Switching to limited company status remains the solid option for financing land purchases
In my time advising farmers I have encountered many occasions where I'm faced with the difficult task of making a judgement call on whether my client sitting in front of me has the wherewithal to buy a piece of land that he would dearly love to get his hands on.
More often than not the piece of land is at the other side of the boundary ditch or backing on to his farm yard.
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How could I say no, particularly bearing in mind that my experience has taught me that, notwithstanding all the sophisticated budgeting tools available to me, buying land quite frequently works out in practice but not in theory.
This is probably because the farmer will do whatever it takes to ensure the loan is paid down.
Generally, the economics of buying land will have little or no bearing on the decision as farmers don't buy land as an investment but rather as an asset that they will hopefully pass on to the next generation.
That said, land is certainly not a bad investment where one takes a long-term view.
If we compare the price of good agricultural land bought in 1980 at €2,000 per acre with today's typical value of €10,000 per acre, the average annual compounded return on investment is a healthy 4.1pc.
During that period cumulative inflation was 296pc meaning that if land price just held in line with inflation, its value today would be just shy of €6,000 per acre.
The only notable interruptions to land price inflation were the recessions in the mid 1980s and the more recent recession which we are all familiar with.
There are a number of factors that will have a bearing on one's ability to buy and pay for land. I will list these as follows:
- recent and predicted farm profit profile;
- available funds;
- land that can be disposed of;
- taxation profile.
FARM PROFIT CAPACITY
Where borrowing is going to be central to most land purchase proposition, it is essential for the farmer to assess what repayment capacity the farm possesses.
This will require an expert assessment to determine what funds are available after meeting drawings, existing debt servicing, capital investment and taxation. Ideally, an average of four years should be used while also factoring in the impact of any planned expansion.
The case study set out below gives an idea of how to establish the available funds.
Readers may have encountered the term EBITDA which means earnings before interest, taxation, depreciation and amortisation which I will use in the case study. EBITDA is what is available to fund drawings, taxation, total repayments and capital expenditure.
Using existing funds such as bank deposits will have no negative tax consequences but if the available funds comprise Co-op or Plc shares it is probable that disposing of any or all of these shares will generally incur a Capital Gains Tax liability of 33pc unless there are prior losses available to offset or unless the shares were acquired by way of gift or inheritance in which case the tax exposure may be lower.
Where land needs to be disposed of to fund the purchase of a new holding it is vital that the Capital Gains Tax implications are checked out first. There are two reliefs that may apply that could eliminate any tax, namely Retirement Relief or Farm Restructuring Relief. In the event that neither relief is available the farmer may be entitled to Entrepreneur Relief which reduces the rate of tax on the gain to 10pc.
Land purchase which is funded by debt may have significant tax implications in the medium to long term in that the cost of the land must be met out of after-tax earnings.
The price paid for land is not a tax-deductable expense but the interest on a loan taken out to fund the purchase is.
This means that at current tax rates where an acre of land is costing €10k and is funded by borrowing, it will require a sole trader farmer to have approximately €20k in taxable earnings to service the principal alone.
The truth of the matter is that borrowing money to pay for land is generally only feasible within a limited company structure.
A further tax consideration is Stamp Duty. The standard rate is 6pc but young trained farmers may qualify for the exemption.
However, caution is urged where the farmer decides to place the new land in the son or daughter's name in order to avail of the exemption as the rules are quite specific and onerous.
The young farmer must retain and farm the land for five years and there can only be one claim for the exemption.
Accordingly, if it is planned to transfer the home farm to the same individual at a later stage the exemption will not be available so the sums may need to be done to see if holding off is a better bet.
Case study: Converting to limited company status to boost borrowing capacity
Joe Farmer has sale agreed on 35 acres of adjoining land that is costing €350,000.
He will be borrowing €300k and will fund Stamp Duty and legal fees from his own resources.
He has current outstanding debt of €100k which is costing €23k to service which comprises mainly Hire Purchase on a jeep and bulk tank.
He had no immediate plans for new capital investment. His wife is working and funds many of the household expenses, but the farm also funds over €20k per year of the family drawings requirement.
Joe needs to satisfy his bank that he can afford to service the new loan while also meeting his existing commitments.
His average profit for the past three years as per his farm accounts is €78,000 which gives him an EBITDA (see above) of €90,000.
He has no expansion plans at present and will be happy if he can maintain his recent performance.
He is a sole trader and his tax bill is calculated to be €22k for the next few years assuming he remains a sole trader.
Acquiring the new land will enable him to drop rented land that is currently costing him €7k per year. The following is his position;
Projected Surplus (EBITDA): €97,000
Less: drawings of €20,000, existing loan repayments of €23,000, new loan repayments of €27,000 and taxation €22,000
This surplus of €5,000 may not be enough to satisfy the bank.
However, if Joe converted to a limited company, he would reduce his tax bill to approximately €12k thereby increasing his surplus to €15,000 which may prove crucial in getting loan approval.
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