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Good day All. Today we will look at Trusts, as an effective tool for managing agricultural assets. It is a fact that the key to investment success, is the effective management of an investment portfolio. For families, one of the key requirements is a multi-generational portfolio, this is a portfolio that is effectively passed from generation to generation.
Asset management is so critical and in every type of investment venture, the management system, philosophy and structure is even far more important than the ability to buy or sell individual securities. This is especially true, as algorithms have completely cornered the short term trading opportunities in the financial markets. Therefore, success lies in the ability of an investor to be broader and more strategic in their thinking.
I have said many times before, but it is worth repeating that it is critical to have an investment plan that includes goals, time frames, risk management, portfolio management systems and if an investor cannot do this themselves then it is important to seek professional advice, because one’s financial future must be correctly planned.
Having said that, I must also add that I do not believe in passive investment management strategies, because the phrase ‘passive investment management’ is an oxymoron, because the word ‘management’ and its synonym ‘stewardship’, are words that denotes control, responsibility and positive action to add value through hard work, knowledge, wisdom and experience, so that in the end, the value of what was given has dramatically increased.
The idea of added value - by being passive and simply following the market, then expecting to be handsomely rewarded for that. It is absurd to say the least and the fact, that this has become so acceptable is tragic. The investment management industry has lost its will to fight and to do right for its clients, but it is simply content for taking fees while doing the basic minimum.
There is something so liberating about hard work and having an ethic of excellence which has been lost in our society today, there is comfort in knowing that if I work hard and consistently improve my craft, I will be rewarded, this is my insurance policy. It works because most people only ever reach 40% of what they are capable of without giving up and by doing that little extra, one can become in the top 10% of any field, therefore I find passive investing to be an extremely intellectually lazy concept that does not accurately reflect the true essence of our industry to the general investing public.
What is a Trust?
A trust is a legal device that allows several entities to have ownership rights over the same property. A trust has three main parties: the settlor, the trustee and the beneficiary.
The settlor of the trust is the initial owner of the asset, he/she/they create a trust and selects a trustee to manage the trust, which includes the asset or assets known as the trust property.
The agreement between the settlor and the trustee is called the trust deed and it encapsulates the duties of the trustee to manage the assets in a certain way and according to various legal principles for the benefit of the beneficiary who is now the ultimate owner.
From a property and trust law perspective, at this point, the settlor does not have any more rights to the asset but the legal owner is now the trustee. This can be a bank, a law firm, responsible relatives etc.
The trustees will look to the trust deed, which tells them how to manage the assets and what to give to the beneficiaries and when to give it. In many cases, the settlor adds himself/herself as a beneficiary.
This works very effectively in a family setting, where a settlor is looking to put his estate in order. At this point, as soon as he puts it in a trust, the tax status for him, the trust property and the beneficiaries all change.
There are very different rules across common law jurisdictions and also civil law jurisdictions that have transposed trust law principles into their legal systems, but there are various principles and purposes, which are generally applicable to the creation and use of trusts:
1. The trust enables the separation of ownership and control with the trustee having control, while the beneficiaries have ownership based on the specific provision of the trust deed.
2. The trust is a separate taxpayer for tax reasons and it must file its tax returns yearly.
3. The disposition of the trust property from the settlor to the trust, is deemed to be a sale at fair market value, and a valuation must be done from the time the asset was acquired to the day it was transferred to the trust, and the settlor must pay capital gains tax and depending on the personal circumstances of the settlor, he/she/they could have various capital gains exemptions.
4. There are various tax mitigation rules and exemptions that vary in different legal jurisdictions and based on different types of trusts.
5. The main use of trusts, is tax planning. In jurisdictions, where one has graduated tax rates, whereby as one’s income rises, their tax rises. Trusts are useful, because the income can be split across the family including the farmer, his spouse and their children - as beneficiaries, and they can all be taxed at lower rates.
6. Inheritance Mitigation - upon the death of the settlor, the assets will not need to be reported and assessed for inheritance tax.
7. Creditor Protection. The property does not belong to the settlor, the trustee or the beneficiaries so the assets are protected from creditors.
8. Confidentiality is a benefit, as the trustee conducts business in the name of the trustee or the trust and the beneficiaries do not need to be disclosed.
9. Trusts help to protect against matrimonial claims, as they are ineligible to be considered as matrimonial property, as the beneficiary does not have any interest in the land, so farmland can be protected in case of matrimonial breakdown.
10. Discretion on vesting rights - the trustee is normally required to use discretion in cases where one child wants to keep farming, but the others do not, then the trustee decides which child gets which asset.
11. Protection of Beneficiaries. For example, where the trust vest when the beneficiary is over twenty one years.
12. Spousal Trusts. In instances, where the surviving spouse may not be able to manage the property correctly, so the farm is put into a trust, this can also be in cases where the spouse is a spendthrift or has medical conditions that has left them incapacitated.
13. Farm Purification is another useful use of trust, when excess cash is used to purchase non farming assets, which can disqualify it from various farming tax benefits. In such cases, the non-farming assets can be transferred to the beneficiaries directly or a sister company controlled by the beneficiaries.
Certainly trusts are as easy or complicated as the assets, family structure and advisors, who are structuring them, but they remain a very useful asset management vehicle.
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Good day everyone. Today, I will delve more into the concept of trust, as both an asset management and tax mitigation vehicle.
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Once again, I welcome all of the readers of these blogs.
Today, I will like to look at some strategies to use when one is investing in farmland. However, before I do so, I want to speak a bit on key concepts of property rights and land law, to create a legal framework through which we can understand the strategies and cash flow.
If space allows, I may also briefly touch on trusts, as an asset management and tax mitigation tool that is very useful when investors are investing for the long term, especially in assets like agricultural land.
One of the reasons I like the farmland and forestry complex, is that it is such a fantastic asset to help families that want to grow and preserve capital for many generations.
I will start with a brief discussion of land and property law from the English law perspective. These concepts has formed the intellectual framework of global financial investments for hundreds of years and English Law remains the most flexible, stable and mature legal system for building an international portfolio.
The basics of land law is to define the supply and uses of land. Therefore, it is about regulating issues of ownership, control and usage interests in the land.
Each person with interests in the land has a bundle of rights called titles and it works like a chain.
The greatest possible property right to land is the fee simple in possession. In such as a case, the holder of this right is the absolute owner of the land to do as he/she pleases with it.
This person has absolute control over the whole land and all of its fruits and is said to have absolute titles to the land.
The next level down is the leasehold title or estate. This is where someone else is allowed to take possession of the land and use it for a certain amount of time and when that time is finished, it reverts back to the fee simple estate.
Depending on the nature of the lease contract, the lessee can also sub lease part of the land to sub lessees for a shorter period of time.
The third level is the ‘easement estate’. This is simply created to give someone a specific right of possession to a part of the land for a specific reason such as when utility companies have to lay part of their infrastructure within someone’s land.
These issues of titles in land may seem trivial, but they are extremely important because they determine ownership of mineral rights and water rights.
I remember spending a lot of time last year with some oilmen from Texas who educated me on the process of how they go about aggregating drilling rights from landowners in areas where they knew oil was present and how they shared the proceeds, because generally, where there is a fee simple owner, he/she or they own the mineral and water rights in what is known as a ‘unified estate’.
This owner can split these rights and convey them through a sale or lease to other parties separately, as I remember that in various parts of Texas, while they were drilling, they came across a lot of water, but the water did not belong to them, so they could not bottle it and sell it if they wanted to, because they were only entitled to the mineral right, specifically crude oil and natural gas.
While investing in farmland, these rights are extremely important. The most obvious is water rights, as in most circumstances one will need to irrigate the land, but also the issue of easements are very important if the access to an investor’s farm from the road, goes through another farmer’s land, then that easement must be investigated to see the terms even before buying, because that can significantly affect value.
Another easement that is becoming more important is ‘air easements’, especially when one is using drones to monitor one’s agricultural fields.
Especially important is to investigate all of the legal implications thoroughly, because rights and titles to land and even usage customs are very hard to change, especially when they have been established for years.
This can even affect the investor’s land, if they intend to plant organic products on their land in instances where the farm next to it is planting conventional products and using chemical fertilizers, which is draining into a shared water source.
An even more challenging is when investors are investing in farmland in developing economies, because in such countries, all of the various titles to the land may not be registered, so it can be challenging to fully investigate the ownership of different rights attached to the land, e.g. ancient animal grazing land or fishing rights when there are significant bodies of water attached to the land, or where access is through the investor’s farmland, like in the Great Lakes regions of East Africa.
This was quite a big problem in Africa, but the AfDB (African Development Bank) are hard at work with African companies to develop full registration of land across the continent. When this is complete, I have no doubt that it will unleash the full potential of African agriculture.
Additionally, there will inevitably be cultural and customary usage or access to water sources for communities, which the investor must take into account while making the investing decisions. It is always advisable to work with a top quality legal adviser in these cases; the money spent on excellent legal counsel is never wasted, especially a lawyer with good commercial awareness that tells the investor how to overcome the obstacles and manages the risks, not one that advises against taking the risks.
Ultimately, it comes down to the goal and strategy, because in any case, it is always good practice to integrate the considerations of the local community into an investing decision framework.
These titles or bundle of rights are the basis of asset creation and cash flow.
Before looking further to the strategies, I will briefly mention the types of value drivers we discussed yesterday. If an investor is looking to develop a sustainable farming operation, his value drivers are: price premiums, market access, lower costs, risk mitigation, and consistent yield.
Virtually all of the investment strategies can be summarized under two investment theses, these are:
1. Create value by investing in efficiencies, especially within the ecosystem to enhance the performance of the land.
2. Focusing strategies on meeting the nuanced demands of the food industry e.g. organic food.
Under the first investment thesis, we have strategies like cover cropping, rotational grazing, ecological farming, vertical integration, irrigation, skilled management team and project contracts.
I will speak more about these in the next blog. I will also speak of the main management models and we will look at portfolio management and tax mitigation strategies using vehicles like trusts.
However, I will finish today with one thought:
‘’Farmland is not merely an asset, but it is the carrier of hopes, dreams, identity and future for all of us in some way or form, therefore great wisdom is necessary for those that invest in farmland.’’
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Investing in Farmland | Part I