Ecosystem services

Over the last few years, biodiversity net gain (BNG), nutrient neutrality and carbon schemes have become a feature of conversations with farming and landed estate clients as another way to generate a return from their assets.

Whilst environmental projects can provide a useful income stream at a time when traditional returns remain under pressure, and there has been increasing political support for them, there has also been a lack of certainty around their tax treatment.

Over these last few years, as BNG came to the fore as part of diversification projects in the rural sector, we could only make educated assumptions based on our view of likely HMRC practice and the legislation. There simply wasn’t any specific HMRC guidance available on how longstanding tax legislation applies to these schemes.

There was the slightly strange change to inheritance tax relief for environmental management schemes from April 2025 but even that government relaxation created uncertainty. It was prospective when announced and left questions over the historic position.

HMRC guidance issued

Thankfully this uncertainty has now been much reduced as HMRC has issued a technical note on the tax treatment. This note sets out HMRC’s approach to the taxation of ecosystem services, including BNG units, nutrient credits and carbon credits, and it’s an exciting read if you like that kind of thing.

Farm and landed estate diversification touches on all the difficult bits of our tax system and in particular whether income and expenditure is:

• Capital or revenue?
• Trading income or the exploitation of land?
• Taxable or non-taxable?
• Part of a single trade or a separate trade?

For those that aren’t familiar with these longstanding fault lines in our tax system, capital receipts are favoured and capital expenditure isn’t, trading activity is favoured and the letting of land isn’t, woodland income has been non-taxable since 1988 but that means expenditure on woodlands can’t get tax relief.

The distinction between trading activity and the letting of land is a difficult one and has been central to disputes over furnished holiday letting and similar activities sitting on the boundary between very different tax treatments. Since the Labour government was elected in 2024, property letting has been further disincentivised, which makes the distinction even more important.

The issue of whether an activity is part of an existing trade or a separate trade has been a feature of recent HMRC challenges, including in the MacDonald case. It will be important for loss offset and when considering farm profitability and averaging. It may also affect how the wider farming business is viewed.

Greater certainty is good news

More landowners have been exploring opportunities to generate income from natural capital projects but the challenge is that these arrangements rarely fit neatly into our tax system. Many involve significant upfront payments, long-term management obligations and commitments that can extend 30 years or more.

Whilst the technical note doesn’t answer every possible question, it is a big step forward and helps clarify the tax framework that we have to work within when advising. It is a real help for landowners and their professional advisers but as is hopefully clear, any advice remains a matter of judgement and experience.

Tax is only part of the picture

Having HMRC publicly set out its thinking should give all parties more confidence when assessing projects and making decisions but tax alone should not drive a decision.

The starting questions are:

• Does this fit with the long-term objectives of the farm or estate?
• What land is being taken out of production or another existing use?
• How will the agreement affect future generations?
• What flexibility is being given up?
• What happens if circumstances change in 10, 20 or 30 years’ time?

Environmental schemes can provide attractive returns, but they often come with obligations that outlast the current generation of owners and occupiers. It’s important to understand exactly what is being signed up to rather than focusing solely on the headline receipt.

Don’t forget succession planning

For many family farms and landed estates, succession planning remains one of the biggest considerations. Long-term environmental agreements can have implications for land values, future use of the land and inheritance tax planning. Where environmental schemes fit in needs to be determined as part of an overall strategy for the business.

Every situation will be different and what works for one farm or landed estate won’t necessarily work for another. Whilst there are legal issues to consider in any agreement, the first thing to assess is how any new activities fit within the existing business and what implications they have for the trading and long-term succession arrangements.

A maturing market

HMRC’s guidance is another sign that ecosystem services markets are maturing. The opportunities in biodiversity, nutrient mitigation and carbon projects remain significant. However, as with any diversification project, the right approach is to proceed with a clear understanding of both the opportunities and the long-term consequences.

The tax position may now be clearer, but careful planning remains just as important as ever. Any advice needs to be business specific and judgemental, relying on a detailed understanding of these complex tax provisions and experience in this field.