The tried and tested business vehicle for most farm businesses was and is the farm partnership. In fact, the legislation relating to partnerships dates back to the 19th century and has operated successfully ever since.
Partnerships provide clarity on who does what, who owns what and how profits are allocated under the terms of the partnership agreement. In general terms, partnerships have the flexibility to cater for the succession of the business to the next generation in a clear and tax efficient manner.
While partnerships normally comprise a partnership of individuals, they need not be restricted to individuals. In recent years, for tax planning reasons, many farm businesses have brought in a new limited company as partner alongside the individual family members. The logic behind this is so that a portion of the farm profit can be allocated to the company which is taxed at the lower (20%) corporation tax rate thus building up funds in the business in a more tax efficient way, compared to individual partners who are subject to income tax at rates of up to 45%.
More recently, new income sources, such as income from wind turbines, has resulted in a further increase in the number of farm companies, again to access the lower tax rate but also with the added attraction of ring-fencing any potential liabilities within the limited company.
All of this is eminently sensible, above board and has been the preferred way of operating many successful farm businesses throughout Scotland in recent years.
Every silver lining has a cloud, and Chancellor George Osborne has said new legislation will be introduced, effectively putting a big stick in the spokes of successfully using limited companies as partners in a partnership business.
In essence, HM Revenue and Customs has woken up to the fact that a portion of partnership income is being allocated to the company partner and taxed at a lower rate, potentially resulting in a loss of tax revenue. The fact that any business can chose to operate as a partnership or a limited company seems to be lost on HMRC. Having a company in partnership with individuals to whom the company is connected is now perceived by HMRC as being a form of tax avoidance – albeit legitimate.
To counter this, new legislation is being introduced retrospectively from December 5, 2013, for all partnerships with a company partner. The change means that the profit allocated to the company is taxed instead on the individual partners so that income tax is paid on the profit, rather than a potentially lower rate of corporation tax.
There may be a number of exceptions to the reallocation of profits to the individual partners – most notably when the capital contributed by the company to the partnership is sufficient to warrant a reasonable return being paid to the company by way of profit share. This is a point which all farm partnership businesses with company partners will need to review carefully.
Although new legislation is not as yet on the statute book, now is the time for all farm businesses affected to speak to their tax advisers to fully consider the next steps. In some situations, a full incorporation of the farm business may be appropriate, in others the most practical solution may simply be to wind up the farm company. There may also be situations where companies in partnership can potentially still operate successfully within the terms of the new legislation, provided sufficient care is taken on the future allocation of partnership profits.
HMRC’s untimely intervention in the commercial workings of farm partnerships is unfortunate, but as always, farmers together with their advisers are well versed in coping with the best efforts of the bureaucrats be they European or home-grown.
Is this the death knell for the farm partnership? Certainly not. The partnership as the medium for successfully operating any farm business is likely to remain. What is clear, though, is that mixing companies with individuals in partnership may be that bit more challenging going forward. But with careful attention to detail, this could still work successfully, albeit slightly less tax efficiently.
Ewan Wallace is the farm tax partner with chartered accountants Johnston Carmichael at Elgin