by Chris Roberts and Barry Gamble
Since the March 1988 Budget, in which the Chancellor withdrew the income tax relief available for commercial woodlands, the market has altered significantly. As with most other fundamental changes new opportunities have been created while the attractions of others have been reduced. What, then, has been happening over the past two years: and where does forestry stand in the commercial property market?
Tax structure
The decision to remove forestry from the ambit of both income tax and corporation tax was motivated by the political realities of a concerted media campaign to reform forestry taxation. The Government, however, recognised the continuing need for a strong forestry industry and restated its support for an afforestation programme of 33,000 hectares (80,000 acres) of new planting a year. It replaced income tax relief by a new Woodland Grant Scheme which increased the level of direct aid from £240 per hectare (£97 per acre) to £615 per hectare (£249 per acre) for the planting of a commercial conifer crop. On many sites this grant can represent 50% or more of the planting costs and is, therefore, more favourable than relief at 40% under the old arrangements.
The exclusion of forestry from the income tax provisions also has a plus side: all income from timber is tax free.
The March 1988 Budget did not alter the capital tax incentives available to private clients which recognise the long-term nature of forestry. Capital gains arising from the disposal of business assets, such as land or goodwill, may be deferred by “rolling over” the gain into the land value of a forestry enterprise with the development costs relating to the capital infrastructure, typically new roads and fencing.
Timber itself is free from capital gains tax, so while the initial gains tax liability at 40% has been deferred, the future capital growth of the property, which lies largely in the timber, is exempt from tax. The 1989 Budget announced restrictions on holdover relief available on the lifetime gifting of property. Forestry’s classification as “business property” excludes it from these restrictions, and the holdover provisions, therefore, still apply to the gift of a forestry estate.
Under the inheritance tax regulations, forestry, after two years’ ownership, qualifies for business property relief at 50%, while the opportunity to pay the tax due by annual interest-free instalments over a 10-year period reduces the liability still further. An option to elect deferring the payment of tax following death until the timber is felled also exists, but needs to be exercised with caution as the increase in the value of the timber may raise the overall tax bill.
Yield
There has always been a substantial group of investors — mainly pension funds and insurance companies — which has been unable to take advantage of the tax arrangements available to individuals, but has still included forestry as part of an overall investment strategy. Returns of between 4.5% and 6% above inflation are achievable, and although perhaps not so rewarding in the short term as some more speculative investments, over the medium to long term the better forestry properties have kept pace with equities and outrun gilts.
Such projected returns assume that timber prices keep pace with inflation. Both historically and in the future real rises of between 1% and 1.5% are realistic and returns would, therefore, be further enhanced. A more difficult assessment is the yield associated with amenity, sporting and recreation. Although undoubtedly part of the equation, this factor does not have the hard parameters associated with most investment characteristics. Recent work suggests that the yield achievable from this element is 0.5% to 1%. Overall yields of between 6% and 8.5% in real terms are, therefore, indicated.
World situation
An investment in forestry is underpinned by both global and national considerations. Many studies have concluded that a world timber shortage is unavoidable within the foreseeable future; this has been brought about by over-exploitation of natural timber crops both in the northern coniferous area — largely the USSR and Canada — and the tropical rain forests. The felling of the rain forests is an important environmental issue, but the main commercial concern is with the coniferous forests of the north which, although accounting for only 21% of the world’s forest resource, supplies 70% of its industrial timber.
The pressure on this supply is set to intensify both from increased demand for products traditionally derived from this source and its increasing use as substitute for rain forest timber. The deficit, although identified, is not easy to correct in the short term as timber crops over much of the area concerned can take in excess of 80 or more years to mature.
United Kingdom
The United Kingdom has several natural advantages. A combination of favourable temperatures, a long growing season and rainfall evenly distributed throughout the year ensures tree growth which not only exceeds the volume of timber achievable by our major competitors but also means that we can often achieve it in half the time. We also have a surplus of land available which is suitable for planting.
At present only 10% of our land area is occupied by forests and at current rates of planting it is unlikely that we could reach the EC average of 24% even if planting continued at current rates for the next 100 years.
Imports into the UK of timber products have been on a continuing upward trend for many years, and at present amount to over £6.5b and 88% of our timber product requirements.
The combination of a balance of payments deficit approximately a third of our total import bill, predicted increase in demand against a shortage of raw material and our natural advantages within the international market produce the basis for the optimistic view of the future taken by those who have control of what is, in effect, a world commodity at source. The significant impact of timber in our balance of payments also accounts for the continuing support of the Government — albeit with a change in emphasis.
Processing industry
This bullish view of the forestry industry has also been taken by overseas processing companies. In the latter part of the 1980s some £1,000m has been spent by the processing industry, either in developing new sites or upgrading existing facilities. This expansion has come mainly from Scandinavia, but other European countries have been strongly represented as has Canada and, most recently, New Zealand, with Fletcher Challenge’s purchase of UK Paper. The point that comes across most strongly is that all the countries involved have strong historical involvement with timber and confidence in its long-term future. They also recognise the UK as being a particularly suitable source of supply with a positive forestry policy.
Post-Budget attitudes
The 1988 Budget did not, therefore, change the fundamentals of forestry investment, but it has changed the perception of forestry from outside the industry and the type of client considering forestry as an investment.
Prior to March 1988 much of the new money coming into forestry was tax driven and directed at planting extensive areas of bare land. Most of the costs in establishing a forest occur in the first few years and, under the old system, most relief was accordingly obtained during the early years of the forest life. Post-Budget attitudes have been concerned more with the performance of forestry as a straightforward investment. The tax benefits are valued, but used more to assist the planning of the type and age of forest required to maximise the efficiency of the investment than as the prime mover.
This has resulted in a strong market for well-established high-quality plantations and a weaker market for bare land suitable for planting. This latter trend is unfortunate as the increasing knowledge and technology presently available to the forester can ensure a higher productivity on land planted now than was achieved on similar areas in the past.
Planting land
The planting figures, down from a high point in 1988 of 29,000 hectares (72,000 acres) to an estimated 15,000 hectares (37,500 acres) in 1989, reflect the major change in the market. However, some of the more opportunistic investors, notably pension funds, have recognised the contribution given by the new high level of grants and have purchased and planted land which they would have not considered pre-1988.
Those with capital gains to roll over are also showing a strong interest in bare land properties. As relief is available on, primarily, the land element of a forestry purchase, the maximum efficiency is achieved where the land provides the major proportion of the purchase price. Additional relief is available on capital development items and the planting programme cost is substantially relieved by grants.
A typical example of such a property on the market at present is an area of some 260 hectares (642 acres) in south Scotland. Offers in the region of £113,000 are being sought with planting and development costs over a five-year period being estimated at £157,000 — these costs will be reduced by a grant contribution of £109,000, leaving a net £48,000. The total cost to the investor is, therefore, in the region of £161,000, of which £113,000 (land purchase price) and £10,000 on roads and fencing is available for roll over. This effectively means that capital gains tax liability at 40% can be deferred over 70% of the net costs incurred, with the additional bonus that the subsequent capital growth in timber value is free of tax.
For those prepared to invest in America the capital gains tax rollover position can be even more efficient as it is possible to roll over into both land and timber value. Forests in the northeastern states compare particularly favourably with those in the UK. Hardwood areas, which would cost £2,000 to £2,500 per hectare (£800 to £1,000 per acre) in the UK, can be purchased for around $625 per hectare ($250 per acre) in the US and, by careful structuring of the purchase, the inheritance tax benefits available to British forests can also be retained.
Plantations
The market in well-established and productive woodland has been particularly buoyant during the past two years. Not only have the traditional investors, major institutions, self-administered funds and individuals been active, but the interest of the new processors in acquiring a proportion of their long-term requirements in standing timber has introduced a new major player to the market. Further impetus has been given by the entry of a number of wealthy Europeans who, with changing conditions at home and within Europe, recognise the comparative value of British forests against those on offer elsewhere.
Notable recent sales have been the beautiful Invertrossachs Woodland where 890 hectares (2,200 acres) of relatively young woodland were put on the market at a guideline price of £1.1m and sold within days to a Scandinavian at, it is said, a premium of more than 30% of the asking price. The Raera Woodlands, around 2,500 hectares (6,000 acres), scarcely had time to appear on the market before they were purchased by a pension fund for over £3m. Typical prices of varying types of property are shown below.
Amenity woodlands
Although it is the major properties that make the news, sensible investment properties can be bought for around £50,000 — indeed some high-yielding woodlands can be justified at as little as £30,000 to £35,000. There are, of course, a great number of smaller properties for sale, but they usually fetch prices well in excess of their forestry investment value, particularly in the South East and close to the main population centres. They do, however, provide a great deal of enjoyment to their purchasers from the amenity and recreational aspect, and may also provide an element of speculation.
Mature woods
Established woodlands produce an almost ideal investment for inheritance tax planning, particularly for older clients. To take another example of a woodland currently on the market. Fingle Woodland, nearly 400 hectares (1,000 acres) in Devon, is being offered on the market at £1.625m. After two years’ ownership this woodland can be gifted, under the provisions of business property relief, at an inheritance tax value of around £812,500 which, in the event of a charge to inheritance tax, would suffer a tax bill of £325,000 instead of the £650,000 which would otherwise have been due. The tax liability can be spread equally over 10 years at a cost of £32,500 pa, leading to further savings of around 25%.
Owing to the age and diversity of this particular forest, the annual payments can easily be financed each year by timber income, leaving the beneficiary with, after 10 years, a high-value income-producing capital asset which has not required any additional funding to pay the taxes due on transfer. An interesting parallel in tax treatment can be drawn with an individual’s principal private residence; both provide tax-free capital gain, but the family home does not carry inheritance tax benefits.
Forestry Commission
Although numerous forests and woodlands are brought on to the market year in and year out, the availability of the more mature forests is low — who would sell an asset which is providing both tax-free income and capital growth unless forced to do so?
The recent announcement by the Forestry Commission that it is to sell 100,000 hectares (250,000 acres) of its forest estate — approximately 11% of the holding — should produce a wider selection of age ranges on the market, thus providing intending investors with a comprehensive choice of the most suitable age for them to enter the market. It is understood that sales are to be brought forward at the rate of around 10,000 hectares (25,000 acres) a year to avoid any imbalance in the market.
A previous programme of substantial sales did not lead to any appreciable softening of the market, but led more to an acceptance that the buying and selling of forests was as normal as buying and selling other properties. Previously, there was a misconception that forestry payouts were associated only with felling-timber after a long wait.
Conclusion
Forestry is a unique investment in property in that it demonstrates the organic growth of a world commodity with a secure market, and which is forecast to be in short supply. Age of crop and size of area allows flexibility in tax and financial planning, while the nature of the investment gives the added attraction of sporting and recreational benefits.
In many ways it could be said that the 1988 Budget raised the relative merits of the tax returns offered by forestry as it escaped the rise from 30% to 40% suffered on capital gains and still receives its income free of tax. As such it should be regarded as an unlimited PEP and should form part of any well-balanced portfolio. As a senior accountant recently remarked: “It’s outside tax, therefore it must be interesting.”
