AS IF times were not hard enough for farmers, now comes a warning they could face tax bills they did not reckon on if they diversify.

Northern representative of the Institute of Chartered Accountants' farming group, John McGrother, says the Government is not making diversification attractive enough from the taxation point of view.

He said: "Farmers have a favourable tax situation, but if they diversify they could lose tax advantages."

He added: "Tony Blair has made much of the need for farmers to diversify into other rural businesses but, unfortunately, his treasury is doing little to make this attractive from a taxation point of view.

"Many an entrepreneurial farmer could end up with some exceedingly unwelcome tax side effects from diversification."

He cited as an example the farmer's wife who does bed and breakfast. By doing this, she could be losing the farm its agricultural property relief.

The institute says farmers must change their ways if they are to survive. But the advice to farmers is to check with their accountant before entering into diversification schemes.

The National Farmers' Union runs a tax help line for farmers. Spokesman Rob Simpson said every business had to be run in a commercial way. He urged people setting up new enterprises to be very careful and ensure they were not incurring additional tax costs. "They have to use their own judgement as to whether they should seek advice or not," he said.

The NFU tax helpline is on (01993) 706999.

Mr McGrother offers the following advice to farmers thinking of diversification:

INCOME TAX

a farm shop may constitute a separate trade

if farming ceases, losses cannot be set against other income

if the five years losses rule applies, farming losses cannot be set against other income

if property is let, the Schedule A rules may restrict the eligibility of some expenses and also the ability to make pension contributions.

CAPITAL GAINS TAX

provided assets are used in a trade, the same relief should apply as if they were used in farming

problems arise if they stop being used for the purpose of a trade

loss of business taper

loss of Section 156 gift relief. Many farmers are aware of their ability to gift farming assets and hold over any resulting gains. The fact that this is not available on a converted barn may cause some consternation, especially if they find out after making the gift.

INHERITANCE TAX

a farm business tenancy will no longer attract agricultural property relief if the owners continue to live in the farm house

assets no longer used for agriculture but used in another trade will not qualify for agricultural property relief.

assets let outside agriculture will not usually gain any inheritance tax relief.

VAT

diversification can very easily turn a fully taxable farming activity into a partially or fully exempt business

with major developments or conversions the ability to recover the input tax on the expenditure will impact on the overall viability of the project.