The competent farmer – sideways loss relief allowed

The First-tier Tribunal decision in the case of French v The Commissioners for HM Revenue & Customs [2014] UKFTT 940 (7 October 2014) concerned a family farm which had been involved in dairy farming for 30 years. The use of milk as a loss-leader by supermarkets had depressed the price of milk to the point that the business became loss-making in 1998. After three years of losses and seeing no prospect of recovery in the dairy business, Mr and Mrs French took the painful decision to sell their herd. For the next three years the Frenchs rented out their land to a neighbour, who put the land back to arable use.

In addition to having been under grass for the last 30 years, the Frenchs’ farm suffered from difficult soil conditions, making arable farming difficult and requiring significant work and investment in the land to bring the farm into profit.

In 2004, the arrangement between the neighbour and the Frenchs changed – the neighbour continued to work on the land for the Frenchs, but as a contractor for them and not as a tenant. In 2011 the work on the farm finally began to pay off, and modest profits began to be made.

The issue at stake before the tribunal was whether the losses incurred in the farm business could be offset against other income.

HMRC sought to deny relief on the basis that section 67 ITA 2007 denies relief where losses have been made over more than a five year period. This provision is intended to prevent “hobby farmers” from offsetting losses from a venture that is not undertaken as a profit making business against their other income.

HMRC also went on to argue that the exemption in section 68, which allows relief to be given if there is a reasonable expectation that profits will be made in the future. Section 68(3) lists the criteria to be met:
“68(3) The test is met if:

(a) a competent person carrying on the activities in the current tax year would reasonably expect future profits (see subsection(4)), but

(b) a competent person carrying on the activities at the beginning of the prior period of loss (see subsection(5)) could not reasonably have expected the activities to become profitable until after the end of the current tax year.”

HMRC and the Tribunal accepted that Mr French was a competent person (the Tribunal considered that he had demonstrated a unique competence to farm his land), but HMRC’s argument was that it had taken Mr and Mrs French 7 years to turn their business to profit, which meant that their losses from 2005 onwards would not have been allowable, on the basis that they became loss-making in 1998.

The Tribunal held against HMRC on two grounds. The first of which was that Mr and Mrs French had ceased their business of farming in 2000 when they sold their herd and only recommenced trading in 2004 when they terminated their leasing arrangement with their neighbour.

In the alternative, the Tribunal held that the test in section 68(3) turns on the hypothetical competent person carrying on the same activities as the actual tax-payer. In this case, Mr and Mrs French had been undertaking one activity, dairy farming, until the point where it was determined that there was no prospect of returning to profit in 2000. From that point, the activity of arable farming started and the business returned to profit 11 years later.

Given the acknowledged competence of Mr French, it was reasonable to say that the time that a competent person undertaking the activity of arable farming would return the farm to profit should be benchmarked from the point that the Frenchs’ neighbour began the work of returning it to arable use, not the point at which Mr and Mrs French took over the business of farming it. In summary, the Tribunal held that a competent person farming the Frenchs’ land would take 13 years to return to profit transitioning from loss making dairy to arable production.

The case serves as an interesting and useful discussion of the rules on sideways loss relief, highlighting the difficulties that can arise in applying the letter of the legislation to businesses in transition.

For further information on sideways loss relief please contact the TaxDesk on 0845 4900 509 and ask for Paul Howard.