The importance of having a farming partnership agreement

We are currently dealing with a number of Farming Partnership disputes and some of our colleagues are similarly engaged. Many of the matters that are arising could have been avoided or more easily resolved if there had been a written partnership agreement in place. Other issues could have been resolved if that agreement had been updated as partners retired or passed away.

I am thinking of one where there were five partners drafted so that when the father had was alive, he had the casting vote. This agreement was not updated when he died, issues then arose between the four remaining partners with two siding against the other two, and the Partnership Agreement left them unable to take any partnership decisions.

If you run your farming operation with others, it is essential to have a properly drawn up partnership agreement to regulate how the partnership operates and to update it as situations change. This is, in my experience essential in all cases and especially where your partners are family members.

What happens if there is no partnership agreement?

If there is no written partnership agreement the partnership will be regulated by The Partnership Act 1890 (‘the 1890 Act’). The provisions of the 1890 Act may well not be suitable for your farming operation. For example the 1890 Act contains provisions which give all partners an equal vote and an equal share of the profits. That may well not be appropriate. It also states that the partnership will dissolve if one of the partners dies. That may be very undesirable, since unintended tax and legal consequences may ensue.

What should the partnership agreement cover?

A written partnership agreement can cover many matters, as appropriate in the situation, such as the name of the partnership, its commencement date and place of business, capital contributions, capital assets, withdrawal of capital, voting rights as well as what happens if someone dies, resigns, or is assumed to the partnership. To avoid cessation of the partnership on the death of a partner the agreement should contain a clause to say the trade will continue. Consideration should also be given to how to deal with surviving partners and the paying out of the beneficiaries of a deceased partner. The agreement can also regulate the routine management of the partnership.

Ownership of land and tax

When drafting a partnership agreement it is important to consider whether the farmland is a partnership asset. Often farms will have been bought in parts over years, with some land being taken in the name of the partnership and some in the name of individuals. When drawing up a partnership agreement it is important to understand the legal ownership of the farm so that this is correctly defined and handled in the agreement.

From an inheritance tax perspective, only partnership property qualifies for 100% business property relief.  Farmland held outside the partnership only gets relief at 50%. There is no such distinction as regards agricultural property relief, but maximising business property relief may be of particular benefit where land has development value or there are non-agricultural assets.

Where land is not partnership property, a transfer to the partnership may be achieved by a formal conveyance of the land to the partnership or entering into a declaration to the effect that the land is held for the benefit of the partnership. This might require an entry to be made and kept updated in the Register of Persons Holding a Controlled Interest in Land. This Register is something that must not be overlooked. Both ways of dealing with transferring land to the partnership have tax implications but this is where a carefully thought out and defined agreement with appropriate land capital accounts, can be used to mitigate the potential tax.

Compatibility with partners’ existing wills and the title deeds

It is vital ensure to ensure that the partnership agreement is compatible with the partners’ individual Wills and if the farm is held on a partnership title or on trust for the partnership you may need to consider the question of legal rights in the partners’ estates. Considering the legal rights question is vital in all partnership arrangements and no solicitor should draft a Will for a partner without seeing the partnership agreement and understanding how partnership property is dealt with.

Legal rights may be claimed on the death of a Scottish domiciled individual by the surviving spouse and children. A claim to legal rights can only be made on the deceased’s moveable estate which would normally exclude land. However, if land is partnership property the deceased’s interest in the land may be subject to a legal rights claim.  Any partnership agreement should be drafted to deal with the issue of legal rights to provide the partners with certainty about who can and will inherit their farm.

What are my next steps?

If you don’t have a partnership agreement in place, we consider that this is risky and that you should give serious consideration to having an agreement drawn up. This could save you time, money and strife in the future.

Equally if you haven’t reviewed your partnership agreement for a while, look it out and make sure it is still fit for purpose. Ideally partnership agreements, like Wills, should be reviewed every 3-5 years to check whether there have been any changes to legal or tax rules that need to be thought about. Additionally, the agreement should be reviewed every time a partner leaves or a new partner joins.

This article was first published in July 2022 and updated in October 2023.

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