The summer heatwave in the UK has highlighted the increasing importance of environmental management and climate resilience. As governments and businesses seek to meet environmental targets, opportunities continue to emerge for landowners to generate income from natural capital schemes.
After a period of uncertainty, HM Revenue & Customs have now produced some guidance on the tax treatment of natural capital units and credits. Whilst the guidance is not definitive, and is inevitably HMRC’s view of matters rather than the law, this has provided some most welcome clarity.
Listed below are the four most common types, together with their tax treatments.
Biodiversity Net Gain (BNG) Credits
In England, land developers must deliver a biodiversity net gain of 10% when developing land. One of the ways they can do this is by buying BNG credits from landowners. BNG credits must be secured for at least 30 years, so the land used to create the credits is tied up for a significant period.
Nutrient Neutrality
Construction of overnight accommodation in certain river catchments in England may only proceed if it will not cause additional nutrient pollution (excess nitrogen, phosphorous or both entering the waterways). Landowners can create nutrient credits by changing land use or by improving drainage and sewerage, then sell these to developers operating within the same catchment to help them achieve this.
The scheme will be changed on the implementation of the Planning and Infrastructure Act 2025.
Woodland Carbon Code Credits and Peatland Code Credits
Landowners can develop projects which create carbon credits. Subject to accreditation, these can be sold on the open market to businesses required or wishing to offset carbon they emit, or other entities wishing to buy them for philanthropic purposes.
Stacking
Stacking is where two or more types of credits are created on the same piece of land. This only applies where the same environmental gain is not double counted.
Tax Treatment for the Landowner
The information below is intended as a high-level summary only, and you should always take advice from a suitably qualified individual. Tax treatment will depend on the specific facts and circumstances of each project, including how the land is used, ownership structure and the contractual arrangements put in place.
| Credit type | Biodiversity Net Gain Credits | Nutrient Credits | Peatland Code | Woodland Carbon Code |
| Area | England only | Certain areas of England only | UK | UK |
| Income tax | Normally taxed as trading income | Income from a commercial woodland is exempt | ||
| Corporation tax | Normally taxed as trading income | |||
| VAT | Subject to VAT | Likely subject to VAT | Usually subject to VAT, but certain exemptions apply | |
| Capital Gains Tax | Exceptionally, credits may be treated as capital disposals, in which case they follow the normal rules.
Disposals of land are taxable as normal. Business reliefs such as holdover and rollover may apply. |
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| Inheritance tax | Agricultural Property Relief (APR) can apply to land subject to an environmental agreement.
The land may also qualify for Business Property Relief (BPR) subject to the normal criteria |
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| SDLT | Payments for ecosystem services are not assessable to SDLT.
If land is acquired, leases granted, or covenants created, SDLT will apply |
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Accounting recognition of receipts
If the landowner uses the cash basis, the receipt should be brought into account when received.
Otherwise, the GAAP (Generally Accepted Accounting Practice) rules should be used, and may result in the receipt being spread over the life of the agreement or taxed immediately.
Capital vs Income Treatment
One of the key outstanding issues is whether receipts from natural capital schemes should be treated as income or capital.
In general, the tax treatment should follow the accounting treatment.
HMRC’s view is that receipts are normally income payments from a trade. However, there are arguments for treating them as capital, if, for example, there is a large upfront payment, as the landowner is receiving a payment for what amounts to a restrictive covenant over the land, which would seem to be compensation for the impairment of an asset, or for loss of use of the land.
The length of time for which the ecosystem service is maintained is also relevant, although not conclusive.
If capital treatment can be argued, receipts will benefit from the lower CGT rates of 24%, rather than being assessed to income tax at up to 45% (60% effective rate if it pushes the taxpayer’s income over £100,000).
However, there are benefits to a single, upfront receipt being spread over the life of the agreement as annual income:
- Expenditure will normally be incurred each year in maintaining the scheme. If the payment is taxed as a single, upfront capital receipt, no tax relief will be available on subsequent expenditure. In contrast, each year’s expenses can be offset if the receipt is apportioned over the life of the agreement as income.
- Spreading the receipt defers the tax liability, as only a proportion is assessable each year rather than the entire payment being taxed in the first year.
- The regular receipt of income will help bolster the argument that the business is overall trading, which is important for various tax purposes, including the offsetting of losses and Balfour planning for inheritance tax purposes.
Landowner’s expenditure
If the land is being held for trading purposes, expenditure incurred in setting up and maintaining the scheme will usually be an allowable deduction for tax purposes, subject to the normal rules.
If the land is held within a property business, the expenditure will be allowable against the income of the property business, again subject to the normal rules, including the lease premium and reverse premium rules.
Capital allowances may also be available on any plant and machinery purchased.
Practical considerations
The land in question must be maintained for a minimum period. For BNG units this is 30 years. For Nutrient Credits it can exceed 75 years. This will inevitably have further consequences:
- There will be an impact on land values; although one might expect these to fall, we have heard mixed views from valuers.
- If the value is reduced as result of the natural capital scheme, this will in turn likely reduce the maximum amount of borrowing that can be secured against the land. It may also be harder generally to secure borrowing against the land.
- The land may become less marketable because a purchaser will inherit the responsibility of complying with the environmental obligations attached to the scheme.
- Given the length of time, any natural capital agreements may impact future generations who inherit the land.
- It may be that following the sale of units, the landowner’s own business is subsequently required to provide units itself. For example, a farmer may be required to show they are sequestering carbon, and having sold all the units they have generated, may be obliged to buy units back from the market, perhaps at an increased cost.
Before entering into a natural capital agreement, landowners should therefore consider:
- The duration of the commitment.
- The impact on future farming or development opportunities.
- Financing and borrowing implications.
- Succession and inheritance planning considerations.
- Exit options and obligations on a future sale of the land.
Conclusion
Natural capital schemes can provide landowners with an attractive additional income stream while contributing to wider environmental goals. However, the long-term commitments involved, coupled with evolving tax and regulatory treatments, mean that careful planning and professional advice are essential before entering into any arrangement.
If you’d like to discuss any issues covered in this article, please contact us.
