-farming family member as part of succession planning, it may not be viable for that family member to have an equal capital value of the assets without overburdening those left running the farming business.

“The person receiving the core farming assets has the ongoing risk of running a farming business and may need more capital value, while some rental properties may be sufficient to provide a non-farming family member with a steady income stream,” says Mrs Wright.

Having that acceptance at the beginning will help push forward and speed up the process – often the benefits of getting a split done are greater than the risk of losing another financial year.

When there is debt involved, partners must also work out whether there will be adequate security and whether banking covenants, which make loans conditional on financial performance of the business, will be met by the separated businesses.

Costs and collaboration

Each party will engage their own solicitors, accountants and professional advisers to deal with the financial and legal processes. Costs will vary according to the complexity of the business.

If the process is impeded by disagreements or communication breaks down, it can get expensive.

Jeanette Dennis is a partner in Ashtons Legal and says keeping channels of communication open will keep costs down.

“Keep talking, and engage advisers who are going to be robust on your behalf, but who are not going to look to pick a fight from the word go.

“Point scoring and getting into arguments about who did what five years ago doesn’t get a solution.”

The starting point will be the written partnership agreement and the business accounts.

If there is no written agreement then a split may not be straightforward, Ms Dennis warns.

“It is for this reason all partnerships should be recorded in writing.

“If there is no dispute then now is the best time to do it, just in case there is a death, a divorce or family dispute.”

Asset valuation

One of the standard clauses in a partnership agreement is how assets will be valued on a split or dissolution. This will cover all the farming assets, including land – if it is in the partnership – crops, livestock and machinery.

If the partners cannot agree a value between themselves then the assets will need to be valued by a professional. This element usually benefits from advice on the related tax and legal issues.

Sometimes the assets and liabilities on both sides allow for an even split, with each partner to walk away with assets that are worth roughly the same and with a similar farmed area and trading value.

If there is no written agreement and there is land in the partnership, the valuation of that will fall under the outdated Partnership Act 1890 and it will be valued at open market value.

“This may not be ideal as it may mean a much higher value has to be paid than, for instance, at book value, or even at a value to be agreed between the partners on a different basis, and this is open to a lot of arguments,” says Ms Dennis.

“Avoid arguments and get this clear in a written agreement. Putting the land into the business may help improve inheritance tax and capital gains tax positions too, gaining reliefs that may not otherwise be claimed in an unwritten situation.”

A written agreement can be drawn up at any stage during the partnership.

During the valuation, there may be certain assets that have development potential or “hope value”.

So, on any split of land between partners, it may be appropriate to include an overage clause to share in any future development gain.

“Alternatively, it can be arranged that where land has been split, then a partner or former partner/family member may be given the right of first refusal to buy that land back if it is to be sold,” says Ms Dennis.

Written confirmation

She recommends having an exit plan set out in a confirmatory partnership document that will smooth the process should partners decide to go their separate ways in the future.

This document, drawn up by a solicitor or accountant, is written confirmation of the main terms agreed in principle and outlines the timetable and obligations of the parties during the negotiations.

The document is not legally binding but it sets out a pathway, Ms Dennis advises.

“It will record who is acting for who, a timeframe, what the parties are agreeing in terms of valuation, it will show who is going to own what, how assets such as crops in store are going to be valued.

“It gives everyone a reference point, a starting point, and is far better than spending thousands of pounds on meetings, emails and negotiation and an uncontrollable escalation of professional fees.”

Setting up a new business

One of the partners may retain the existing business structure while the one leaving will need to set up a new business.

That will require, among other things, a new bank account, VAT registration, payroll, accounting system, herd records and supply contracts.

Tax relief

Whether the business is a partnership or a limited company, there are tax reliefs and HMRC clearances that can mitigate the financial cost of a split.

Mrs Wright says when any business restructuring occurs, the tax position of everyone involved needs to be carefully considered as splitting a business can trigger many unintentional tax consequences.

If the business is run through a company, it is possible to divide different activities into separate companies via a demerger, resulting in one person owning one company and another owning the other.

“With careful planning, the restructuring can be implemented without attracting income tax or capital gains tax [CGT], although sometimes stamp duty applies,” says Mrs Wright.

Within a partnership, the disposal of plant and machinery can give rise to balancing charges, which is subject to income tax on the partners. 

However, if the business has more than one trade and one of the trades is transferred to the retiring partner, including all the kit relating to that trade, in some circumstances it is possible to jointly elect for the asset to be transferred at its tax written-down value to prevent a balancing charge from being triggered. A similar election can also apply to stock.

Generally, a disposal of an interest in land or buildings is a chargeable event for CGT at a rate of 20% for land or 28% for residential property, even if it is in exchange for another property interest.

However, a form of rollover relief allows joint owners to exchange their interests without giving rise to a CGT charge and stamp duty land tax (SDLT), says Mrs Wright.

“For example, if land is owned jointly between two siblings and certain conditions are met, one can become the sole beneficiary of one block of land and the other the owner of the other land.”

“Broadly, the capital gain arising on the disposal may be eligible for rollover and the acquisition ‘base’ cost is reduced accordingly.”

One of the main conditions with this relief is that the value relinquished should be equal to the value of the assets gained. 

In some cases, the exchange may not be of equal value and an equalisation payment is required.

For example, if two partners own land worth £1.5m and they carve up the farm so one block is worth £850,000 and the other is worth £700,000, an equalisation payment of £150,000 could be required to make the exchange fair.

“In this situation, only the equalisation payment would be subject to capital gains tax at a rate of 20%,” Mrs Wright advises.

It is not always the case that businesses are split into two. A partnership may split because the partners no longer wish to continue farming together and one wishes to be bought out.

In these situations, it is most likely that the remaining partners will need to raise finance to pay out the retiring partner.

Interest payments on a bank loan to purchase a retiring partner’s share is normally tax deductible, although there may be some restriction if residential property is involved, says Mrs Wright.

“As cash is being exchanged, capital gains tax will then be likely to trigger on the retiring partner and stamp duty land tax due on the purchasing partner.

“It may be possible for business asset disposal relief to apply in these situations, reducing the tax rate for the retiring partner from 20% to 10%, on up to £1m of gain.”

CGT can be quite significant when assets have been held for a long time; however, if the assets have been recently inherited, the gain may be minimal as the base cost will be at probate value at the date of inheritance.

Another option is that the partner leaving disposes of their interest in the partnership and reinvests the proceeds into a new farm or other qualifying trade elsewhere, Mrs Wright explains.

“In these situations, as long as certain conditions are met – for example, the farm is bought one year before or three years after the disposal of land and buildings from the previous partnership – they can roll over the capital gain into the new farm purchase, reducing the base cost of the new asset accordingly, therefore deferring the capital gain.”

How long will it take?

The process to split a business can take several years, depending on its complexity, with the need to get agreement between all parties the most time-consuming element, says Mrs Wright.