Farmers and landowners must be able to show they are operating their assets on a commercial basis if their estates are to qualify for tax relief when they die, a Midland specialist has warned.

George Thomas, of Savills, was speaking following a recent case relating to business property relief (BPR) brought by the executors of the late Fourth Earl of Balfour.

The result of the action against Revenue and Customers (HMRC) helps clarify the position on relief from inheritance tax for diversified rural businesses, said Mr Thomas, who works from Savills’ Oxford office.

“Whilst government policy has actively encouraged farmers to add other income streams to their core business, doing so could prejudice future eligibility for BPR,” he said.

Mr Thomas explained that generally a farm or estate actively managed by its owner – deemed as having an “in-hand” trading element – may qualify for BPR.

This reduces the tax payable at death on the market value of the business and its assets by between 50 per cent and 100 per cent.

The inheritance tax regulations state, however, that relief is not available where the business consists “wholly or mainly… of making or holding investments”.

“Following the case of Farmer v IRC 1999 it became clear that an element of investment activity was acceptable provided that the trading activity dominated,” Mr Thomas said.

“Certain indicators proving this to be the case were required including capital used, turnover and profit generated, employee and management time spent and the historical connection between the properties.”

In the case of the Fourth Earl of Balfour, a Scottish laird who died in 2003, the Revenue disputed the claim for BPR on a number of grounds. The Tax Tribunal had to consider whether the estate was run as a single business for the requisite period (two years) and whether the investment activity dominated.

Lord Balfour’s Whittingehame Estate in East Lothian comprised 1907 acres including 665 acres farmed in-hand, 917 acres let out and 308 acres of woods and parkland. There were also 26 houses and cottages and two commercial premises.

The tribunal chairman decided that the business was run as a whole despite separate bank accounts and VAT registrations for the “farm” and “estate” elements. One person had overall control and the accounting separation did not impact on day-to-day management.

Overall the in-hand farming enterprise turned over more than the investment activities and the balance of time spent was on the farms.

The residential components were considered ‘an important part of the overall business’ and had a strong historical association with the estate.

The cottages, for example, were let to tenants who might be able to benefit the estate.

The owner’s business skills were required for all parts of the business.

Mr Thomas said the chairman considered where “the preponderance of business activity” lay and concluded that the letting activity was ancillary to the rest of the business. He did not consider an analytical approach appropriate, rather it was “a matter of more general assessment and impression as to where the preponderance of business activity lies”.

“This decision may yet be appealed by HMRC but advice to landowners must be to deal with all parts of the business in a commercial way for the benefit of the business as a whole, whilst seeking to ensure that agricultural activities dominate.

“HMRC is constantly seeking to tighten the criteria for the consideration of relief from inheritance tax.

“This case helps to redress the balance and to show that a prescriptive test for the availability of relief is not appropriate”.