Further thoughts on the budget

Since the Budget was released there has been considerable headlines given to the implications of the changes on inheritance tax. These are far-reaching and complex, and it is difficult to provide a single impact assessment given the complexity of farm business ownership models.

However, the positive is that we are proactively talking about a difficult subject, and for each farm to make the most informed decision getting detailed tax advice is evidently the best place to start.

I’ll come on to tax, but there remain aspects of the Budget which are worrying for the immediate impact and longer term.

Erosion of funding

Delinked payments in 2025 will be based on the payments received in 2020. There will be a 76% reduction on the first £30,000 of payments, and no payments for any portion above £30,000.

We’ve put these changes through our virtual farms to give some indicative examples of the impact. For our 375ha arable farm, the changes will mean that delinked payments in 2025 will 73% less than predicted at the original gradual reduction pace. That means a payment of £7,200 compared to an expected £26,282 at the previous gradual reduction. The farm is losing just over £19,000 of expected income or putting it another way that’s over 100 tonnes of wheat at forward market prices.

The rationale for this change is that is further funds the move to environmental land management (ELM) schemes. Which brings me on to the Defra budget for 25/26 of £2.4bn.

As we have highlighted in our previous analysis, farm input costs have increased overall by 44% since December 2019. This in turn has eroded the purchasing potential of that budget already - assuming farmers spend the money received for their ELMs actions on the farming business needs (seed, fertiliser, fuel etc).

The Office of Budgetary Responsibility then also published inflation forecasts that were on the higher side of 2% in the coming years. So, if the budget from 2019 remains to until 2027, taking into account the 2019-2024 inflation and OBR forecasts, the Defra budget of £2.4bn will actually be worth £1.15bn in 2027 in real terms.

Therefore, not only is funding being cut immediately in the form of direct support to English farmers, but the longer-term budget potential is being eroded through not keeping up with core-inflation and the higher rates of agri-inflation triggered by the covid inflationary boom and conflict in Ukraine.

Tax implications

Moving on to tax and this is clearly a complex and nuanced area. Again, using our virtual farms we’ve calculated the impact of the changes to our 455ha arable farm, based in Cambridgeshire. At this point, we must heavily caveat that this is for illustrative purposes only and does not constitute advice or actions. We have used the information held within this online explanatory note from Defra and HM Treasury as the basis for this analysis.

Our analysis assumes land values of £10,000 per acre and a house value of £330,000. We are only taking these into account and have not included any other assets such as machinery, buildings or personal assets. Therefore, the value of the farmland and house stands at £7.6m.

In our scenario, we assume that the farm is owned by a married couple with direct descendants, giving them a total tax relief of £3m (as per Defra information found here).

This gives us a total taxable value of just under £4.6m to be taxed at 20%, giving a total of £930,000 tax to pay. Using our virtual farm analysis, if this this tax was to be paid off using the government’s repayment scheme over 10 years this would cause a fall in net profit of 71% to £39k in the first year.

The total tax paid including interest of 7.5% would come to a little over £1.3m. Which leaves the second option of selling land to pay; the farm would need to sell close to 100 acres of land to cover the tax cost.

By reducing the acreage of our virtual farm and associated variable costs we can estimate a fall in net profit of 21% to £179k per year.

The option for selling land is not only the most beneficial on a profit level, but also may be further compounded by reluctance from lenders to facilitate loans which would increase a farming business debt-to-asset ratio. This reluctance may be further compounded by the poor return on capital employed in agriculture meaning that the assets which are now more leveraged with debt do not appreciate value/income at a fast pace.

Coupled with the variable gross margins driven by volatility in commodity markets and the option of selling land to fund inheritance tax becomes more prevalent. In these circumstances, distressed seller of land would push down the value of the land and could attract institutional investors who see this as a long-term buying opportunity despite the tax implications, as the need for land and food isn’t going to change because of a tax rule revision.

What does this mean?

The immediate impact of all of these factors on the farming industry is uncertainty. There’s a difference between risk and uncertainty. Risk is something which is quite specific, you can see an issue and plan for a specified outcome. Uncertainty, on the other hand, is far wider ranging and cannot be planned for as well.

Uncertainty is the bigger issue. One that curtails investment, reduces confidence and leads to lower or stagnating productivity.

We know from previous research that the factors that most influence performance and are within a farmers control are business costs, levels of contracting, debt, participation in agri-environmental schemes, diversification, yields/output and attitude to change. Amid the current climate, one could argue that all of these factors are being adversely affected by policy, market and climate changes.

What do we do? And what do we want to achieve? Ultimately, we want a thriving domestic agricultural sector with business stability, innovation and food security. Whilst this may feel a long way off, there are steps we can do to manage some of the controllables. Starting off with furthering the knowledge of the detail of your agri-business, this undoubtedly takes time and effort. But, given the potential financial risks from lower delinked payments, inflation eroding spending power and managing tax changes, the time to start proactively planning is now.