Environmental agreements - understanding the income tax position

We are starting to see momentum pick up, with a large volume of heads of terms for various environmental agreements coming across our desks, whether these are for the creation of carbon credits, wetlands or biodiversity net gain agreements.

So far, the agreements all differ in terms of:

• The length - with some ranging from 30-50 years to some spanning 80 years to perpetuity.
• The restrictions on the land.
• The acreage and monies involved.
• The structure of the agreement and structure of payments; and
• When and what basis the payments will be made.

This gives accountants a bit of a headache, as all these differences mean that there is no ‘one size fits all’ approach to either the accounting or tax treatment and, consequently, our advice. In addition, as these agreements are only just coming to the table, no case has yet been tested in the courts and so there is no precedent to follow.

To help provide some understanding as to how the range of agreements affect the tax position and therefore our advice, I thought I’d briefly run through some of the issues in turn.

If the agreement is likely to de-value the land due to covenants restricting its use, the income/compensation for this devaluation could be treated as capital. This would then be subject to capital gains tax, instead of income tax. With lower rates for capital gains tax, this treatment may be more favourable but not necessarily guaranteed.

If, however, the receipts are considered payment in return for providing a service then this would be treated as income, subject to income or corporation tax. If this is the case, we then need to understand when this income will be recognised.

As we are not aware of any comparable cases to set a precedent for these agreements, we therefore must refer to UK Generally Accepted Accounting Practice (GAAP) to consider when the income will need to be recognised for both accounting and income tax purposes.

Under UK GAAP, income is generally recognised when goods or services are provided, or when services are performed. With long term contracts, revenue is recognised with reference to the stage of completion.

Part of the agreement may therefore refer to the ongoing management and maintenance costs and this element could be argued to be spread over the term of the agreement. However, part of the income might be received earlier to reflect the initial outlay required in the first few years. In this situation, a proportion of the income may be recognised sooner.

In addition, part of the receipts will fall due when certain qualifying criteria has been met.

In many cases, there will often be a mix of the above, with a proportion of the income spread over the term and part being recognised sooner, depending on the detail in the agreement.

Depending on the amount of income involved, even if the income is recognised over the term of the agreement, this could result in paying higher rates of tax, losing your taxfree personal allowance and a clawback of child benefits, where received. To put some perspective on this:

If you are due to receive £3.5m over 35 years, that could result in an extra £647k tax if received by you personally compared to being received through a limited company – and that’s on the basis the income is spread over the term!

However, while we will want to ensure we are mitigating your income tax position, it is also important to ensure all taxes have been considered and that mitigating the income tax position is not detrimental to potentially more valuable Inheritance tax reliefs.

Aside from tax, it is also worth considering the position of risk. If you do not meet the management criteria and have already received a large lump sum payment, would there be a claw back of this payment? If so, how would this be calculated, how much would be clawed back and could this risk be mitigated through the use of a limited company.

It is therefore important to speak with us as soon as possible so that we can ensure the agreements consider your overall position.

Should you wish us to review any draft agreements or Heads of terms or would like any advice in this area, then please do get in touch.