11 December 2018

The pros and cons of incorporating farming partnerships

There are a number of factors to considering whether to incorporate your farming business

It may look like an attractive option to incorporate your farming business and take advantage of the lower rates of corporation tax (currently 19%) instead of income tax rates of up to 46% but there are a number of other factors to consider.

Incorporation will generally involve the existing sole-trader or partnership disposing of assets to a newly formed company of which they will be directors and shareholders.  The individual or partners will therefore be connected to the company for tax purposes and so these disposals will be deemed to take place at market value.  This could result in a substantial capital gains tax liability but no cash available to pay the tax.  The company won’t have any cash so payment for the business will have to be made in the form of loans and/or shares.  Incorporation relief is available where all assets except cash are transferred wholly for shares. This effectively rolls the gain over into the base cost of the shares thereby deferring the tax bill.

There may also be Land and Buildings Transaction Tax payable if any cash is received or debt connected to the land and buildings is transferred to the company.

There are also additional costs for companies holding residential property.  Where the farmhouse is occupied by the new company directors there will be a Benefit in Kind.  There is an Annual Tax on Enveloped Dwellings on any residential property worth at least £500,000.  In addition, the Agricultural Property Relief on the farmhouse may be at risk.  It is worth noting that minority shareholdings do not attract Agricultural Property Relief.

For those farming businesses that hold land with significant development value it is also important to preserve Business Property Relief as APR only covers the agricultural value of land, not the market value.

It may be advantageous to partially incorporate; specific areas of the farming business can be transferred to a company.  These would generally be the most profitable enterprises.  This also means that land and buildings can be kept out of the company, the owners may let the land to the company under a tenancy agreement.  Such a structure should preserve APR as it is not who uses the land that is important but the use to which the land is put that determines whether land qualifies.  This should also preserve APR on the farmhouse.

In an unincorporated business the owners are taxed on the full profits of the business regardless of how much cash they take out.  There is greater flexibility with a company; the directors can decide how much they wish to withdraw from the company and only pay tax on those withdrawals.  Profits can be extracted in a number of ways; in the form of salary, dividends, rent for the land or interest on any amounts due by the company to the directors or shareholders. 

There is no one solution to fit each farming business, a detailed review of the business and the owners' requirements should be made before a decision is reached as any income tax savings could be wiped out by the potential additional capital gains tax and inheritance tax payable.