Conditional Exemption: yes or no?

We have previously looked at the tax benefits of using Conditional Exemption (CE) on rural estates in our article Conditional exemption for historic buildings and outstanding landscapes but it is not always the right answer. CE can act as a straitjacket preventing alternative land uses. This can create a tension with the emergent natural capital markets and new environmental land uses and some estates are choosing not to seek CE or to de-exempt land already subject to it.

Alternative use

Despite the advantages CE offers in relation to Inheritance Tax (IHT) and Capital Gains Tax (CGT), CE may not be optimal for land where other development options exist. Although land that might qualify for CE (typically land of outstanding scenic, historic or scientific interest) is unlikely to be suitable for standard development (building), it may well be suitable for other opportunities like creating habitat banks for Biodiversity Net Gain (BNG). 

BNG and similar uses are likely to become increasingly tax efficient in their own right, because the Government is keen to support them. The scope of Agricultural Property Relief (APR) has been extended to cover land managed under environmental agreements made with the Government and other qualifying bodies, such as local authorities. This includes land used for off-site BNG.

Crossover with CE?

The problem with using CE on land the estate wants to use for environmental purposes is that a common feature of many environmental schemes (such as countryside stewardship) is that an applicant cannot already be under a separate contractual or statutory obligation to do the same works. In practice, there is frequently an overlap between obligations put on landowners via CE undertakings and those put on landowners under such schemes. As such, CE may prevent estates putting land into these otherwise lucrative schemes.

Objectives

Even for land uses where APR is not available, such as solar farms, it might still be the case that the immediate cashflow or liquidity created by such a development outweighs the longer-term benefit of IHT relief from CE.

Long term tax relief versus immediate and significant cashflow bring different financial benefits and it is sometimes valuable to step back and consider whether one might outweigh the other and how that fits with the estate’s wider needs and strategy.

Loss of CE and de-exemption

Once CE is granted it remains in place until a chargeable event such as a sale or disposal of the land or death of the person beneficially entitled to it occurs. Alternatively, the land can be actively de-exempted at any time and this will also count as a chargeable event giving rise to a tax charge. The process of de-exemption is fairly straightforward and involves an application to the relevant Heritage Tax team with full details, including an open market valuation and a calculation (and payment!) of any tax due. 

Tax following a chargeable event

In some cases, there is both CGT and IHT payable on a chargeable event (whereas on death where there would be a capital gains uplift to the value of the land as at the date of death).

Crucially, when CE ceases to apply, neither APR nor Business Property Relief is available to reduce the value for the tax charge, regardless of whether these reliefs were available when the CE status was awarded. This is because these reliefs are only available on a "transfer of value", whereas the loss of CE is a "chargeable event", and the relief is not extended from one to the other.

When considering de-exempting part, it is critical to ensure that the amount of land or assets being de-exempted does not lead to the loss of CE status on the remaining land, or indeed any supporting Maintenance Fund (which would be liable for an IHT charge if the underlying asset lose its CE status). The charge to tax will only be restricted to the proceeds of that de-exemption if HMRC is satisfied that the "entity" has not been 2materially affected" by the portion de-exempted.

Do the maths!

Weighing up whether CE is (or remains) the optimal position for land within an estate requires careful analysis of the estate’s long-term strategy, objectives and immediate cash needs, as well as the tax costs of each option available. 

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, April 2024