Key VAT considerations for expanding farming businesses

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As the agricultural landscape evolves, many farming businesses are choosing to diversify by adding new activities alongside their core farming work.

In Cumbria, this usually means developing tourism-related activities, but other ventures, such as storage and creating industrial units, are also common.

Those who have diversified or are looking to do so need to be aware of the VAT pitfalls that can arise. You should first consider the nature of the income from the new venture and whether VAT is payable on this income.

There are three main VAT treatments, and the key issues are whether VAT has to be charged on different sources of income and whether VAT on related expenses can be reclaimed. They are:

• Standard-rated – for example, wool sales, contracting work, sale of machinery and holiday letting income – where 20% VAT must be charged and paid over
• Zero-rated – for example, sales of cattle, sheep, milk – where no VAT is charged but input VAT can be reclaimed on related expenses
• Exempt – for example, rent of residential property and most land – where no VAT is charged

VAT on rental income and land use

Whilst the default position is that rental income is exempt from VAT, and no VAT is charged, there are exceptions; car parking, storage of goods, and furnished holiday lettings are all compulsorily standard-rated, and 20% VAT must be charged. Additionally, a landowner can “opt to tax” land and commercial buildings so that VAT is charged on rents. The reason for doing this is to improve the recoverability of VAT on related expenses.

The letting of land under short-term agreements can be either a zero-rated sale of grazing or an exempt rent of land. The answer depends on how involved the landowner is in the management of the land, such as the application of fertiliser, spraying weeds and fencing, etc.

VAT on expenses

Turning to VAT on expenses, the general rule is that VAT is only reclaimable if it relates to either standard-rated or zero-rated supplies. A farming business making only zero-rated sales of livestock and crops can therefore claim back all the VAT on expenses. If, however, a business rents out land and cottages, then no VAT can be reclaimed unless an option to tax has been made on the land. There is, however, a relaxation to this rule, which allows a business with a small amount of exempt income to recover all the VAT on expenses, but this is a very complex area.

The key point here is to look at the nature of your customers. If both parties to a transaction are VAT registered, then one side pays over VAT to HMRC, and the other claims it back. When looking at tourism activities, the customer is a private individual who cannot reclaim VAT. This means there can be an advantage in undertaking this activity in a separate entity that is not VAT registered. However, this means that VAT cannot be claimed on any expenses incurred.

Caution when creating separate entities

Care needs to be taken in setting up separate entities, as HMRC may challenge the arrangement on the basis that a business has been artificially split. Therefore, all transactions between the two businesses need to be done on an arms-length basis. There are rumours that the Chancellor is considering significantly reducing the VAT registration threshold, which is currently £90,000, which would make this planning more difficult in future.