Contract farming can be good deal

Contract farming has become an increasingly popular way to manage land. The main reasons farmers enter into these agreements are to free up capital invested in equipment, free up time and, in many cases, the new structure can generate a better return than the previous in-hand farming operation.

Active farmers also enjoy a number of favourable tax breaks. It is important that these agreements are properly set up and administered to ensure that these are achieved.

A properly constructed contract farming agreement should afford the landowner or ‘farmer’ the ability to claim agricultural property relief (APR) and business property relief (BPR) for inheritance tax (IHT) purposes and the ability to claim business tax reliefs for capital gains tax (CGT) purposes.

This could be the difference between paying 40% IHT on the value of the assets on death or receiving full relief, and the difference between paying 28% or 20% CGT on a disposal rather than a reduced rate of 10%.

Where a contract farming agreement has not been set up properly, or has not been operated in the correct manner, there are risks that the tax reliefs mentioned above will not be available.

This could have a huge impact in the event of a land disposal or on death.

There are a number of things that a farmer can do to ensure that his business is treated as trading.

The implementation of the farming policy for the land should be the responsibility of the farmer. It is a key requirement that regular meetings are held between the contractor and the farmer in order to discuss the cropping or livestock management plans.

These meetings should be documented for reference purposes.

There have been cases where an agent has undertaken the implementation of the farming policy on the farmer’s behalf, with the farmer not undertaking any active management, and tax relief has been lost.

It is, therefore, very important to ensure that the farmer is active in their role.

The farmer needs to be exposed to risk through a contract farming agreement in the same manner as any other farming business would be.

If there is an agreed return in the contracting agreement and the farming operation makes a loss in the year, the farmer must share in this loss.

If the agreement states that the farmer’s loss in one year is to be carried forward and paid out of subsequent years’ profits, then there is a danger that HMRC could view this as a glorified rental agreement between the parties and not a trading business.

It is very important that the farmer keeps good accounting and farm management records. The former are needed for the production of VAT returns and the annual accounts and the latter will be needed for IACS etc.

The accounting records kept by the farmer will be used not only to produce their year-end accounts and tax return forms, but also to produce the contract farming accounts for the harvest period in question.

It needs to be remembered that the farmer/contractor relationship is neither an employment nor a partnership. The contractor will raise an invoice for work done with VAT charged, the farmer will then be able to reclaim this VAT.

Where the farmer agrees to pay the contractor a bonus to reflect good performance in the year, the contractor should raise an additional invoice to the farmer, charging VAT for the agreed amount.

Contract farming agreements can create a very attractive way to manage land. With the correct professional advice and good management, they can deliver huge benefits to the farmer and contractor.

Robert Young is manager of EQ Accountants LLP’S Forfar office.