Permitted Development, Barn Conversions and the Tax Implications

Driving around the countryside, the effects of the permitted development rules are now clear to see. The rules have supported landowners to diversify, have provided much needed additional accommodation in rural areas for farm workers and the rural community, and in some cases have provided a capital lump sum from a sale to reinvest in the business elsewhere.

Whether selling a barn for conversion or developing it for use in the business, the tax implications are important, alongside the personal and commercial considerations. Often the costs to convert a barn are substantial so considering all the costs are crucial to making the right decision for the long term benefit of the business.

The tax implications will depend on whether the barn is to be sold with planning permission or developed by the business. If the latter, the intended use of the barn once converted will make a difference to the tax implications.

Assuming the barn is to be sold with planning permission there will be a tax charge on the difference between the sale value and acquisition value. The difference will be chargeable to capital gains tax (CGT) at 10% or 20%, depending on whether the owner has utilised their basic rate band for income tax purposes. Every individual has a CGT annual exemption, currently £12.3K but reducing to £6K from 6 April 2023 and £3K from 6 April 2024. Farm losses in the year of sale or historic milk quota losses may still be available to reduce the taxable gain.

Where the capital gain is substantial, further tax planning such as gifting shares to other parties before planning permission and whilst the barn is used for agricultural purposes, could be beneficial. In addition, rollover relief can be used if the proceeds from the sale are re-invested in other qualifying assets in the business such as new farmland or improvements to buildings.

Where a large proportion of the gain is likely to be taxed at 20%, consideration should be given to whether business asset disposal relief (BADR) can apply. BADR can halve the tax bill but needs careful planning in advance of the sale.

Finally, the inheritance tax (IHT) position should be considered. A farm building currently occupied for the purposes of agriculture qualifies for up to 100% relief from IHT. However, a converted building may not and the cash proceeds, unless invested into new relievable IHT assets, will be chargeable to IHT. If the proceeds are not needed in the hands of the current owners, gifting the barn whilst it is still occupied for the purposes of agriculture may be tax efficient.

If the barn is to be developed by the business the main tax cost of the development will be VAT. The rate of VAT and the amount of VAT that can be reclaimed will depend on the intended use of the barn once developed.

For example, at first sight the VAT rate that should be applied by a contractor for converting a non-residential barn into a single house or a number of houses should be the reduced rate of 5%. However, where there is a restriction to the planning permission such that the barn cannot be sold separately to the rest of the farm, the standard rate of VAT of 20% will apply. In addition the DIY Housebuilders Scheme cannot be used to recover the VAT charged. Therefore it is important to take advice to protect the benefit of the reduced rate of VAT.

Where VAT is charged it can be reclaimed if the barn is to be occupied by a farmworker. A partial reclaim can be made if it is to be occupied as a farmhouse by the business owner. In addition if the converted barn is to be used as holiday accommodation then VAT is recoverable although VAT will need to be charged and paid over to H M Revenue and Customs on the holiday letting income.

Finally the DIY Housebuilder and Converters’ Scheme allows VAT recovery where the house is to be occupied by the owner or a member of the owner’s family, assuming there are no planning restrictions as mentioned above.

If the barn is to be rented out then the recovery of VAT will be more complicated. Unless the costs fall within partial exemption limits the VAT is unlikely to be recoverable.

Another important area when converting a property for use in the business is capital allowances. If the barn is to be occupied by a farmworker, or used for holiday accommodation, then relief will be available for the cost of plant and machinery and integral features in the building. This will include kitchen and bathroom fittings as well as internal electrics, heating and plumbing amongst other costs. In a recent case a new farmworker’s cottage which cost £160K to build, included items qualifying for capital allowances of £60K. With the current annual investment allowance set at £1M a year this expenditure was written off against the farming profits to reduce the income tax bill.

Where the business converts a barn with a view to selling it on, the gain will be chargeable to income tax rather than capital gains tax. As a result the tax payable will be a lot more. The treatment of the sale and the associated conversion costs for VAT purposes will depend on the planning permission. In either case advice should be taken to ensure the correct business structure is put in place to undertake this activity.

As always, taking advice early on can help the business make the right decision for the long term future benefit of the farm.