The future of the Basic Payments Scheme

In my previous article I discussed the The Agriculture Bill, its keys elements and the rejected amendments. The Agriculture Bill is the biggest piece of legislation for the farming and agribusiness industry for a generation.

The introduction of a new era for UK farming unearths uncertainties for farmers and their profit margins. The land based direct payments of Basic Payment Scheme (BPS) subsidies are being withdrawn over a seven-year transition period and will be replaced with new Environmental Land Management Schemes (ELMS). However, odd as it may seem, the Agriculture Bill provides no official details in its current form on the specifics of these schemes, yet they are anticipated to commence from 2021 and 2024 respectively.

BPS tapering and our New Zealand counterparts

For the benefit of our clients and readers, the tapering reduction of the BPS payment illustration has been drafted into an example of estimated year one impacts on cashflows, as outlined by DEFRA.

Larger businesses are likely to take the brunt of the impact during year one but should be able to spread their fixed costs over a large acreage, allowing for profits to be made through operational efficiencies and without the need for subsidies. Nonetheless, whatever the size of the enterprise, farmers and landowners must prepare for this loss of cash flow when the future of ELMS looks unlikely to provide such levels of subsidy.

Although the above example provides a good illustration of what farmers and landowners might expect for impacts in year one of the tapering, whether year one commences in 2021 or 2022 is still up for debate and is indeed being debated in the House of Commons and the industry generally. The cause of the potential delay being as a result of the Brexit pushback and the COVID-19 pandemic.

If we look back to the 1980s, our southern hemisphere counterparts in New Zealand would have valued any tapering period. A snap election in 1984 brought a new labour government into power and introduced significant austerity measures with budget cuts to a number of industries, and agriculture the biggest – the loss of subsidies.

A New Zealand Reserve Bank bulletin from 1986 suggested 10% of all farmers were in a critical financial state. High inflation rates, debt across the agricultural sector and the aligning of rural lending interest rates with market rates were crippling for farmers. What’s more, the ‘artificially’ inflated land prices, believed to be linked to subsidies, declined immediately. A situation in which the UK farming community may well find itself in the years to come. Nonetheless, given the current inheritance tax breaks for farmland the extent of a decline, if any, would be short lived. Unless on the back of the COVID-19 pandemic, the government revisits its evaluation of IHT and the associated tax breaks.

Among those who exited the industry were highly geared businesses with large debts to facilitate on a reduced cash flow. It is not unusual for farming businesses in the UK to operate within or around their overdraft all year round, incurring interest and yearly charges which with lowering subsidies will further impact operational cashflows.

From my parents recent Nuffield Scholar trip to New Zealand, they met a farmer who was highly geared prior to the instant subsidy cut of 1984. Since that day, it took 30 years to financially recover, and at first it saw him work without a salary for almost two years. A harsh reality, but a possibility for some businesses across the UK who don’t properly prepare. One survival technique applied was reducing assets to critical machines only, e.g. drill, sprayer, fertiliser spreader and combine. Many farms have excess and underutilised machinery, a point that some farmers are beginning to manage by cooperative farming.

We must remember, New Zealand agriculture recovered. Farmers took the initiative and responded to the subsidy cut and have become a world leader in agriculture. Producing food to feed approximately 40 million people and exporting 90% of farm outputs produced.

UK farmers must adapt and move towards a more efficient, cost tight structure by understanding their finances throughout the year through incorporating cash flows and budgeting. They’ll need to look for diversification opportunities and begin to explore value-added farming products, if possible.

Turnover is vanity, profit is sanity, but cash is king

Cash is King, a mantra that many businesses survive on.The ability for farmers and landowners to make their cash work for them will be key in how they come out the other side of the BPS removal. Part of this is cashflow forecasting, a good discipline for any business but far too often lacking in a farming enterprise. DEFRA have previously noted only 33% of farming businesses produce a 12-month forecast.

Part of maintaining cash levels and understanding the cash requirement in your business can be important to making key business and investment decisions.

Farming and landowners should create a 5-10 year cashflow scenario based on a standard crop rotation without any receipt of subsidies to stress test their businesses. Does the business survive? What does the business look like? Take a step back and consider all possibilities, if necessary, even the unthinkable – sell up and get out. Often farming business rely on 10-20% of their revenue from subsidies therefore testing survival without this income is the first step towards commercial longevity which can be enhanced through diversification.

Since the original discussions around removal of and the publication of the tapering period, many have looked to diversifying their revenue streams as survival technique whether it be into holiday rentals, property or vineyards through joint ventures with neighbours. Different business have different opportunities because some projects will favour owner-managed farms whilst others may be more favourable to tenanted farmers

In recent years, joint ventures between neighbouring farmers have grown in popularity as they look to share the burden of key fixed costs such as labour, machinery repairs and maintenance and depreciation. By sharing the fixed costs, it aids cash flow in each farmers separate business whilst there are further gains from a reduced capital outlay on machinery and implements for each farmer whilst obtaining the full benefit. It tackles the point of farming businesses owning underutilised machinery that is costing them in insurance, repairs and maintenance and depreciation.

With any new enterprise, taking timely advice is important. Getting the legal structure and agreements right, as well as planning and business rates considerations correct from the outset, is imperative. It would also be remiss of me not to mention tax! Understanding how the income is taxed and the impact on capital taxes, as well as VAT, will make sure your new diversification venture gets off on the right foot.

Future subsidies

All is not lost. Yes – we are losing BPS payments which will impact our farming businesses and our current cash inflows, BUT the future of ELMS will begin to contribute from 2024. Both via environmental enhancement and cash flow improvement as the “public money for public goods” is engrained into the next generation of farmers.

As DEFRA has previously stated “to be in the black, it helps to be green”.

We will discuss the future of ELMS in our next edition.

For more information please get in touch with your usual Larking Gowen contact. You can find contact details on the Our People section of the Larking Gowen website.  Alternatively, call 0330 024 0888 or email enquiry@larking-gowen.co.uk.

Laurie Hill