Farmers were alarmed by changes to inheritance tax (IHT) in the October budget, with agricultural property (APR) and business property reliefs (BPR) being the greatest causes for concern.
Until now there has been no limit on the size of a farm or business eligible for APR or BPR, so the heirs of a farmer with assets of more than £15m would face the same IHT bill on death as those of a smallholder with less than £750,000 to their name.
But the budget changes all this: from 2026, the limit for 100% relief is set at £1m in total, for both APR and BPR. Above this, the relief drops from 100% to 50%.
APR and BPR have not disappeared; they have, however, been severely curtailed. In fact this is nothing new: until the early 1990s, the starting rate of APR was 50%, and there was no first tranche relieved at 100%.
The recent changes could nevertheless mean that even modest-sized farms take a big hit on the death of the owner if no succession plans have been made. But can the problem be avoided?
Issues with Treasury rationale
The Treasury published two tables in its policy paper on the reforms purporting to show that a modest family farm would largely be unaffected by the changes and relatively few estates would suffer from the changes.
There are two difficulties with the data, though. The tables dealt with APR and BPR respectively and separately, yet in fact a working farm qualifies for both reliefs: APR on the agricultural value of the land and buildings, and to some extent the farmhouse, and BPR on the plant, machinery and livestock. Development value can also be relieved by BPR. But the tables tell us nothing about the combined effect.
The other difficulty with the statistics not telling the full story arises from the skewed nature of agricultural statistics, because farm sizes do not follow a normal distribution curve. Consider the latest Department for Food, Environment & Rural Affairs (DEFRA) statistics for England 2023, for example, which deal with around 9m ha of farmland in England. Of around 102,000 holdings, just fewer than 40,000 are less than 20ha (around 50 acres) in farmed area. The land occupied by these holdings is just 4% of the total.
At the other end, 54% of England's farmed area is on just 11,213 holdings, run by a mere 11% of the country's farmers. This is to say that a lot of farmers farm a very small area between themselves, while a few farmers farm a much larger area in total. Ask yourself which are producing most of our food, and offer the greatest potential for environmental benefits?
This skewed distribution also accounts for the disparity between the mean, mode and median averages of UK farm sizes: the mean, over all farms, is 87.9ha, rising to 138.9ha if those below 20ha are ignored. The mode is in the bracket of those smaller than 20ha, rising to the 20–50ha bracket if we ignore the smaller holdings. The median farm by area is larger, in the 100–200ha bracket. This uneven distribution underlines the point that the bare IHT statistics do not therefore tell the whole story. But what are the correct figures?
DEFRA also publishes data for the net worth of farmers, derived from the annual Farm Business Survey (FBS). The latest figures for England dated from 2022/23, and range from £2,690/ha for tenanted farms to £33,800/ha for horticultural holdings. The figure for owner-occupied farms is £25,320/ha, within confidence intervals of 95%, meaning in the range of £23,680–£26,950. The all-farm average is £14,690/ha (just under £6,000/acre).
In DEFRA's terms, net worth entails adding up all business assets, including land owned, deducting all liabilities including outstanding mortgages; the figure you are left with is net worth. Land and property values are based on current estimates, so in some cases the market value of the property may be different.
These figures are not therefore a bad proxy for the value of the farming estate for IHT purposes, as the tax is levied on market values at the moment before the owner's death. They are also a good proxy for the values on which APR and BPR can be claimed.
Example shows how liability can be reduced
Take the threshold for the largest size in DEFRA's data on distribution of commercial holdings, set at 200ha. Using the net worth data above as a starting point for our example, 200ha at £14,690/ha, that amounts to £2.938m; remembering that more than half the farmland in England is on holdings of this size or larger, even if this only includes 11% of farmers.
If the farm is owned by one person – although that is a big assumption – we can see that the changes will have an effect. Previously, IHT on this farm would have been nil because of the combined effects of APR and BPR. Afterwards, however, the first £1m will still enjoy 100% APR and BPR, and the remaining £1.938m will be reduced by 50% APR and BPR. This will leave £969,000 chargeable to IHT at 40%, so the new tax bill will be £387,600, 13.2% of the net worth value.
The IHT bill could be even less if the £1m allowance for the nil rate threshold and the residence nil rate shared between spouses can be brought into the calculation. The £1.938m chargeable would then drop to £938,000; taxed at 40%, this would mean a liability of £187,600 or 6.4% of the net worth.
In this context, several possible scenarios could be used to reduce taxes. The first involves sharing ownership between farmer and spouse or civil partner. If they each own 50% of all the assets, their net worth is divided between them, and they also trigger another £1m of APR and BPR entitlement.
The important thing here would be to ensure that the couple own their respective shares in the land separately as tenants in common and bequeath these to their children rather than each other, because a spouse transfer on death would wipe out the benefits.
This alone could remove the IHT liability altogether, if a full £3m of relief could be available; that would be made up of the general nil rate band and residential nil rate allowance, worth £1m for the couple, plus two £1m allowances of APR and BPR. Furthermore the transfer of half the farm to the spouse would not trigger capital gains tax (CGT) because spouse transfers are exempt from this.
The second plan involves a gift of a part interest in the farm to the eldest child, who is in this example 40 years old and in a stable marriage, by a parent who is aged 70. Say that half the farm is transferred, which is worth £1.469m. This would be a chargeable transfer for CGT, but holdover (gifts) relief can be claimed to defer the payment of the tax, potentially indefinitely.
Provided it is an outright gift and there are no strings attached, this will count as a potentially exempt transfer for IHT. If the parent lives another seven years, the gift no longer counts towards their estate on death. This plan leaves the parent with a net worth of £1.469m, which could also be shared with the parent's partner or may be covered by parent's £1m APR and BPR at 100% and the general nil rate band and residence allowance.
The third plan is a three-way split between each of the couple and a child. Each ends up with £980,000, and all are now under the £1m limit and can claim 100% APR.
Farmers should make contingency plans
People rarely die according to plan. The parent might die within the seven years before the potentially exempt transfer becomes exempt. In that case, the transfer would use up their allowances, leaving very little, if anything, against the remaining estate on death.
A 70-year-old male still has a reasonable life expectancy, which in England doesn't drop to seven years until 81 to 82, and females have an even longer life expectancy. At 70 they could also take out a gift inter vivos policy, insurance that can pay the required amount if IHT does becomes due. Over the full seven years of cover required, this will cost about 1.5% of the value of the gift. The policy needs to be written in trust for the benefit of the child, though, so that the pay-out does not compound the problem by increasing the estate.
Another problem would arise if the child were to die before the parent. At 40 the child has a very good life expectancy, but farming has a high accident rate. A good life insurance policy would be a suitable measure in this case.
Divorce is another worry in these situations; however, divorce laws do now distinguish between marital and non-marital property. Pre-nuptial agreements are well known; less well known is the ability to create a nuptial agreement that would try to ensure that the property transferred is to be treated as non-marital property in case there is a separation later.
This is not bomb-proof, but does offer some protection. It means that the court will consider the nuptial agreement in the event of a divorce where the division of assets between the couple will have to be determined. Non-marital property is that which is considered to belong exclusively to one partner and not the other, the implication being that the owner keeps what is theirs after divorce.
There are also more sophisticated solutions involving trusts and limited companies. But it's clear that some simple restructuring could go a long way to protect a reasonably sized farm.
'It's clear that some simple restructuring could go a long way to protect a reasonably sized farm'
Other legislation will affects farmers' considerations
The government confirmed that the definition of agricultural property for IHT would be extended to include land in certain environmental agreements from April. While this is good news for land managers and farmers contemplating this route, the value of this extension will be limited by the new rules on APR that arrive one year later, unless changes are made before then. This may become a negative factor in weighing up the allocation of land to these long-term environmental agreements.
Tenancies created on or after 1 September 1995 have also qualified for APR at 100%, while those already in existence at the time were restricted to 50%. For all but the smallest landlords, the recent changes to APR bring a measure of equality as the £1m restriction does not apply to APR and BPR claims where the rate of relief is only 50%.
Trusts created before 30 October 2024 by the same settlor can have £1m of relief each, whereas the £1m must be shared by all trusts created by the same settlor after that date. This will have a bearing on the thinking of larger landlords who may be reluctant to disturb existing trust arrangements if this means the loss of the related relief.
The FBS data quotes an average net worth of £2,690/ha for wholly tenanted farms. On a simple division of this into £1m of relief, a tenanted farm would have to be at least 371ha to reach the 50% threshold.
The sorry figure in this story will be elderly or very sick farmers who have left it too late to rely on potentially exempt transfers to their children, and for whom the cost of gift inter vivos insurance is likely to be prohibitive. Perhaps some transitional measures may be in order here, for example, phasing in changes over a longer period with or without conditions on the future use of the land.
Nevertheless, careful assessment, evaluation and option appraisal are in most cases the answers. This is no time to panic; it is time to think carefully about the future.
Charles Cowap MRICS is visiting professor in land management at Harper Adams University
Related competencies include: Agriculture, Capital taxation, Environmental management, Valuation