Two weeks ago a fellow professional contributor to this column wrote about the Chancellor’s intention to crack down on tax avoidance.
The concern of the Chancellor is that tax advantages of partnerships are being abused. As a result there is a real threat to farming partnerships that have structured their business to include a ‘corporate partner’ in order reduce income tax and national insurance liabilities.
I have an alternative solution to consider. A contract farming agreement could be set up to utilise the existing limited company to reduce the tax liabilities of the farming partnership.
A contract farming agreement is established between the partnership and the limited company, with the partnership forming the role as the ‘farmer’ and the limited company forming the role as the ‘contractor’.
Both parties retain their individual identity as farm businesses in their own right.
The partnership would continue to provide the land and buildings and would form a new bank account ‘the No 2 account’.
The limited company would provide the labour, machinery and management expertise. The machinery would be transferred from the partnership into the limited company, and the employees would be ‘TUPEd’ across to the limited company.
The contract agreement would set out the terms of engagement, the operation of the contract, the formula for calculating remuneration to each party and termination procedures covering all eventualities.
Given that contract farming agreements are based on performance-related returns, it allows the transfer of profits out of the partnership and into the limited company, and hence enjoying the tax advantages previously experienced.
The role of the ‘No 2 account’ is to simplify administration. All financial transactions are undertaken in the farmer’s name and can be identified separately through the use of the No 2 account.
The costs paid through the No 2 account would be all the variable/inputs costs, together with certain agreed fixed costs.
The contract farming agreement would be tailored to suit both businesses with a view to reducing the tax liabilities. In doing so the contractor would be remunerated by an agreed formula. This comprises an initial fixed fee (the contractor’s basic fee) on a £/ac basis that contributes only partially to the contractor’s true costs.
The farmer would receive an initial ‘farmer’s retention’ to his main account, an amount likely to be a similar level to the contractor’s basic fee.
Following receipt of the final sales of the harvest year a divisible surplus is then calculated. This is the balance of monies ‘left in the pot’ after accounting for all incomings and outgoings.
A pre-agreed formula set out in the contract will determine the shares that should be allocated to both farmer and contractor.
In times of high volatility of returns, the use of two or three tiers of surplus share splits may be appropriate, and a suitable basis for such allocation will be determined by the likely forecasted profit that may be achieved.
From a tax viewpoint, once operational, the farmer’s input in overall planning is important. It is essential that minuted quarterly farm meetings are held.
HMRC have shown that they scrutinise contract farming agreements, with two high-profile legal cases.
Therefore it is important to take advice in order to ensure that a formal agreement exists and that the structure is at appropriate levels.
Whilst contract farming would offer a solution to the looming problem of the ‘corporate partner’, there are of course numerous other benefits.
Contract farming is becoming an increasingly popular alternative to a tenancy arrangement, given the freedom of contract.
The advantages are as follows.
Advantages to the farmer
* Avoids creation of tenancy or complex partnerships.
* Retains occupation of the farm with associated benefits, including both residential and sporting.
* Greater stability of returns.
* Retains taxation reliefs where applicable.
* Release of working capital.
* Benefits from contractor’s economies of scale.
* Incentivises the contractor to perform.
Advantages to the contractor
* Broadens the farming base.
* Achieves economies of scale.
* Cash-flow benefits quarterly or six-monthly payments enable forward planning.
* Opportunity for performance-related returns.
A contract farming agreement utilising the existing limited company will offer farming partnerships the same reduction in tax liabilities that they have previously enjoyed.
The nature of contract farming agreements allow for flexibility in the agreement, conversely, allowing for profit reallocation to be made successfully to the limited company which will enjoy the lower rate of corporation tax.
* Ian Hope is a partner with CKD Galbraith in the Alyth office.