Succession Planning for Landed Estates
This is the first of a series of articles which we will be publishing over the coming weeks and months on succession planning for landed estates, covering such matters as taxation, strategic planning, diversification, land development and heritage property. A separate series of articles will also be published on personal succession planning for individuals and families.
What is a Landed Estate?
Downton Abbey is a quintessential example of what many of us envisage a landed estate to be – an historic mansion house, surrounded by extensive rural property, farmland and farm buildings, cottages and woodland.
Historically great swathes of the country were owned by a few hundred families; many gifted by the monarch in recognition of services given. The majority of estates were at the heart of their local community, providing employment and homes to those working on them.
Many landowners were instrumental in our industrial revolution because of the natural resources found on their estates, such as coal and minerals. Others travelled extensively and curated collections of artistic or historical importance which now form an integral part of our national heritage.
Once heavy taxation arrived from the mid-20th century and with greater personal freedom of movement and employment in the post-war era, estates began to fragment and diversify away from the traditional Downton Abbey model.
Today, a landed estate can mean much more than this. Many still provide a home for the family that has lived there for generations, but others are now lived in and cared for by new families who have seen success in business and have decided to take on the lifestyle and the challenges that come with it. Sometimes the manor house remains, sometimes it is long since sold off. Many estates retain their strong farming roots, but the financial security of the modern estate relies on not standing still, on diversifying and looking out for opportunities. From opera to glamping, musical festivals to wind farms, commercial lets to affordable housing, the modern landed estate is constantly evolving.
Rarely is a landed estate owned outright by a single person. Often they are held in trust, sometimes multiple trusts might own a single estate. And there are a number of different types of trust which might be involved.
Estates that have passed down through generations are often held in strict settlements, governed by the Settled Land Act 1925. The underlying concept of a strict settlement was simple - to protect the family and the community supported by the estate. This was achieved by imposing a set of rules which governed the administration of the estate and its succession to the next generation. Over time those rules became outdated and inflexible. In particular, a strict settlement was normally founded on the concept of male primogeniture, which provided for the estate to pass down the male line (according to seniority) to the exclusion of female heirs – the plight of the Bennet daughters in Pride and Prejudice!
No new strict settlements can be created since the introduction of the Trusts of Land and Appointment of Trustees Act 1996 but pre-existing strict settlements will continue to be governed by the old rules, until all estate land is sold. There is limited scope to make changes to a strict settlement, for example to provide for a female heir, but this often requires an application to court, which can prove prohibitively expensive.
Over time, for example, where an estate has been sold or new estate created, the strict settlement has been gradually replaced with ownership in a bespoke (flexible) trust and to a lesser extent, personal ownership or a corporate vehicle (company, limited liability partnership etc) or general partnership.
Today, we might see landed estates owned by working farmers, families, entrepreneurs, trustees, charities, pension funds and institutional investors.
How an estate is owned will influence how it can be run, the scope to diversify, how it can be passed to a successor/the next generation and underpinning all these factors, its tax treatment.
Identifying an heir/successor
Once upon a time, the concept of primogeniture made identifying an heir straightforward – it would be the eldest son, or in the absence of sons, the younger brother. With the nobility, the estate would usually follow the title. Now, while some families still prefer to apply male primogeniture, it is no longer a given. The eldest son might not be interested in running the estate and where the owner of an estate has bought it, rather than inherited it, there is a far greater likelihood that the heir to it will be the member of the next generation who is interested in it, wants it, and perhaps most importantly, has shown him or herself to be capable of running it.
What is clear is that the owner of a landed estate needs to put a succession plan in place early, and it is here that careful advice is required, both to make sure the estate passes to (or becomes held for the benefit of) the appropriate successor at the right time and in the right way. Ignoring this puts the estate at risk of being taxed on the death of the current owner (or beneficiary) in a less than optimal manner. Ignoring this also generates scope for family disharmony, as developing a succession plan in a timely manner can help to ensure that the whole family has time to think about, understand, and buy into that plan.
The problem with a landed estate is evident in the name – the main asset is land. Land and buildings are very valuable, but illiquid. This means that when an inheritance tax liability arises, and especially if that liability is an unexpected one, paying it can be a problem. With limited cash, paying a tax liability that has not been planned for could impact heavily on the estate. It could lead to land having to be sold (problematic where an estate is being run as a cohesive whole – or put up as security for borrowing (again, problematic without a plan for repaying the borrowing, and particularly problematic if the only cash available is in the form of income which can’t be converted into capital)).
The ownership of a landed estate will influence its inheritance tax treatment:
- If the land remains held in a strict settlement and has not passed from one generation to the next since before 2006, there is a good chance it will be treated as a ‘qualifying interest in possession’. What this means is that, on the death of the current beneficiary, an inheritance tax liability will arise (the prevailing rate of inheritance tax is 40%). Given the nature of a strict settlement, no spouse exemption from inheritance tax is likely to be available. Other reliefs may be available to reduce the tax liability, and they are touched on below.
- Similar rules apply if the land is held on a more modern life interest trust that predated 2006, or a life interest trust created by Will before or after that date.
- If the land is held in a discretionary trust, or certain other types of more flexible trust, it will be within the ‘relevant property regime’ for inheritance tax, which has the up-side of not imposing a tax charge on a beneficiary’s death, but the downside of inheritance tax charges at a lower rate every ten years.
- Estates can also be held by companies, or by partnerships or limited liability partnerships. These all come with their own tax consequences, some beneficial, some not, but ultimately the inheritance tax risk to achieve succession to the next generation remains.
The activity carried out on a landed estate will also influence its inheritance tax treatment. Two incredibly important inheritance tax reliefs are Agricultural Property Relief (known as APR) and Business Property Relief (known as BPR).
With many landed estates being engaged primarily in farming, APR will help to reduce the inheritance tax liability in a lot of cases. But it is not a given. First, APR only relieves the agricultural value of the land. If an estate finds itself, through luck or judgment, with land that is suitable for development and has increased in value accordingly, that extra value will not be relieved by APR. Then, there are rules about how the land is used for agriculture. Land that is farmed in hand can have its agricultural value wholly relieved after two years of ownership, while land let to a third party for agricultural purposes will only be relieved after seven years, and then potentially only 50% of the value will be relieved. Farmhouses need to be demonstrably farmhouses and farm cottages and buildings need to be occupied for the purposes of agriculture. It is not a straightforward relief and advice should always be sought if it is intended to be relied upon.
Agriculture is a business and BPR may also be available, to relieve more than just the agricultural value of the land. Plant, machinery, working capital, the non-agricultural value of the land, all of these can potentially be relieved through BPR.
What about let properties? Many landed estates include residential lets, be they cottages no longer needed for farm workers, or whole villages, a legacy of the days when the landowner didn’t just employ all the local workers, but housed them all as well. These properties do not benefit from APR, and normally owning and letting properties is treated as investment activity and not a business, but with careful planning it may be possible to demonstrate that the agricultural activity and the property letting activity form, not a series of discrete trading and investment activities, but a single, composite business, the whole of which should benefit from BPR. Known as ‘Balfour Planning’ after the leading case which concerned the Scottish estate of the Fourth Earl of Balfour, whether it will be successful or not is highly fact sensitive and depends on such things as there being a single management plan for the whole estate, the property side being less valuable and less income generative than the agricultural side, and the same employees working across all elements of the business. HM Revenue & Customs look at claims for BPR on a case by case basis and professional advice is necessary when undertaking such planning. We are dedicating a whole article to estate restructuring and Balfour Planning later in this series.
Landed estates are not just about land. Often, and especially in the case of long established estates which have been in the same family for generations, there will be significant collections of art and items of historic and even national interest. Sometimes the values involved can be eye-watering and can dwarf the value, not only of the building containing the collection, but potentially the estate as a whole. Clearly such values cannot be relieved by APR, but sometimes BPR can be available. Where the mansion house is open to the public, or used for events, art and artefacts can be a necessary part of the visitor experience, so all may not be lost from a tax point of view. If there is no business in which the chattels are used, items of the highest quality and importance can be exempted from inheritance tax in other ways. Conditional exemption will take items out of the scope of inheritance tax, on various conditions, including that they be made available to be seen by the public. The acceptance in lieu scheme can be even more generous, but does require the items to be ‘sold’ to the nation, as a form of tax payment in kind. As with Balfour planning, we are dedicating an article to the topic of heritage property later in the series.
Protecting the Estate for the Future
For the majority of estates the chosen successor (or entity) will assume a ‘custodian’ role, rather than receive an asset windfall. The chosen successor will become the person ‘in charge’ for a period of time, capable of making changes to achieve his/her own vision for the estate, but the legacy of their custodianship will dictate the financial viability of the estate for the next generation (and beyond).
In our experience the succession plan should double-up as a business plan, setting short, mid and long term objectives that are constantly reviewed.
The death of the current owner (or custodian) should not be a cliff-edge event, but the final stage of a handover of responsibility (and control) that has been achieved over many years. Read more about The Whole Estate Plan here.