Tax considerations of green farming in 2023

Mr Birchall’s guidance provides a foundation for farmers who wish to explore carbon markets as a means of diversification or to reduce their farms’ environmental impact, enabling them to build on a solid financial footing.

Selling BNG units to developers is the most direct form of capitalising on habitat creation on-farm and is always accompanied by a Habitat Management Agreement. Currently, there’s no specific HMRC guidance to follow in this area, as tax legislation is yet to catch up with the new arrangements, Mr Birchall said.

Therefore, the tax treatment of payments received for BNG units is subject to interpretation. If the farmer receives a single lump sum from the developer that is considered capital payment, the earnings will be subject to the Capital Gains Tax treatment, so long as the BNG unit is described as a payment derived from an asset (i.e. the land), Mr Birchall explained.

Otherwise, the payment will be treated as taxable income and will be subject to Income Tax. On the other hand, the distinction may be less important if the business operates as a company, as the corporation tax rate will be the same whether the payment is treated as income or capital, he pointed out.

With regards to VAT, the current HMRC view is that carbon credits are outside the scope of VAT. However, BNG units may be different as farmers must comply with the Habitat Management Agreement, which could be considered a form of service provided to developers, Mr Birchall said.

As to whether the land on which habitat is being created will benefit from Agricultural Property Relief (APR) is still a grey area due to the lack of clarity in current legislation. According to Mr Birchall, if the arrangement is simply habitat management where there is no underlying agricultural functionality of the land, then APR would not normally apply.

However, farmers can still claim APR on BNG land that is also used for agricultural activity such as grazing, he added.

Where APR is not claimable, landowners might benefit from Business Property Relief (BPR) as long as investment activities on the land don’t predominate trading activities.

“Where land is let to acquire BPR in its own right, there need to be additional activities which dominate the simple letting of land for the activity to be trading,” Mr Birchall explained.

Leasing to the Environment Bank

The Environment Bank is a company that offers farmers the opportunity to earn a secure income from habitats created on their land and share the risk of selling BNG units to developers via a third-party agreement.

As part of the arrangement, farmers are required to enter a 33-year Farm Business Tenancy Agreement with the company that outlines how the land is going to be managed over the lease term.

Kerriann McLackland, head of land (South East) at the Environment Bank, explained: “We create the new habitats, meet all the capital costs of creation, then we lease it back to you for 33 years minus a day and you carry out the management.

“The income comes to farmers in two forms: the rent that we pay for the head lease, and the management payments we pay to you to keep the habitat in the agreed condition.”

According to Mr Birchall, the rent and management fees received from the Environment Bank will be treated as taxable income. Farmers are also entitled to charge VAT on the services provided as part of the agroecological arrangements.

While the leaseback arrangement comes with more complex tax issues, it may not affect farmers’ ability to claim APR or BPR as they will still be in “occupation” of the land, Mr Birchall confirmed.

When it comes to business structuring, he noted some landowners might be tempted to house habitat creation within a separate business entity, which could provide a pathway to future family succession if assets need to be spread amongst different family members.

“However, from the perspective of BPR, it can be useful to merge all the various activities together as long as you can carefully balance the trading and investment split,” he added.

Ultimately, Mr Birchall said the way farmers decide to structure BNG activities depends entirely on their long-term priorities. If the 50/50 trade/investment split can be maintained on the BNG land, incorporating activities within one entity may present an advantage when accessing BPR from Inheritance Tax (IHT).

At the same time, farmers may choose to create a number of separate business entities for reasons such as:

• Difficulty to keep within the 50/50 split and longer-term risk of move to an 80/20 split
• May wish to ring-fence risks of certain activities so that they do not contaminate assets
• Future succession
• Access to grants and finance

While Mr Birchall said this is a viable option, landowners will need to consider the impact on IHT reliefs and the way in which the structure affects the utilisation of losses.

Woodland Carbon Units – “complicated for tax purposes”

Woodland carbon units (WCU) represent a measurable amount of CO₂ removed from the atmosphere by trees as they grow. They are a form of carbon credit typically sold on carbon markets as a way for individuals or organisations to offset their emissions and are becoming a key component in the CSR (Corporate Social Responsibility) policy of many large companies.

Mr Birchall explained WCUs are initially pending issuance units (PIUs), which represent a ‘promise to deliver’ a WCU in the future. These units are held in the UK Land and Carbon Registry, which checks the performance of projects every ten years. At each of these points, PIUs are converted to WCUs if the project is performing well.

The sale of WCUs is likely to be regarded as income receipts, with the key tax issue being whether they benefit from “commercial occupation” woodland tax exemption. Mr Birchall said the main deciding factor is whether the income is viewed as derived from investment or trade.

If selling WCUs is considered a form of trade, it may be relevant to reliefs such as Business Asset Disposal Relief or IHT BPR. However, simply exploitation of land to generate recurring revenue is often seen as investment, Mr Birchall said, and no definite conclusions can currently be drawn.

“The more activities you need to perform to generate that income, the more the business points towards a trading side,” he added.

Like BNG units, WCUs are also ambiguous when it comes to APR, as woodland must be “occupied with” agricultural land and “the occupation is ancillary to that of the agricultural land” for APR to apply, Mr Birchall said.

“There is also a view that if income is being generated from the woodland alone, that can no longer be considered as “ancillary” to the agricultural land as that is having a commercial use of itself.

“If APR is not available, there is IHT relief which allows the value of trees or underwood to be left out of account in determining IHT value on death,” he added.

While there is no clear HMRC guidance at the moment, Mr Birchall believes landowners selling WCUs can still benefit from BPR if they are conducting a mix of activities on that land. Moreover, if the woodland is part of a wider farm or other trading business, it should possible to benefit from BPR even if not viewed as trading activity.

Whether WCUs benefit from woodland tax exemption is also controversial. On the one hand, income that arises from a commercial woodland occupied with a view to the realisation of profits is exempt from a charge to income/corporation tax.

According to Mr Birchall, the government’s Woodland Carbon Guarantee scheme comments that the commercial woodland exemption is available on the sale of the carbon credits covered by that scheme. In addition, the Forestry Commission document, ‘Creating a new woodland; woodland carbon guarantee’, states:

‘Currently, profits arising from the commercial occupation of woodlands are not chargeable to income tax and corporation tax and the value attributable to trees is exempt from capital gains tax.’

However, no clear HMRC guidance is available as to whether the sale of WCUs is definitely covered by the woodlands tax exemption, Mr Birchall remarked.

In summary, he concluded that WCU’s are complicated for tax purposes for several reasons. For once, they could be subject to tax at 0% (woodland), 25% (corporation tax), or 20-45% (income tax).

There is also CGT uncertainty around whether selling WCU’s represent a trading or investment activity. Last but not least, the availability of APR may be in doubt in some cases, but farmers could still benefit from BPR if business is structured appropriately.