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HMRC internal manual

Business Income Manual

Farming losses: let-out for long term ventures

S68 Income Tax Act 2007

The strict application of the five year rule is modified to meet the genuine case of a farmer etc who engages in specialised activities which are potentially profit making but cannot be expected to show a profit before the end of the year of claim.

Both of the following requirements must be satisfied for the loss to be allowable.

  1. The farmer must show that the whole of the activities carried on in the year of claim, are of such a nature and carried on in such a way as would have justified a reasonable expectation of the realisation of profits in future if they had been undertaken by a competent farmer. This test is designed to deny relief where the activities could never make a profit, however efficiently they were carried out. An example would be a farm where the fixed overheads were such that the gross profit could not exceed them.
  2. A mere promise or hope of future profit is not enough. The onus is on the farmer to produce hard evidence to justify his claim of a reasonable expectation of future profits. Good evidence would be the sort of thing which would satisfy a bank manager as to the viability of the farming for a farmer who did not have other resources or assets to provide security for a loan. If the farmer has sought advice from an agricultural consultancy such as ADAS then you should obtain and consider their reports. Experience shows that such contemporary outside advice will often provide information which will enable you to displace the contention that this requirement is satisfied. For example, the advice may say that, without changes in the activities or the way in which they are carried on, there is no prospect of profit. Nonetheless the farmer may not have made the changes because of the attractions of country life, other business commitments elsewhere, or a particular interest in the type of farming carried on.
  3. The farmer must show that a competent farmer carrying on the whole of the activities carried on in the year of claim at the start of the ‘prior period of loss’ could not reasonably have expected to show a profit by the end of the year of claim. The `prior period of loss’ for this purpose is all the prior years making up the successive loss years subject to a minimum of five years.

Where a claimant seeks to demonstrate that these requirements are met, the whole of his or her farming activities are to be taken into consideration. By activities we mean the type(s) of farming; arable, sheep, dairying, beef rearing and stud farming are examples of activities. For example, a claimant who is farming for the purposes of prestige, recreation or a pleasant life style, and whose activities include a long term venture such as stud farming, cannot prevent the operation of the five year rule merely by pointing to the long term nature of the activity. The onus of proof is laid entirely on the claimant who must show that the nature of the whole of the activities taken together is such as to provide a reasonable expectation of profit in the future.

Thus farming which, however efficiently carried on, could never show a profit, does not qualify. But also the claimant must show that the activities are carried on in the way which would be expected of a competent farmer farming the land commercially and with a reasonable expectation of profit.

To satisfy the condition set out in (b) above, the claimant should produce evidence as to the normal period of years during which a competent farmer, engaged in the same type of long term farming or market gardening activity, would be expected to show initial losses before the operations reached a profit-making level.

It will be clear from the above how tightly the legislation is drawn and this legislation is, by its nature, strictly implemented.

The legislation does not call into question the competence of the farmer who made the losses. It is an objective test using a hypothetical competent farmer. But we would expect our hypothetical competent farmer’s reasonable expectations of the farm’s potential for profit to match or exceed those of the loss maker. Outside advice or the farmer’s own evidence may show that the activities could reasonably have been expected to become profitable within the prior period of loss, either without changes to the way they were carried on or with planned or recommended changes. If so then the second test will not be satisfied since the hypothetical competent farmer would reasonably have expected to do as well or better. If there is no such evidence then local experience or information from a local university or agricultural college may show what might reasonably have been expected from the activities concerned in your area.

For the test in (a) above we are also concerned with the way the activities were carried on. In other words the hypothetical competent farmer is constrained by the way the farming was actually carried on in the year of claim including, for example, understocking, overmanning, inexperience and excessive borrowing. This may be contrasted with the test in (b) above which requires us to consider what would have happened if a competent farmer had carried out the activities from the start of the prior period of loss but does not set constraints about the way they are carried on. When applying this test we are concerned, by definition, with a competent farmer. So we can assume, for example, that the results would not be depressed by high interest resulting from excessive levels of borrowing or by the need to employ labour because the farmer’s time was occupied elsewhere. A competent farmer would be expected to devote his full attention to the business and would not be burdened with excessive borrowing since to be so burdened would not be competent.

It is the activities of the year of claim which are under consideration, and the taxpayer must show that if any competent farmer carried on those activities from the start of the prior period of loss, then he could not have been reasonably expected to produce profits for the year of claim. Thus the past history of the farm is to a large extent irrelevant. Whatever types of farming may have been explored in the past, all we are concerned with is activities which were actually being carried on in the year of claim.

Although the onus is on the farmer to show that the requirements are satisfied, you will not be able to displace what he says without a thorough knowledge of the way the business works. In cases where the point is pressed you should analyse the results over the years, invite and consider the farmer’s detailed representations and, if possible, visit the farm to discuss the activities with the farmer. This work may reveal the farmer’s true reasons for allowing the run of losses to continue without either giving up altogether or making the changes needed to bring it to profit. It will also help prepare you for any Tribunal hearing which might be necessary.

Any case in which relief is claimed on the basis that the requirements are satisfied will need to be considered on its merits. Where there is a substantial doubt, or where difficulty arises, and in any case before a claim is considered appropriate for hearing before the Tribunal, a report should be made to Business Profits.