Alistair Campbell looks at the niche forestry investment market and outlines its potential benefits
What are the benefits of investing in forestry?
Investment in forestry is perhaps a little out of the ordinary compared with traditional stocks, shares and bonds. However, the prospects for steady, long-term growth are excellent and the UK tax benefits are clear.
Investments in forestry also have the benefit that, as a long-term investment, if another recession should come along, it is generally possible to sit out any softness in timber prices for a few years while the crop matures and grows in volume – quite different from agriculture where one generally has to harvest at a particular time.
What is the investment strategy?
Investment in forestry is neither particularly complicated nor high risk, considering it can be regarded as an alternative or a commodity. The basic strategy is physical growth of the timber crop and a hope or expectation timber prices will at least maintain their value in real terms. As the trees grow, not only does the volume of standing timber increase but so does the unit price, as the quality and value of the timber increase with its radius.
In the UK, profits and gains derived from commercial forestry are beyond the scope of taxation. This means although no allowances are available on expenditure, commercial forestry in the UK is free from income tax, capital gains tax (other than gains on the underlying land as opposed to the timber crop), corporation tax and, if held for more than two years, inheritance tax.
How can retail investors invest?
An individual investment in commercial timber is probably uneconomic below the level of £250,000, thus excluding a decent number of investors who might like to invest at lower levels. However, there are quite a large number of potential investors who would like exposure to UK forestry but wish to invest less than this figure. For them, a collective forestry fund could be the answer. But how they are grouped together and how forestry funds are structured requires careful thought.
It is the combination of grouping investors together so the taxation benefits of investment are maintained for each individual investor that makes the forest funds business particularly interesting from a structural point of view.
How are forest fund businesses structured?
There are many structures in which investors can be grouped together. Unlike most investments, forestry in the UK is not now usually carried out through limited companies. That is because, although the limited company will itself enjoy the benefits of the tax-free nature of its profits and gains – commercial forestry not being chargeable to its corporation tax – dividends from shareholdings and gains on the sale of shares in a forestry company will be taxed in the normal way in the investor’s hands.
An efficient investment in UK forestry on a collective basis should be made through a
vehicle which is tax transparent, so all the tax-free benefits of the investment flow directly through to the individual investors. Partnerships, trusts and limited partnerships can all be used to achieve this.
For a small group of investors or a family, a general partnership may be the best way. General partnerships tend to be fairly loose structural arrangements and provide no limited liability to any of the partners. These are perhaps not practicable for more than say five investors. Where there are a small number of investors like this, the alternative is a limited liability partnership (LLP) under the Limited Liability Partnerships Act 2000, where the partners may be involved in day-to-day management but have the benefit of limited liability.
Sometimes groupings of investors are made by way of forestry trusts – simple trusts which recognise the proportionate ownership interest of investors in the plantations. These structures can be rather unwieldy in that the investors can generally issue instructions to the trustees as to how investments should be – possibly making the trustees unhappy not only to be personally liable for their actions but also potentially to receive conflicting instructions from investors.
The most attractive structure is the traditional Limited Partnership (LP) formed under the 1907 Limited Partnership Act. Both it and the trust structure above will be Unregulated Collective Investment Schemes under Section 235 of the Financial Services and Markets Act 2000. As such, they require an operator with authorisation from the FSA to act in this capacity.
The limited partners are prevented by the terms of the Limited Partnership Act from taking part in day-to-day running of the business and their liability is limited to the funds which they have contributed. The general partner will usually be a limited company subsidiary of the forestry manager, will have unlimited liability and will be responsible for the day-to-day business of the investment.
One further curiosity of LPs is those registered in Scotland have a legal personality of their own – that is to say they can hold property directly, and can sue and be sued in their own name. LPs registered in England have no such separate legal personality. All very academic – until a limited partner/investor defaults (for example, by not paying up sums that are due) and the LP wishes to enforce its rights. In Scotland that does not present a problem, but in England the LP may require to be dissolved before rights can be formally enforced.
Are there any time limits for investments?
The term or duration of the investment will generally be stated in the Limited Partnership Agreement. This may be anything from 10 to 20 years but the investors, often with a 75% by value vote, will also have the ability either to terminate early or extend the investment period. In some forestry funds there is a degree of liquidity in that investment managers will try to make a market matching buyers and sellers of shares of the forestry partnerships. This can be important if the investment has been held for inheritance tax relief and a death has occurred.
There are several specialist forestry investment managers present in the UK such as John Clegg and Scottish Woodlands, with the UK market leader in collective forestry funds being FIM Services Limited.
Alistair Campbell, partner, Brodies LLP
