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Readers' Forum - Replies to Queries - 2

25 February 2002
Issue: 3846 / Categories:
Tax on compensation
We act for a tenant farmer, who has been offered substantial compensation to quit the farm, as the landlords want to obtain planning consent on the buildings. The farm is run by a husband and wife partnership (both aged 40) and the tenant's share of milk quota has been paid out to help fund a new shed.
Our queries, based on the assumption £200,000 is received, are:

(1) Can part of the compensation be deemed to be for the farmhouse and hence tax free under the principal private residence rules?
Tax on compensation
We act for a tenant farmer, who has been offered substantial compensation to quit the farm, as the landlords want to obtain planning consent on the buildings. The farm is run by a husband and wife partnership (both aged 40) and the tenant's share of milk quota has been paid out to help fund a new shed.
Our queries, based on the assumption £200,000 is received, are:

(1) Can part of the compensation be deemed to be for the farmhouse and hence tax free under the principal private residence rules?
(2) Is there any part of the compensation that is tax free anyway (for example, four times rent)?
(3) Is the balance of the compensation after the above eligible for maximum business asset taper relief (after 5 April 2002)?
(4) Is the gain taxable on the tenant farmer, or the partnership?
(Query T15,961) - Landlover.


One issue needs to be cleared at the outset: what happened to the milk quota? Although this can only pass by attachment to an interest in land, and could therefore only have been acquired by the tenant of record, it is recognised as permissible for this to be held upon trust for a partnership not holding a tenancy as partnership property: see Swift v Dairywise Farms Ltd [2000] 1 All ER 320, at 327j. If, however, it was issued to present partners as 'farmer' when the scheme was first instituted, then no trusteeship is required. In these circumstances, the funding of the new shed may have been accompanied by a roll-over for capital gains tax purposes under sections 152(1) and 155, Class 1, Head A.1 and Class 5, Taxation of Chargeable Gains Act 1992. There could be a problem here, since the concept of 'tenant's quota' is not one known to jurisprudence. The proportion of the proceeds of sale which the tenant has to pay to the landlord to obtain his consent to the transfer of quota does not represent a separate asset. The whole of the quota 'belongs' to the tenant, and what he pays to the landlord is a deduction from the 'consideration' under section 38(1)(b), Taxation of Chargeable Gains Act 1992 rather than a reduction in the amount of the consideration. Under section 152(1), it is the gross consideration which has to be taken into account.
It also needs to be borne in mind that, by electing for a roll-over, the taper clock restarts in relation to the asset rolled into: see section 2A(4), Taxation of Chargeable Gains Act 1992. The separation of buildings from the land on which they stand is a fiction which exists for roll-over purposes only, and the effect of a roll-over in these circumstances is unclear. As a general rule, taper differs from indexation in ignoring the date upon which enhancements were made: see paragraph 14 of Schedule A1 to the Taxation of Chargeable Gains Act 1992.
The end result may, however, be to make the status of the asset disposed of in return for the compensation to be paid by the landlord of more critical importance than appreciated. In order to determine this, it is first necessary to ascertain who owns the asset disposed of through the receipt of a capital sum within section 22(1)(c), Taxation of Chargeable Gains Act 1992. It is not stated when the tenancy commenced, but the sum suggested makes little sense if it was not one granted before 1 September 1995 under the Agricultural Holdings Act 1986.
Such tenancies are normally non-assignable. It is therefore unlikely that the landlord would be willing to accept that it was held on behalf of the partnership, even assuming the tenant of record to be one of the partners. If the tenancy is a partnership asset, then the gain made on the section 22(1)(c) event is deemed by section 59(b), Taxation of Chargeable Gains Act 1992 to have been made by the husband and the wife in the proportions in which they share profits. In such circumstances, paragraph 5(2)(a) of Schedule A1 to the Taxation of Chargeable Gains Act 1992 attributes business asset status for taper purposes. If, as is more likely, the tenancy is not a partnership asset, but the tenant of record is one of the partners, then the whole gain will be attributed to that partner, and the same provision gives business asset status. Only if the tenant of record is not a partner will business asset taper not be available.
In principle the whole of the sum received will be within the charge to capital gains tax but, if the landlord, either through choice or by arrangement, uses the notice to quit procedure (which will, in these circumstances, usually have to be after planning consent has been granted), then the sum he is required to pay by statute will be excluded from the consideration brought into charge, up to the limit laid down by section 60(3)(a), Agricultural Holdings Act 1986: see Davis v Powell [1977] STC 32, and Davis v Henderson (SpC 46), respectively. The particular circumstances may provide for a higher basis of compensation than the rental multiple, but the excess will be brought into charge under section 22(1)(c), Taxation of Chargeable Gains Act 1992.
That sum may be reduced under a three-step process by a claim for main residence relief, assuming all the criteria to be present. First, the proportion exempt under Davis v Powell will have to be excluded from relief. Second, there will have to be a valuation of the dwelling house element as a proportion of the whole. Third, there will have to be added back into the chargeable proportion an allowance for any exclusive business use of part or parts of the farmhouse under section 224(1), Taxation of Chargeable Gains Act 1992. Provided that the tenant of record is one of the partners, it matters not that his or her occupation is 'as partner'. Section 222(1), Taxation of Chargeable Gains Act 1992 does not require the interest of the occupant claiming relief to be one which is 'in possession'. - Zibultong.


If the agricultural tenancy was brought into existence before 1 September 1995, it will fall within the provisions of the Agricultural Holdings Act 1986. Most agricultural tenancies are annual tenancies, that is they only last for one year but are automatically renewed for another year unless action is taken to bring them to an end. For capital gains tax purposes, an agricultural tenancy is treated as one continuous tenancy, not as a series of one-year tenancies.
The Inland Revenue considers that such a tenancy should be treated as a wasting asset when the tenant's life expectancy becomes less than 50 years. Its judgment of the predictable life expectancy of the tenant is based on actuarial evidence. The tenancy may also have a base cost if it was either purchased (unlikely) or was in existence at 31 March 1982. Unless there is evidence that the tenancy was marketable at 31 March 1982, any value at that date is likely to be small, based on the profit rental approach adopted by the Lands Tribunal in Walton (Walton's Executors v Commissioners of Inland Revenue [1996] STC 68).
A landlord can terminate a tenancy by serving a notice to quit if he has grounds for doing so. Various grounds for serving a notice are specified at Schedule 3 to the Agricultural Holdings Act 1986. Where a notice to quit is served, the tenant will be entitled to statutory compensation, except where the notice is served under Cases C to G of Schedule 3 to the Agricultural Holdings Act 1986 because the tenant is in breach of his tenancy, for example because of failure to farm the holding properly, failure to pay rent or comply with some other term of the tenancy.
The amount of the statutory compensation is normally five times the annual rent of the holding immediately before the tenancy ends. In some cases it can be higher if the tenant makes a claim based on actual loss of profits. Following Davis v Powell [1977] STC 32, statutory compensation payable under section 60, Agricultural Holdings Act 1986 is not chargeable to capital gains tax. The tenant may also be entitled to compensation for improvements to the holding which cannot be removed when the tenancy is terminated, either under section 64, Agricultural Holdings Act 1986 or under section 16, Agricultural Tenancy Act 1995. These amounts will also be not chargeable to capital gains tax following Davis v Powell. In addition to the statutory compensation, the tenant may be paid additional amounts for agreeing to forgo his normal period of notice, so that the landlord may gain early entry. These amounts will be liable to capital gains tax.
The Special Commissioners' cases of Davis v Henderson (SpC 46) and Pritchard & Purves (SpC47) together with the Inland Revenue Capital Gains Tax Manual (at paragraphs CG72388 to 72402) all suggest that the Revenue is unwilling to accept that any part of the compensation is statutory compensation unless a notice to quit has been served by the landlord prior to the surrender.
The sum paid in addition to the statutory compensation arises from the tenant giving up his rights under the tenancy and, if the tenancy includes a farmhouse that is a dwelling house within the meaning of sections 222 to 226, Taxation of Chargeable Gains Act 1992, there is no reason why part of the chargeable proceeds should not be apportioned to the dwelling house. The Revenue appears to accept this in practice. The question of what fraction of the compensation may be apportioned to the farmhouse will be one for a valuer to consider.
If the farmland and farm buildings within the tenancy have been used for the purposes of the trade carried on by a partnership of which the partner is a member, the tenancy will qualify as a business asset for taper relief purposes by virtue of paragraph 5(2)(a) of Schedule A1 to the Taxation of Chargeable Gains Act 1992.
Any compensation will be due to the tenant, and it is the tenant who will be charged, unless it can be demonstrated that the named tenant holds the tenancy as bare trustee for the partnership, in which case the partners will share the gain either as the partnership deed directs or, in the absence of a deed, in the same way that capital profits are shared.
What is meant by the statement that 'the tenant's share of the milk quota has been paid out to help fund a new shed' is not clear.
If the displaced agricultural tenant was a dairy farmer, he will have been obliged to transfer the farm's milk quota to the landlord when the tenancy came to an end. The Agricultural Holdings Act 1986 provides that the tenant should receive compensation in such circumstances. Even if the compensation received under that Act is exempt from capital gains tax, the compensation for the loss of the milk quota will be within the scope of capital gains tax. If instead of paying the tenant compensation, the landlord agrees to contribute to the cost of a new building constructed on the new holding, the contributed cost will be the consideration received for the disposal of the 'tenant's share' in the quota.
If the partnership, rather than the tenant, was the registered milk producer, the Revenue will accept that the compensation paid, in cash or kind, for the transfer of the quota to the landlord, is assessable on the partners rather than the tenant. The Revenue's view is that milk quota is a separate asset from the land, to which it attaches for the purposes of identification, and therefore does not have a base cost, unless it was purchased. The view is based on comments made in the European Court cases of Wachauf and Von Deetzen (neither of which were tax cases) and the Special Commissioners' decision in Cottle v Coldicott (SpC40) (which is not binding). It is debatable whether that analysis is correct in the case of a tenant farmer, and a case may be brought before the Special Commissioners to test this in the near future.
Any gain arising on the disposal of the milk quota will also be eligible for taper relief at the business asset rate if it has been used for the purposes of the partnership's trade since April 1998. - Hayloft.
Issue: 3846 / Categories:
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