Farm diversification: Why considering Inheritance Tax is key

The idea of farmers diversifying and using their land for non-farming activities is not a new one, but it is something that has gained traction. With multiple challenges facing farm businesses, diversification can offer a buffer against turmoil and, by having various income streams, go some way to protecting the farmer’s livelihood.

Popular types of diversification include camping and holiday lets, renewables, livery and equestrian and farm shops.

Any diversification requires very careful planning and it is sensible to take expert advice at the earliest opportunity. Carried out correctly, diversification can form a key part of succession planning, and help to ensure farmers can pass down a thriving business to the next generation. However, one element that is often over looked when it comes to diversification, is the impact it can have down the line in terms of Inheritance Tax (IHT).

The importance of estate planning

IHT is currently charged at a rate of 40% on the part of an estate above the nil rate band threshold of £325,000 (but this amount may vary depending on circumstances). For large estates this can present a significant amount of IHT. However, Agricultural Relief (AR) of either 100% or 50% is available for land and buildings used for farming activities.

AR only covers agricultural property and land that is used to grow crops or to rear animals intensively.  The relief is restricted to the agricultural value which may vary, sometimes significantly, from the open market value.  AR may  include:

• Stud farms for breeding and rearing horses and grazing
• Woodland, where ancillary to the main farming
• Trees that are planted and harvested at least every 10 years (short-rotation coppice) for renewable fuel
• Land not currently farmed but under an environmental land management agreement
• Some agricultural shares and securities
• Farm buildings, farm cottages and farmhouses

This is not an exhaustive list and is subject to change. For example, vineyards and cider making orchards have recently become eligible for AR, having been previously excluded.  It will also always depend on the particular circumstances.

When it comes to IHT, HMRC looks at farming estates in the round, taking into account the various ways the land is used and occupied, among other factors. As such, any activity which diversifies from agricultural use may risk the whole business not qualifying for AR.

However, Business Relief (BR) may instead be applicable. This is typically less generous than AR, but can still help to reduce IHT liability. In addition, BR is not always available, as to qualify the land needs to be used for trading and generating an income rather than investment purposes. The Balfour test stipulates a ratio of 51% trading to 49% investing in land. As such, when it comes to diversification there is a fine balance between qualifying for either AR or BR and losing all IHT reliefs. This 51 : 49 split has been the subject of reviews and may be altered, perhaps to an 80:20 split.

To put this into context, running a B&B would be seen as trade, but letting cottages out to holiday makers is seen as investing in the land unless significant extra services are provided. Similarly, running a full service livery yard may be counted as a trade, but renting out stables and field grazing to horse owners is seen as investing in the land. Farm owners should be particularly mindful of how the main farmhouse is used, as this is often a sizable asset. If AR is lost, relief on a farmhouse is likely to be lost, or at best extremely limited when relying on BR.

With all of these factors in mind, it is advisable to make estate planning part of any wider diversification business plans, as the implications for IHT can have a large impact on the type of diversification pursued.

Mitigating risks

With careful and expert estate planning, there are steps that farm owners can take to reduce their IHT liability. However, the rules around AR and BR are complex and HMRC takes a robust and thorough approach, so it is vital to access advice from a specialist.

For example, if losing all reliefs is a possibility due to the split between trade and investment activities, it may be possible to separate the farm business into trading and non-trading activities by creating separate businesses.  For example, if part of the land is to be used for an activity likely to be seen as investment activity and with a good income stream, such as a solar farm, then perhaps setting up a limited company may be beneficial. Any such structure should be discussed with your trusted advisors of lawyer, accountant and land agent. Alternatively, farmers nearing retirement may think about gifting some of the farm to the next generation. This can be done outright – in which case the giver will need to survive seven years from the date of the gift, otherwise the value of the land and/or property gifted will form part of the estate for IHT purposes.  However, if the giver fails to survive the gift by seven years all may not be lost if AR/BR applied to the gift when made and will continue to apply. It is worth keeping in mind that any outright gift may be liable for Capital Gains Tax (CGT).

It is also possible to pass any gift into a trust, although this may be liable for an immediate IHT charge of 20% if reliefs do not fully apply, with a further liability due if the donor does not survive for seven years. This option does have the benefit of being able to defer any immediate CGT bill however.

Any planning for lifetime gifting or for succession on death will also need to consider that AR and BR have from 6 April 2026 a capped allowance of £2.5million.

The right approach will depend very much on each farm owner’s circumstances and goals. What is important to remember is that there are options available to enable diversification while still minimising exposure to IHT. The key is to plan early.