Natural England

taxation measures for the pre-budget submission AP02/19

FOR DECISION

Purpose

1. This paper outlines the work of the Agency's Budget Group and the shortlisted changes to existing taxes that we are proposing to recommend in an Agency submission to the Treasury, ahead of its (Autumn 2002) pre-Budget statement.

Background

2. Fiscal changes could play a significant role in meeting the Agency's aims for the countryside and rural areas. They could benefit rural businesses, rural communities and the countryside environment. They can provide incentives (eg tax credits), as well as disincentives, and could help change behaviours. 

3. The Board agreed for the current Corporate Plan that the Agency should develop work on taxation, so that it could make an annual submission about what it wanted to see in the Chancellor's pre-Budget statement. Last year the Agency submitted to Treasury a note with some early thinking, but it was clear we would need to invest more effort to have any real influence. In taking forward this work, we have been careful to ask ourselves whether tax changes are the right way of achieving policy objectives (rather than grant schemes, regulation, etc).

Progress to date

4. The work has been managed by an economist in the Rural Proofing Studies Unit and it has been steered by an internal Agency Budget Group, chaired by Victoria Edwards, and involving a range of interests in the Agency.

5. In December, we let a contract to undertake a wide ranging review of 67 potential tax changes or new measures that could assist Agency objectives and to provide an initial assessment of them. The consultants' report, received in April, recommended a shortlist of 8 potential measures which we might want to pursue further.

6. We have also established good relations with members of the Treasury taxation team and with economists with an interest in DEFRA, English Nature and the Environment Agency. Indeed, we have discussed the consultants' report with Treasury, to get an initial reaction from them and to ensure that we were not pursuing any measures they considered unrealistic.

7. We held a workshop with a range of partner organisations in April, chaired by Victoria Edwards, seeking views on the consultants' work and any further measures that we should consider. Inevitably, some organisations had particular perspectives, but the workshop showed a good deal of support for the findings overall. It also highlighted issues we will need to examine in more detail before any pre-Budget submission.

8. In order to make a credible submission to the Treasury, we need to commission more detailed analysis of some shortlisted tax changes, to examine particular issues and to estimate their Exchequer costs and benefits. The timetable for this is very tight, with a pre-Budget submission needed by mid-September, so we have tendered the contract on the basis of the four tax changes that we believe are most beneficial and realistic this year. Nevertheless, there is still scope to prioritise those we have shortlisted and to say which we want to pick up again next year. (Next year our aim is to get this work on to a slightly earlier cycle, so we can consult the Board sooner.)

Proposals

9. We propose to include the four tax changes below in the Agency's pre-Budget submission this September, subject to the Board's agreement and assuming that the further detailed analysis commissioned does not find any major weaknesses. We reduced the consultants' 8 proposals down to 4 on the basis of: their simplicity to introduce; the level of support (political, Treasury and other); how many rural businesses, people or how much of the countryside would benefit; and the expected real world impact. We also dropped some suggested tax changes, because we felt they required more work than is possible in the run up to September, but they could be taken forward for 2003.

10. Annex A contains more information about the proposed 4 tax changes above. Annex B contains information about the other 4 tax measures shortlisted by the ERM study, but which we are not proposing to take forward this year. Annex C lists the full 67 tax measures that ERM assessed.

11. It would be helpful to have any early suggestions from the Board about tax measures or changes that they would wish the team to consider for 2003, since the Agency's work towards next year's pre-Budget will need to start this Autumn. Whilst the team does not have any firm views at this stage, it considers that there are three early contenders:

• The equalisation of VAT between new-build and renovations;
• Reduced VAT on listed buildings;
• A taxation measure to encourage affordable housing (probably not Capital Gains Tax).

  The Board may wish to consider other measures, including those from the long list submitted by the consultants (Annex B). 

  Financial and manpower consequences

  12. There are no additional financial or manpower consequences. The commissioned studies and input for the economist have been allowed for.

  Next steps

  13. We are in the process of awarding the contract for the further work needed to examine in detail our four recommended tax changes. This contract will be due to complete in early September and we are aiming to make a pre-Budget submission to Treasury in mid-September. We are advised that it will have less impact if left later. 

  Risks and mitigation measures

  14. Given the complexity of taxation, there is always a risk of misunderstanding or overlooking significant issues. By contracting tax specialists and involving other interested parties, we should have overcome this risk. There is also the potential for political risk, if we back tax changes that could penalise certain rural groups or activities. We have involved a range of partner organisations in our work. Most of the taxes can be considered uncontentious. One of those in our top 4 could be unpopular with some in the farming lobby, though it would still further the Agency's goals for the future of land management.

ANNEX A

A - Business Rate Relief

Current status

• mandatory 50% (discretionary 100%) rate relief for new, non agricultural business on previously agricultural land or buildings provided rateable value does not exceed £6,000. 
• mandatory 50% (discretionary 100%) rate relief for sole pubs or petrol stations with ratable values of up to £9,000 
• Rural Rate Relief mandatory 50% rate relief (discretionary to 100%) for businesses with rateable values of less than £6,000 which are in rural villages with a population of less than 3,000 and are:   

• District Councils have further discretionary powers to give 100% relief for businesses in rural villages (less than 3000 people) if the rateable value is less than £12,000 and the business provides an essential service to the local community.  

Proposed Change: A mandatory 50 % tax relief (discretionary 100 %) to:

A1. all rural businesses with a rateable value of less than £12,000; or

A2. rural shops with a rateable value of less than £12,000; and/or

A3. rural businesses offering community facilities (e.g. pubs and garages) and whose rateable value is less than £12,000. 

These tax measures aim to reduce fixed cost burdens for small rural businesses. 

Key Issues:

ANNEX A

General

• Is this about underpinning marginal businesses or providing key community facilities?
• Cannot justify to all businesses, so why are rural businesses special?
• Concern was expressed that Treasury would not buy into such a tax relief measure for businesses purely because they were sited in a rural as opposed to urban areas 
• It was felt the focus should be on rural businesses offering community facilities
• Concern was expressed that any proposal should have a rural definition which would include market towns
• if you expand the rural population definition size to more than 3000 the rationale for supporting such measures would disappear. e.g. you could justify rate relief for a business which had social benefits like the only village shop but not if there were lots of shops which would be likely if you included a definition of say 10,000.
• Need to be clear where and how it is applied
• Existing system of reliefs fairly complicated, people were often unaware that they qualified for relief.
• The priority should be simplification. This would also benefit those local authorities who administer the system.
• Good publicity for the existing rate relief measures was also needed, to ensure high take-up.
• It can be confusing at present with different levels of relief and the mandatory/ discretionary 
• LA's are reluctant to publicise the current discretionary relief possibly because it costs them 25% in lost receipts (the Treasury pick up the 75% tab)
• Need to guard against distortions of the proposals, e.g.. B&Bs might open shops to decrease their liability.
• Need to be mindful of how the relief would be financed, i.e. it should not put a burden on other rural tax payers.
• £12000 threshold not based on any science
• There are implications for social enterprises - would they qualify for relief for community facilities? 
• An alternative to the current DTLR definition could be used, e.g.. the definition of rural local authorities adopted during the FMD crisis (151 authorities). Rate relief could be given to all businesses operating below the given rateable threshold in these local authority areas. However, extending the scheme in this way would be make it more costly.  

ANNEX A

B) Reduced VAT (5 %) for repair and maintenance work to community buildings.

Current status: Value added tax (VAT) is charged on the supply of goods and services in the UK and on the import of goods and certain services into the UK. It applies where the supplies are taxable supplies made in the course of business by a taxable person. 

VAT registered traders collect VAT on behalf of Customs and Excise on all sold goods and services; and reclaim VAT paid on goods and services bought in by them. Small businesses and the self-employed not registered for VAT cannot reclaim VAT on goods and services bought in. 

There are two VAT rates, a standard rate of 17.5 % and a reduced rate of 5 %. The only exception to this is the system of zero rated goods. The construction of buildings for residential or charitable use are zero rated good, as are approved alterations to protected buildings under current regulations. Also zero rated is the sale of renovated houses that have not been used for any residential purpose (empty) for at least 10 years. It is not possible to create new zero rated categories, European legislation would be required.

The 5% reduced rate applies to: renovation of dwellings that have been empty for three years or more; residential conversions that result in a change of number of dwellings in the property; converting a non-residential building into a single household dwelling or a number of household dwellings and converting residential property into residential communal homes, such as care homes and houses in multiple occupation.

Proposed Change:  Reduced VAT (5 %) for repair and maintenance work to community buildings. The objective is to provide financial support for the maintenance of community buildings. Village and community halls can make a long-term difference to local communities by providing sustainable, multifunctional and flexible resources where all members of rural communities can take advantage of a range of activities.

Key Issues:

• In general there was support for the measure. 
• Even though the savings would be quite small it was felt that the difference in VAT rates would be equivalent to many fund raising coffee mornings.
• Many village halls are run by charitable groups - who are VAT exempt - so concern was expressed at the mechanism for claiming back the VAT. It was 

• suggested that traders undertaking the repairs could self -certify that the property was a 'community building' and only charge 5% at the point of sale
• The measure is particularly helpful because of the reduction of capital funding for village halls, e.g. there is lots of funding to put things in them but not much funding to fix the roof. 
• It will be difficult to quantify the cost to treasury but it was felt that it would not be that much (say £1million ??) - so Treasury would not miss the costs
• In general it was felt that it should only target rural areas (using the 3,000 definition?) 
• It was recognised that the multiple use of buildings for both 'community' and 'commercial' activities would lead to confusion - but this could be offset by correct 'apportionment.' 
• The definition of 'community buildings' would need to be clarified - best to use a tightly defined measure to get treasury approval and avoid dubious areas such as pubs who will anyway benefit from other tax breaks (such as the reduction in rateable value etc..) Would the definition be based on use of building or ownership? 
• Restrict the 'community buildings' definition to the 8900 village halls in England + sports clubs. Propose a relatively restrictive list with potential for expansion.
• Should the word be "key" community buildings?
• Particularly relevant in the face on conversion charges under the Disability Discrimination Act.  

ANNEX A

C) Agricultural Property Inheritance Tax relief to be made conditional upon sustainable land management and public access provision

Current status: Inheritance tax (IhT) is charged on 'wealth at death, certain lifetime gifts and some transfers into and out of trusts'. Many transfers are exempt from IhT, e.g. gifts on consideration of marriage, gifts to charities, transfers between husband and wife etc.. IhT is charged at 40% beyond the threshold of £250,000.

Heritage land and buildings is IhT exempt, conditional on owners providing 'reasonable public access' to their exempt assets. It allows for IhT exemption for land 'of outstanding scenic, scientific or historic interest', and buildings of outstanding historic or architectural interest and their amenity land. This requires a Heritage Management Plan (HMP) from the owners which contain rolling five-year programme of works used as the basis for measuring compliance. A breach of the undertakings would result in the tax becoming payable.

The National Heritage Unit currently deals with about 300 active cases, which includes advising on eligibility but also in annual monitoring and five-yearly inspection of all exempt property.

However, in 1984 two types of IhT relief were introduced which do not require preservation or public access: business property relief (so-called BPR) and agricultural property relief (APR). 

Agricultural property relief of 100 % is available on the transfer of agricultural property as long as the property is: agricultural land or pasture (incl. short rotation coppice land and farmland dedicated to wildlife habitats under Government Habitat Schemes); or woodland and buildings used for rearing livestock or fish where the occupation of the woodland and buildings is ancillary to that of the agricultural land; or cottages, farm buildings and farmhouses occupied with the agricultural land.

Agricultural property relief is also granted to set-aside land used for permanent or rotational fallow. However, it does NOT include set-aside land used for woodland or approved non-agricultural use (including e.g. tourist facilities, game and nature reserves). 

Proposed Change:  Agricultural Property Inheritance Tax Relief (APR) to be made conditional upon sustainable land management and public access provisions. This proposed tax change would provide an incentive for landowners to dedicate their land for permanent access and would allow access to be seen as an asset rather 

ANNEX A

than as a liability. This would also further the objective of sustainable land management.

Key Issues:

• How it will be policed and access to confidential information.
• Agricultural Property Inheritance Tax relief (APR) was legislated for as it was recognised that agricultural land would give a lower rate of return than other types of business investment.
• Agreed that APR should remain but society should be getting better value for money.
• It prevents fragmentation of agricultural property over time.
• Business Property Relief (BPR) is very similar to APR, therefore if conditional APR is introduced then BPR should also become conditional. This would require a lot of administration.
• Policing of sustainability and access would be quite straightforward as the authority responsible would only need to visit the property upon death. 
• If sustainable land management practices and public access are available then the APR would continue (Therefore site visits would only need to occur approx. every 30 years).
• The public would need to be kept informed of accessible land.
• any new systems for assessing should be simple and transparent (i.e. we don't want extensive management plans). There should be a simple guidance note and agreement dependant on habitat. The public would have access to this guidance. 
• linking APR to CROW land will make access provision an attractive option - they would want to be on the maps.
• It was noted that planning controls are needed over farm buildings.  

ANNEX A

D) Include costs of specific habitat/environmental & access improvements as allowable expenses for the calculation of income and corporation tax

Current status: Income and corporation tax is levied on taxable income. This is derived by taking account of the income and profits, personal allowances (income tax), deductions from income and profits, charges on income, capital allowances and allowable expenses.

The two most important rules for expenses are: expenses must be wholly and exclusively for the purpose of the trade. This implies that you cannot claim for an expense that is both for private and business purposes AND expenses must be of a revenue and not of a capital nature.

Note that the owners or tenants of agricultural land may claim allowances for expenditure incurred for the purpose of 'husbandry' on the construction of buildings, fences, or other works: these include land reclamation and hedge demolition, walls, farm roads etc. .

Although habitat management could be seen to be an intrinsic part of farming, where expenses or capital allowances for habitat management are allowed is very much dependent on the interpretation of the legislation by Inland Revenue and courts.

For example, trimming hedges is an expense against profits, planting a brand new hedge is a capital expense eligible for capital allowances. Repairing gaps in a hedge with new plants can be classed as a repair, the cost of which is an expense that can be set against profits. Hedges are important as they prevent soil erosion and act as windbreaks to protect crops and young animals, as well as natural barriers to keep animals in and trespassers out. The same arguments apply to tree planting and copse management; they are good husbandry. Draining blocked ditches, clearing ponds to allow natural drainage also count as good husbandry (allowed for in Inland Revenue statement of practice SP5/81). Setting aside whole fields and allowing them to temporarily go back to nature can also be allowed. Government Grants (taxable as income) are available for this. The cost of maintaining the set aside field is an allowable expense. All can be regarded good husbandry.

However, problems arise under current legal interpretation when an individual farmer tries to permanently set aside tracts of farmland as natural habitat and claim for the cost of doing so. This would not be seen as good husbandry (the land could not be farmed anymore) but pursuing a farmer's ecological interests.

ANNEX A

In addition, the current system is hampered by the distinction between Schedules A and D (see above, the proposed abolition between Schedule A and D), which does not allow some smaller farmers which only let land (i.e. their incomes fall within Schedule A) to deduct habitat management costs which, if allowed, fall within Scheme D or E

Proposed Change: Include costs of specific habitat/environmental and access improvements as allowable expenses for the calculation of income and corporation tax. This proposed tax change would provide an incentive for habitat management in the countryside. 

Key Issues:

• already happening to some extent (unofficially) and that implementation would be easy, the inland revenue would need to amend its guidelines.
• This change would fit in with the Curry Report and would cover all work that is directly related to maintaining livelihood. 
• Should include hedge building but not new plantations. 
• May have negative consequences such as a plethora of hedge plantation, it was agreed that a series of guidelines would be needed.
• This proposal was confined solely to farmers as a means to promote diversification, which might benefit 'hobby farming'.
• There is a need to ensure public access and that any improvements are in the public good. 
• much more likely to encourage wealthy farmers as they will have the initial capital to improve access etc.., whereas poorer land owners, e.g. hill farmers are unlikely to be able to afford any changes in the first place.
• concerns about the impact on business of the proposal on income and corporation tax deductions.  

ANNEX B

A) Capital allowances on assets

Current Status

Agricultural buildings allowance currently provide for 4 per cent of the cost to be claimed each year, writing off the building over 25 years. In the interpretation of the Capital Allowances regulation by the Inland Revenue, farm shops count as agricultural buildings but the allowable expenditure is restricted to shops on farmland "selling only produce of the farm". 

Proposed Change: Increase to 5% the annual capital allowance on investment in all buildings used by farmers for farm diversification and introduce an 20% initial capital allowance (year 1) for buildings used for farm diversification.

Key issues: 

• Would this proposal apply to farmers only, to encourage them to diversify, or more widely to all business occupiers on former farm premises, to encourage non-farmers in from outside. Would the latter would drive up land prices?
• Phase 2 consultants should advise on the definition of farmers and how the proposal would work if it went wider, in order to meet the objective of improving the wider rural economy. 
• Farmers lack income generating capacity to move from one business to another. It would help if previous farming losses could be included in the calculations.
• The increase from 4% to 5% is not be a sufficient incentive for diversification, and needed to be coupled with the 20% initial capital allowance if it was to be effective. As a combined measure, it was worthy of support.
• The interaction of the tax system here with market effects was very complicated.  

ANNEX B

B) Corporation and income tax

Current Status: Currently farmers who use parts of their land for non-farming purposes cannot deduct the costs incurred from the income from the farm business. This could be seen as a disincentive to invest in amenity woodlands for which there will be only costs and no monetary benefits to set these against for tax purposes.

Inland Revenue currently divide the sources of income into four categories called the Schedules. Schedule A) Income from land, mainly rent; D) Income from a trade or profession and other payments; E) Income from employment or office (including Directors) and pensions; F) Dividends paid by UK resident companies.

Proposed Change:  Tax all income from farming and farm diversification business related activities (excluding commercial woodlands) under Schedule D (Case I), i.e. abolish the distinction between Schedule A and Schedule D (Case I) for the calculation of income and corporation tax. This would mean that any costs incurred by a farmer for sustainable land management or diversification reasons would be included in the general tax calculations and reduce the overall tax burden. The objective is to create incentives for farmers to diversify from intensive food production and adopt sustainable land management practices by giving benefits to using land for non-farming purposes, e.g. for amenity woodlands.

Key Issues:

• Is this measure targeted at farmers or is it at the wider rural economy?
• general support for this measure, for which legislation would be needed. 
• reduce fiscal impediments to diversification.
• important not to confuse the pooling of capital (as distinct from revenue) and income.
• mandatory or discretionary? 
• unlikely that anyone would be disadvantaged by being treated as one tax unit, so mandatory preferred especially with the advantage of transparency.
• Voluntary application would be more complicated as there would effectively be two systems running side by side.
• Would achieve much the same as the rural business unit idea, but doesn't go quite as far.  

ANNEX B

C) Reduced rate VAT (currently 5%) for repair and maintenance work to listed buildings

Current status: VAT situation described above. Currently places of worship have this exemption.

Proposed Change:  Reduced rate VAT (currently 5%) for repair and maintenance work to listed buildings, with the objective of effective repair and maintenance of the rural built heritage.

Key Issues:

• instead of focusing solely on listed buildings should consider the equalisation of VAT on all repairs and planned maintenance to 5% on all buildings. 
• This change would remove the 'black economy'.
• The UK has a zero rate VAT special dispensation from the EU for new build which would not be returnable once given up. This would be a stumbling block in implementation of equalisation.
• inflation might rise if VAT was imposed on new build.
• Will benefit rural because many listed buildings in rural areas.  

ANNEX B

D) 100% relief of capital gains tax if the land/property is sold to be used solely for the provision of affordable housing.

Current status: Capital gains tax applies when chargeable assets are disposed of. Disposal includes any occasion when the ownership of part or all of an asset is transferred from one person to another and may give rise to a chargeable gain or allowable loss. Gains and losses are calculated on each asset. Expenditure, which has increased the asset's value, may be deducted, as may the costs of acquisition/sale. Chargeable assets include all forms of property unless specifically exempt. 

For companies, most of the capital gains tax rules apply but the gains are charged to corporation tax. Subject to an indexation allowance, which adjusts for inflation, gains and losses are aggregated to give the net chargeable gains or allowable losses for the year. For individuals, personal representatives and trustees, indexation allowance was frozen at the amount due up to 1998, and substituted by a taper relief for periods after that. Chargeable gains, after relief, are taxed at rates equivalent to the individual's income tax rate. 

Relief is already provided for: Replacement of business assets; Retirement of a sole trader or partner and certain full-time directors and employees; Gifts of certain assets; Transfer of a business to a company; Assets of negligible value; and Losses on certain loans. 

Proposed Change:  100 % relief of capital gains tax if the land/property is sold to be used solely for the provision of affordable housing. The objective of the proposal is to assist the provision of affordable housing in an attempt to help alleviate social exclusion and help create mixed and viable rural communities. 

Key Issues:

• In general there were some serious question marks raised against this measure. There were doubts over whether it would be effective given the CGT exemptions which already exist for landowners e.g. CGT rollover 
• In addition it was felt that the impact of savings on CGT would not be sufficient to persuade a landowner of the value of selling the land for affordable housing when the value of the land if sold without restrictions was potentially worth millions
• It was felt that in practice the measure could apply to small exception sites and by using the 3,000 population rural definition
• Work on the impact of the measure needs to be done to assess if it is worthwhile
• ANNEX B
• There are not many landowners who would be interested in a 'morally satisfactory' outcome - hence the measure may have limited appeal
• There are legal issues about defining 'affordable housing' 
• Exceptions policies could subsidise farmers for providing affordable housing in unsuitable/sensitive areas. Needs to work within the existing planning system.