Proof of purpose: IHT and APR

This article is based on recent protracted negotiations with HMRC in relation to an estate with several let farms, regarding entitlement to agricultural property relief under the Inheritance Tax Act 1984, Part V, Chapter II.

There are two timescales involved during which it is necessary to prove to HMRC that farm cottages are occupied for the purposes of agriculture, namely the two years prior to the date of death in the case of owner occupied farms, and the seven year period prior to the date of death in the case of the ownership of let farms.

If a farm cottage is rented out by the tenant to someone not involved with the farming operations it will not qualify for APR, as it will be regarded as an investment.

If a cottage is used for holiday lets it will not qualify for APR. It is also unlikely to qualify for business property relief, unless substantial services are provided such as catering.

HMRC will investigate the position regarding each cottage individually, and seek proof that it was occupied for the purposes of agriculture in relation to the farm on which it is situated for the relevant period. They will ask who occupied the cottage, and there may have been a succession of occupiers, and what they did. The onus of proof is on the taxpayer.

In HMRC v Atkinson [2012] STC 289, Warren J at para 18 said: “The search is for some sort of connection between the residential use of the cottage and an agricultural purpose sufficient to make the use occupation for the purpose of agriculture.”

Factual permutations

Where the farm is owner occupied, records of who occupied the cottage and what they did in support of the farm should be readily available, but it is a different matter in the case of a let farm, where the landowner is unlikely to have the relevant information available for the seven year period. The landowner in these circumstances would require to obtain the information requested by HMRC from the tenant, and experience is that, even where the tenant is helpful, the records and information can be lacking in sufficient detail.

Where the cottage was occupied by a farm servant who worked on the farm, there should be no difficulty, and employment records including PAYE records can be produced. Where there was a gap between employees, this will be questioned where it is more than a short time and information requested on what steps were taken to find a replacement employee, for example a copy of advertisements. If a full time employee is replaced with a part time employee this will also be challenged, but provided regular specific tasks are identified and the hours to be worked are reasonable, this should be accepted.

A cottage which is occupied by a retired employee who worked on the farm or his widow qualifies for APR. This is an HMRC concession.

If a cottage is vacant for a period for the purpose of renovation or upgrading – the Housing Act requirements would be a good argument – the work requires to be done expeditiously, and if the time involved is considered by HMRC to be too long they will disallow APR.

HMRC will make their own interdepartmental investigations. Tax records can throw up details of where an occupier of a cottage worked, prompting an assertion that they were not working on the farm and therefore the cottage was not occupied for the purpose of agriculture.

This situation can arise where a son or daughter of a farming family occupies a cottage and has regular input in support of the business with or without any payment, but had employment elsewhere having a need to earn money to live. Regular and substantial input to the business should be sufficient for the cottage to qualify for APR.

Assistance when asked

The most difficult situation is where a cottage is occupied on the basis that the occupier does not pay any rent but will provide assistance on the farm when asked, in exchange for the use of the cottage. In that situation the occupier will normally have a full time job. This situation has become more common with the increase in mechanisation and the reduction in the number of farm employees required by the business. (Gone are the days when a farm of 120 acres was worked with two pairs of horses and cottage accommodation was provided for the horsemen employees as part of the fixed equipment of the farm. Such cottages are often still included in many old leases.)

The essence of the arrangement is that the occupation is for the purposes of agriculture – work on the farm. The occupier’s family can also be involved. Input can be based on expertise such as lambing, maintenance of farm machinery and fencing, or general such as assisting with stock movements on the public road, recovering escaping stock and general supervision. The presence of occupants of cottages on the farm is an important security benefit against theft of equipment, rustling of stock, fireraising and other vandalism, all of which is now prevalent in rural areas. APR has been allowed in such situations, but had to be supported by a complete list of occupiers of each cottage during the relevant period, with details of their supporting activities and statements from the farm tenants explaining their need for support. A considerable amount of work was required to provide the information, including searches of the voters' roll over the seven year period.

Support for the argument could also be found is the definition of a cottar: “In Scotland and Ireland a farm worker who in return for a cottage gives labour when required”.

The message for the estate owner with let farms with cottages included in the leases is to build a record of the occupiers of each cottage, the basis on which they occupy the cottage and what work they do on the farm in support of the farming business, and to update this on a regular basis, say every six months. A suitably worded form completed by the tenant at the time when the rent is paid would be a useful approach. The relevant information would then be readily available to support a claim for APR if an IHT situation arises.

Farmhouse case study

In the case of one of the let farmhouses, a tenancy under the Agricultural Holdings (Scotland) Act 1991 was transferred by the tenant to one of his daughters 18 months before the end of the seven year period. The daughter and her husband lived on a farm a short distance away where they carried on their own farming business. The former tenant and his wife continued to live in the farmhouse. The farm was run very much as a family business with all members of the family assisting with the work when required. The former tenant continued his regular input to the farm business for the remainder of the relevant period. HMRC, founding on Rosser v Inland Revenue Commissioners [2003] STC (SCD) 311 at para 53, maintained that the farmhouse was not occupied by the tenant subsequent to the transfer of the lease and therefore did not qualify for APR. The farmhouse clearly continued to be “occupied for the purposes of agriculture” in relation to the farm and HMRC eventually accepted the position.

In a similar situation the provisions of s 16A of the 1991 Act, which provide that, if there is a residency clause in a 1991 Act lease and the tenant does not reside on the farm, if irritancy is avoided the tenant requires to “ensure that a person who has the skills and experience necessary to farm the holding in accordance with the rules of good husbandry resides on the holding”, would also provide a useful argument.

HMRC sources

Inheritance Tax Manual – Practice Note 10: Part 1, Identification of Agricultural Property
IHTM24017 – Overview of agricultural relief: deceased as landlord
IHTM 24030 – Agricultural property: definition of agricultural property
IHTM 24034 – Agricultural property: Farm Cottages
IHTM 24037 – Agricultural property: Agricultural “property”
IHTM24038 – Agricultural property: Farmhouses