THE TAX CONSEQUENCES OF ENVIRONMENTAL AGREEMENTS

After much anticipation HMRC has finally published its guidance on ecosystem services to clarify the taxation of environmental markets, including biodiversity net gain (BNG), nutrient neutrality, woodland creation and peatland restoration

For farmers and estates this new income stream has been very helpful. However, the tax treatment of these arrangements remains one of the most complex and evolving areas in rural tax.

Under HMRC’s framework, “ecosystem services”, is broadly defined as arrangements where landowners receive payments for delivering environmental benefits such as biodiversity enhancement or habitat creation.

The most critical tax distinction is whether proceeds from ecosystem services are treated as income or capital, and if income, whether it is trading. Often taxpayers wish to argue capital treatment given the capital gains tax rate is currently 24% compared to income tax rates at 45% or more.

In many cases, HMRC is likely to view the activity as a trade where:

• Land is actively managed or habitat created to generate units
• Units are created and sold as a product
• There is a clear profit motive

Where there continues to be a farming trade, the receipts could be part of that trade.

Capital gains tax may arise in two main scenarios:

1. Sale of land used for ecosystem services
2. Long-term change in land use, impacting underlying value. For this there would need to be clear evidence of the impact on value.

Commonly we see commercial structures where there is a large up-front payment from the developer for say, BNG units, with separate contracts for 30 years of management obligations. This raises difficult tax questions in terms of whether the income received should be taxed over the term of the agreement and matched with the expenditure, or on receipt.

HMRC’s guidance acknowledges that the answer depends on the specific facts. Therefore, this remains an area of little clarity. In practice, this will require careful thought on the structuring of agreements and how the income and costs would be dealt with in the accounts, depending on the terms of the agreements. The tax treatment would follow the accounting treatment, and we are still waiting for guidance on this from the Institute of Chartered Accountants. This is not expected until the end of the year.

One of the biggest concerns has been whether entering into these contracts jeopardises Agricultural Property Relief (APR) and Business Property Relief (BPR). The Government extended APR to certain environmental land management schemes from April 2025. However, whether APR is available will depend on the nature of the agreement and who the contract is with and whether the land was previously in agricultural use.

Where the income is treated as trading, this will strengthen the argument that BPR applies, so the income would not upset the ‘Balfour’ balance.

The HMRC technical note provides much-needed clarity on the principles of taxing ecosystem services, but considerable uncertainty remains in practice. Therefore, careful planning in advance remains important, considering the tax and commercial obligation risks early on and whether the use of a limited company would help mitigate those risks.