Balfour structuring for rural Estates: what might be next?
Balfour structuring is a mainstay of inheritance tax (IHT) planning for rural Landed Estates.
Many diversified rural Landed Estates comprise agricultural land and buildings, woodlands, let residential properties and commercial properties. Under statute, agricultural property relief (APR) is applied first. However, this has its limitations. APR will not cover, for example, let or commercial properties on a rural Estate; nor does it apply to any hope/development value on agricultural land.
This is where Balfour structuring comes in. The case commonly known as Balfour established that where there is a composite business which is mainly trading, all the assets of the Estate within that trading business should benefit from business property relief (BPR), assuming they don't already benefit from APR. The Balfour case, HMRC v Brander, sets out several tests for determining whether a business is mainly trading for the purposes of BPR. The detail of those tests is a subject for another time!
In short then, Balfour provides a way to shelter investment assets - which looked at singularly would not benefit from APR or BPR - from IHT by bringing them onto a composite business which is mainly trading. Taking the original example, if the trading assets (in-hand farms and woodlands) outweigh the investment assets (let farms, properties and commercial buildings) these latter assets will benefit from BPR assuming they form part of the Estate's composite trading business.
The purpose of this article is to consider how Balfour structures - normally partnerships or single trades - might be affected by possible upcoming legislative and policy changes.
The Office of Tax Simplification's (OTS) 2019 report on IHT
The OTS has now been disbanded. However, its 2019 report on IHT remains, for most commentators, the most credible indicator of the sorts of changes we might see to these reliefs in the coming years.
Increasing the trading threshold for BPR
Capital gains tax (CGT) includes a number of reliefs for trading businesses. However, a business has to be 80% trading in order to qualify, rather than the lower threshold of 50% required under the BPR rules. The OTS report suggested that the BPR threshold could be increased to bring the two taxes into line.
This would make Balfour structuring less potent. As mentioned, the Balfour matrix comprises a number of tests for judging whether a business is mainly trading. Capital asset values are one such test and, taken in isolation for illustrative purposes, can show the impact of this potential change.
Under current rules, a Balfour structure with £5.1m of trading assets can still be mainly trading with up to £4.9m of investment assets within the business. If the trading threshold is increased to 80%, this structure would no longer be mainly trading and no BPR would apply. If the business includes assets which, on their own, would qualify for BPR, but not APR, you will actually end up in a worse position by leaving them in such a structure. This is because these "BPR potential" assets will no longer benefit from BPR because they are part of a larger composite business which (no longer) counts as trading. This unenviable situation is often referred to as a "reverse Balfour".
If the BPR threshold were to go ahead, existing Balfours would must likely need to be restructured to remove investment assets from the business. If these assets included land, and the structure were a partnership, there could be a nasty stamp duty land tax charge if extracted within three years of establishment.
New Balfour structures would shelter fewer investment assets. Continuing the example above, an estate with £5.1m of trading assets could only be combined with £1.2m of investment assets in order to satisfy the 80% test.
The move would also likely see a further drive towards in-hand farming. In-hand farms are trading assets for the purposes of Balfour whereas let farms are investment assets. Taking farms in hand would therefore enable the trading part of the Balfour matrix to be increased, supporting a shelter for more investment assets.
On the upside, the OTS report also suggested that furnished holiday lets should be considered a trading activity for IHT purposes, thereby aligning how they are treated for income tax and CGT purposes. Where estates have these assets in Balfour structures, this would move them over to the trading side which would help the matrix.
The Rock Review
The Rock Review was an independent report completed in 2022 which focused on the tenanted agricultural sector.
Currently, let farms benefit from APR if they have been owned by the landlord for seven years and farmed throughout that period by the landlord or another. The applicable rate of APR is normally 100% if the farms are let on a farm business tenancy (FBT) or 50% if the farms are let on Agricultural Holdings Act tenancies (AHA).
Attitudes to let farms are currently mixed. If there is no development value, they are normally left out of Balfour structures (given they are investment assets) and, in any event, they already benefit from IHT relief due to APR. That said, many Estates have taken the opportunity to bring the farms in-hand as tenancies (particularly AHAs) end. As mentioned above, in-hand farms are trading assets and therefore support a Balfour matrix.
The Rock Report is alive to this and notes that tax is a key driver in agricultural landlord behaviour. In particular, it notes that the current regime encourages a move towards in-hand farming.
A key focus of the Rock Report is the relationship between APR and environmental schemes. The report reflects that in order to become involved successfully with environmental schemes, tenant farmers require long-term commitments. It therefore advocates for:
- a tax system which incentivises landlords to grant longer FBTs; and
- a broadening of the definition of "agriculture" to encompass environmental schemes so that participation in such schemes does not remove the land from the scope of APR.
More specifically, it recommends that 100% APR should be restricted to FBTs of at least eight years or more and that the same land would qualify for BPR on any non-agricultural value and be entitled to declare income as trading income.
If this were to be enacted, it would likely to lead to a clear bifurcation in behaviour. The well-advised landlord would likely either:
- take land in hand in order to secure both APR at 100% on agricultural value and BPR at 100% on any hope value; or
- grant FBTs of more than eight years in order to secure the same result.
As the IHT outcome would be essentially neutral, broader commercial considerations would likely drive the decision - for example, the relative risk profiles between in-hand contract farming arrangements v longer FBTs.
FBTs of under eight years would virtually disappear. Although the Rock Report is not clear, the suggestion seems to be that these might enjoy 50% APR (and no BPR) and would therefore represent a much more inferior option (in IHT terms).
Subject to the detail of the legislation, either option may lead to an expansion of existing Balfour arrangements in order to leverage the trading status of the restructured agricultural land. These kind of structures would therefore continue to play an important role in rural Estates.
Conservative and Labour policies
There is little well-thought detail on this. As is well known, rumours of abolition swirl around the Conservative camp although these are being met by scepticism. Needless to say, were IHT abolished, Balfour's raison d'être would disappear.
Over in the Labour camp, the Times made headlines recently with the suggestion that APR and BPR are "loopholes" which could be closed. This mainly seems designed to place Labour in direct opposition to the Conservatives and is being put forward as part of Labour's narrative of reducing tax avoidance.
There has been some suggestion that, in terms of APR, this might mean either removing APR from let farms, or reducing the rate to 50%. According to the Rock Review, 64% of the total farmable area in England is let; or 45% of all holdings. The impact of this would therefore be huge. It seems likely that the tenanted sector would collapse as landlord brought land in-hand in order to secure 100% APR and BPR. This could have a profound impact on the wider UK agricultural sector - in the words of the Rock Review: "Tenant farmers are small businesses, innovators and, partly driven by the need to pay rent, can be the engine of efficiency and productivity improvements for the sector". Any attempt to reduce APR on tenanted land is therefore likely to be met by strong opposition by landlords and tenants alike. Nonetheless, if it were to go ahead, the huge uptick in in-hand farming would be a boon for Balfour planning.
In terms of BPR, it is most likely that the “loophole” which Labour has in mind is the availability of BPR to AIM-listed shares. It seems unlikely that BPR would be removed in its entirety given Labour's “Start-Up, Scale-Up” agenda to make Britain the best place to start and grow a business. If correct, any changes that Labour might make to BPR are likely to have a limited impact on Balfour structures.
