by Michael Cardwell and Tim Illston
If a non-corporate tenant enjoys a freely assignable tenancy of an agricultural holding, the conventional advice is that he should assign the tenancy to a family company. From that point, since a company does not die, the freehold owner would be precluded from serving a notice to quit under Case G of Schedule 3 to the Agricultural Holdings Act 1986 (“the Act”). The interests of the next generation in the tenancy would be assured by the ability to transfer to them the shares in the company. Accordingly, the criteria for succession set out in Part IV of the Act should not need to be satisfied — if, indeed, such succession rights were enjoyed at all.
However, before making such an assignment, the tenant should consider carefully the future structure for carrying on the farming activities. Some tenants may be content to incorporate their business, so that the assignee company carries on the farming activities. Notwithstanding the assignment to the company, others may prefer to continue farming as a sole trader or in partnership. The choice of the farming medium will very often be made on the basis of well-recognised tax considerations, which will generally centre on the perceived burden of tax on farming profits. In the majority of cases the decision is to continue the farming activities as before, either as sole trader or in partnership; but in these circumstances due regard may not be given to the legal status of the farmer on the land and the more specific tax implications peculiar to such a structure.
Where the tenancy is to be assigned to the company but the farming activities are to be carried on by a sole trader or partnership, five principal areas of concern may be identified.
First, the farmer’s future status on the land must immediately be determined. In some cases it may be decided that the assignee company should grant a protected subtenancy from year to year. If this is so, there would be advantage in the subtenancy being granted forthwith on assignment. Otherwise, following the assignment but before the grant of the subtenancy, the freehold owner might achieve, pursuant to section 6 of and Schedule 1 to the Act, incorporation of a covenant against assigning, subletting or parting with possession without his written consent. Indeed, by virtue of section 6, any subletting to the farmer would as a general rule be precluded as from service of notice requesting the insertion of such a clause.
Even if no formal subtenancy agreement is completed, there are strong arguments that the farmer would, nonetheless, acquire a subtenancy under section 2 of the Act, any licence enjoyed from the assignee company being converted into a tenancy from year to year (Snell v Snell (1964) 191 EG 361 and Sparkes v Smart [0] 2 EGLR 245 cf Chaplin v Smith [1926] 1 KB 198). That said, if the decision is to grant a subtenancy to the farmer, full documentation should be completed immediately on assignment to put the matter beyond doubt.
As an alternative, the assignee company may enter into a partnership with the farmer, that partnership carrying on the farming activities. This probably does not constitute a breach of any covenant against assigning, subletting or parting with possession, under the principle enunciated in Harrison-Broadley v Smith [4] 1 WLR 456 and Bahamas International Trust Co Ltd v Threadgold [1974] 3 All ER 881. However, following those decisions, it is axiomatic that the assignee company should actively engage in the farming, in order to demonstrate its continued possession of the holding. The resulting structure is complicated and at the same time fails to achieve the advantages of continuing to trade through the medium employed prior to the assignment.
Second, the assignment to the company may give rise to adverse tax consequences. While the decision of Baird’s Executors v Commissioners of Inland Revenue [1] 09 EG 129 and 10 EG 153 is most unlikely to be the final word as to the valuation of agricultural tenancies, it must be recognised that such an assignment may constitute the disposition of a valuable asset. For inheritance tax purposes there would be no transfer of value, despite the absence of full consideration, if the assignor beneficially owns the whole share capital of the company, since the value of the assignor’s estate would not have been diminished. Where that is not the case, the transfer of value may be reduced by ensuring that the assignor has at least a majority shareholding. An assignment to a company would not be a potentially exempt transfer but would be immediately chargeable (see section 3A(1)(c) of the Inheritance Tax Act 1984).
The transaction may also give rise to a chargeable gain for capital gains tax purposes. It is more than likely that a company established by the assignor would be a “connected person” with the result that if the consideration given by the assignee company is less than market value, the Inland Revenue may substitute market value in computing the assignor’s chargeable gain pursuant to sections 62 and 29A of the Capital Gains Tax Act 1979. If an allowable loss arose after indexation and the company is a connected person, by virtue of section 62(3) of the Capital Gains Tax Act 1979 that loss could be used only against gains arising on disposals to the same company.
Accordingly, the assignor may look for roll-over relief under section 123 of the Capital Gains Tax Act 1979, but this will apply only where the whole of the assets of the farming business are transferred in exchange for shares and the company takes over that business as a going concern. Where the farming activities are to be carried on by a sole trader or partnership under a subtenancy rather than by the company, section 123 will therefore not apply. However, relief may instead be sought under section 126 of the Capital Gains Tax Act 1979 to hold over the gain. Where the assignor has owned the agricultural tenancy since March 31 1982, its rebasing to market value at that date may mean that after indexation no chargeable gain will arise.
Third, the grant of a subtenancy to a sole trader or partnership following assignment may also give rise to adverse tax consequences.
There is a risk, if the company is a close company, that the shareholders may be treated as having made a transfer of value for inheritance tax purposes under section 94 of the Inheritance Tax Act 1984 should the subtenant not pay a full market rent to the company (so that section 16 of the Inheritance Tax Act 1984 does not apply). If, as is likely, the sole trader or a member of the partnership farming the land is a shareholder in the close company, the benefit of paying a rent below the full market rent could alternatively be treated as a distribution by the company to the shareholder by virtue of section 418 of the Taxes Act 1988. This section postulates the incurring of expense by the company in providing the benefit; the distribution is an amount equal to so much of the expense as is not made good to the company by the shareholder.
On the assumption that the subtenancy will not have a capital gains tax base cost, a substantial gain might arise on a subsequent disposal of that interest. Reliance would typically need to be placed on roll-over or retirement relief.
As is well known, the provision of living accommodation by a company to an employee or director may give rise to a taxable benefit in kind under sections 145 and 146 of the Taxes Act 1988. In the absence of a full rent the implications of those sections must be considered — see Stones v Hall [9] STC 138. The grant of the subtenancy could also give rise to an income tax charge in respect of benefits in kind under section 154 of the Taxes Act 1988. The scope of these provisions is wide and must be a significant factor in the context of family arrangements. However, any benefit so taxed would not be treated as a distribution under section 418 of the Taxes Act 1988, nor as a transfer of value under section 94 of the Inheritance Tax Act 1984.
Fourth, if the route of assignment and subtenancy is adopted and then subsequently the combined value of the tenanted interests is to be realised, for example by the freehold owner paying to secure vacant possession, the fiscal and conveyancing complexity would be increased.
In these circumstances, a correct valuation of both the headtenancy and the subtenancy is essential. As a matter of tax law, this should prevent any transfer of value for inheritance tax purposes. If the subtenant were to receive sums in excess of his due proportion, it is possible that those sums could alternatively be treated as a distribution, particularly where they pass through the company as “collecting agent”. At the same time care needs to be taken to observe company law. For example, if in order to maximise reliefs (such as roll-over relief or retirement relief) available to the farmer as opposed to the property-holding company, the majority shareholders were to procure that a disproportionate amount of the total proceeds payable by the freehold owner were channelled to the subtenant, the transaction could be viewed as unfair prejudice to minority shareholders. If the majority shareholders were also directors, they might be in breach of their duty to act bona fide in the best interests of the company. In practice, there is no substitute for the company and the subtenant instructing valuers independently.
The implications of value added tax must also be considered now that surrenders of tenancies in the course of furtherance of a business are subject to a charge at the standard rate. it may be that the freehold owner is prepared to register for VAT, “opt to tax” and seek to charge VAT to a subsequent purchaser. Alternatively, the freehold owner may be intending to carry on the farming business himself. In either case, he should generally be able to recover or obtain credit for VAT paid to the company on the surrender of the headtenancy. One option which may mitigate the burden of VAT payable by the freehold owner is for the subtenant to assign his interest direct to the freehold owner rather than to make a surrender to the headtenant. This should not be treated as a surrender for VAT purposes as the freehold owner is not a person for the time being entitled to the reversion of the subtenancy.
Finally, if milk quota is attached to the holding, there may be additional difficulties. For example, where the assignment and grant of a subtenancy trigger a change of occupation for the purposes of the milk quotas legislation and a transfer of milk quota, the freehold owner would be an interested party and his consent would be required before registration of the transfer by the Milk Marketing Board. Indeed the same principle would apply if the only transaction effected was an assignment to the company. Further, the original tenancy may carry all entitlement to compensation for milk quota on termination and quitting under the Agriculture Act 1986. This can be preserved on assignment of the original tenancy (para 3 of Schedule 1 to the Agriculture Act 1986).
However, the position is more complex if a subtenancy is also granted. In particular, for the tenant to sustain a claim, it is required that he either had milk quota allocated to him or was in occupation as tenant on April 2 1984 (para 1 of Schedule 1 to the Agriculture Act 1986).
These factors should not in any sense be thought an exhaustive list of items to bear in mind whenever a freely assignable agricultural tenancy comes to light. None the less, they do indicate that, before assignment, the benefits gained in the form of increased protection under the Act must be weighed against wider considerations and the effect of these is increased where a decision is taken to retain the existing non-corporate trading medium.
