Older landowners looking to step back from their farming business are increasingly turning to contract farming. Tomos Davies explains the pros and cons.
As farmers grow older it’s natural to start thinking about exiting the business, or playing a less active role in day-to-day operations.
However, many owner occupiers do not want to let or sell a farm that may have been in their family for generations and is also their family home. Contract farming allows farmers to keep an arm’s-length involvement in the business, which can also expand as a result of a contract agreement.
The broader picture
With the high price of land and substantial startup capital involved in renting a farm, joint ventures between farmers and contractors represent an innovative way of growing the business.
This is particularly relevant in light of Brexit-related uncertainties and the UK government’s view that expansion is one of the best ways farmers can succeed when the UK leaves the EU.
What is contract farming?
Contract farming developed in the 1970s and has been widely used in the arable sector, although it is becoming increasingly common in livestock businesses.
The system involves a standard contract farming agreement under which the farmer engages the services of a farming contractor to carry out operations for a fixed period – usually three to five years.
The farmer retains occupation and subsidies, while the contractor provides management, equipment and labour. The farmer is paid a fee and takes a share of the profit, while the contractor receives funds to cover the expenses and retains the rest as profit.
Contractors can be a neighbouring farmer, a large farming business, or a smaller farming contractor looking to start up an agri-business or develop an existing one.
Advantages for farmers
Farmers benefit from releasing the capital value of machinery, which frees up funds for a partial exit, for use in other businesses or retirement. In addition, the joint venture nature of contract farming can create economies of scale and drive growth.
A professionally drafted contract farming agreement avoids the creation of a tenancy and means ‘farmer’ status can be kept for subsidy and tax purposes. Agreements can be highly flexible, depending on the needs to the two parties.
Agreements can generate a stable income, while off-loading most of the recurring capital and maintenance costs of machinery. Agreements also enable farmers to avoid employment liabilities, which are taken on by the contractor.
Farmers additionally benefit from tax breaks, provided they stay active in the business. Tax reliefs include income tax and IHT benefits, as well as potential capital gains advantages, such as roll-over relief and entrepreneurs relief.
Downsides for farmers
Maintaining farmer status in this arrangement requires a certain level of involvement in the joint venture and the farmer continues to shoulder some risk.
On top of this, the farmer must pay administration costs, such as managing the agreement and preparing separate financial accounts. He is still, after all, running a business.
How to make contract farming work
An effective contract farming relationship requires trust and flexibility, along with strong incentives for the contractor – which also rewards the farmer via a share of greater profits. Professional advice when drafting the terms of the agreement is also imperative.