I INTRODUCTION

The ownership of works of art forms a significant part of the wealth of many international private clients, and the kudos and personal enjoyment that comes with such ownership is an added benefit to the financial returns many collectors have witnessed in recent years. In the United Kingdom, the art market services international clientele, attracting dealers and collectors from around the globe. A significant boom took place between 2010 and 2015,2 which was followed by a market correction in 2016;3 however, during 2017 and continuing into 2018 there has been a recovery in the market and confidence in art as an asset class has returned.4 Many collectors who may have initially acquired works of art purely for pleasure have since witnessed their acquisitions become a significant proportion of their net wealth during the last decade5 and, with this in mind, other collectors have entered the market seeking to spread their class of investments. Whether this will continue cannot be certain, but for the moment, the fiscal policy has remained largely unchanged. Since the result of the June 2016 UK referendum on membership of the European Union, there has been speculation about the impact Brexit will have on the art market, but no changes to the current rules or policies have been announced at the time of writing.

UK government policy is generally in favour of arts and heritage. The importance of the art, culture and heritage industries for the UK economy is widely promoted6 and has been recognised in some favourable tax treatments (see below). Nevertheless, the importance of establishing the correct ownership structure must be the first consideration for collectors and it is useful to bear in mind the ultimate destination for any collection when deciding how it should be owned, whether that is a legacy to the next generation, a bequest to a museum or, in due course, a sale.

The United Kingdom does not maintain a general register of chattels, although the UK's tax collecting and administration agency, Her Majesty's Revenue and Customs (HMRC), does keep a register of works of art that are conditionally exempt from inheritance tax (IHT). Currently, there is no wealth tax applicable to individuals or their chattels, and consequently there are attractions in terms of privacy, personal enjoyment and deferred taxation to this class of investments for those who are willing to hold non-income producing assets as part of their overall portfolio. Many works of art in the United Kingdom have been held by the same families for generations and the UK tax legislation has beneficial rules to encourage the care and maintenance of heritage chattels in private ownership7 so long as owners give public access to those objects. Since as far back as 18968 there has been a recognition that heritage assets require special protection and successive legislation has addressed this point.9

The government acknowledges that, in order to thrive, the art market requires participation from, and access to, buyers and sellers across the world.10 Through its export-licensing system, the government seeks to strike a balance between the protection and retention in the United Kingdom of those works of art and cultural objects that it considers are of outstanding national importance (and whose export would be a misfortune), and the needs of the UK art market. This is a particularly specialised area and separate advice should always be sought from recognised experts should an export licence for any cultural object or work of art be required.

Finally, the United Kingdom is a signatory to the Convention on the International Trade of Endangered Species and any work of art containing material from endangered species may be subject to import or export restrictions. Value added tax and excise duty are also applicable in certain circumstances, but both are outside the scope of these notes.

II RELEVANT TAX CONSIDERATIONS

The general rules for the taxation of works of art follow the United Kingdom's tax legislation for the relevant ownership structure. Consequently, UK-resident and domiciled individuals are taxed on gains arising on disposal of chattels worldwide, at their prevailing rate of capital gains tax (CGT) (usually at 20 per cent).11 On death, chattels are valued12 and IHT at 40 per cent is paid above the relevant threshold.13 There are some useful exemptions from both taxes (see below). Income tax is payable by self-employed art dealers and agents, and corporation tax by companies dealing in art. UK trustees holding works of art are subject to the rules applicable to trusts and, for relevant property trusts, this means that an IHT charge at around 6 per cent is applied every 10 years to the value of the chattels owned at that date. Likewise, IHT and potentially CGT charges apply on the creation of trusts and appointments from them.

i Capital gains tax

For CGT purposes, particular forms of relief apply to any gains arising on the disposal of chattels. Those chattels disposed of for proceeds (deemed or actual) of £6,000 or less are exempt from CGT, irrespective of any gain arising on that disposal, or the number of chattels disposed of and qualifying for this relief, in any year.14 Likewise, losses arising on a disposal for £6,000 or less are restricted. One of the advantages of the 'chattels' relief' is that the taxpayer is still able to use the annual exemption for CGT purposes against any remaining chargeable gains.

In addition to the general chattels' relief, certain types of chattels are exempt from CGT altogether; for example, no CGT is due on the disposal of private passenger vehicles, wasting assets and chattels held to be plant or machinery.15 In this context, machinery includes other motor vehicles not normally used as private passenger vehicles. Specific rules apply to the treatment of sets of chattels, a good example of which would be the sale of a set of dining room chairs on a chair-by-chair basis, and any attempt to manipulate the sale proceeds of chattels by dividing a set in this way would be ineffective for CGT purposes.16

Non-UK resident individuals may sell works of art in the United Kingdom without incurring a liability to CGT in the year of disposal, although care should be taken that a gain is not deemed to arise on returning to the United Kingdom should residency be resumed within five tax years of departure from it.17 In addition, foreign-resident trustees do not pay CGT on the sale of chattels in the United Kingdom, but both individuals and trustees in these circumstances must be careful not to be deemed to be trading in the United Kingdom. There are also special rules concerning the benefit or enjoyment of a work of art in the United Kingdom where the chattel or chattels are owned by a company or trust and in this specialist area, advice should be sought at the earliest opportunity. Finance (Number 2) Act 2017 introduced new measures that fix the value of the benefit of enjoying works of art in the United Kingdom where the benefit is provided by a trust or company resident outside the United Kingdom. The value of the benefit is calculated as the higher of the amount paid by the person providing the benefit in acquiring the asset (i.e., the acquisition value) or, if higher, the market value at the date when the asset was first provided by that person.18 General anti-avoidance legislation does not impinge on this area of practice at the moment, but this position may well be reviewed again.

Where a UK resident is claiming the remittance basis of taxation, bringing a work of art into the United Kingdom will be treated as a remittance of the underlying income or gains used to purchase it, if the lifetime exemption for temporary importation to the United Kingdom (currently 275 days) is exceeded.19 The rule was brought into force following the Finance Act 2008 but there are some exemptions from the charge. No remittance will be triggered if the chattel was purchased out of 'clean' capital20 (i.e., the capital used did not carry an inherent tax liability derived from its original source) or if the chattels are for personal use, such as jewellery and clothing or for public exhibition, repair or conservation.21 Since 6 April 2012, there has been an exemption for the remittance of works of art that are brought into the United Kingdom specifically for the purposes of sale provided that the proceeds of sale are taken outside the United Kingdom within 45 days of receipt.22

ii Inheritance tax

The United Kingdom provides for the conditional exemption (a form of deferral) from IHT for chattels and works of art that qualify as being of 'pre-eminent'23 importance. The exemption from IHT is granted on the condition that the owner abides by certain undertakings negotiated with HMRC. In return for the grant of conditional exemption, an owner must sign undertakings to make the relevant objects available for the public to see on at least 28 days per year, commonly known as 'the access requirements';24 furthermore, works of art must not be removed from the UK without HMRC's consent and are subject to a duty of care. Since the Finance Act 1998 came into force, the access requirements have become more stringent and access must be advertised (on websites, in guides and relevant publications) and be given without an appointment. A reasonable charge may be imposed to defray some, but not necessarily all, of the owner's costs of fulfilling the obligations and the owner may ask visitors to provide evidence of identity. Pre-1998, the undertakings permitted owners to limit public access to a 'by-appointment' basis and the merit test for qualifying objects was that of 'museum-quality', rather than pre-eminence. HMRC is advised by a panel of experts as to whether an object meets the pre-eminence test.25 Once an object has been accepted for conditional exemption, details of its description, but not value or ownership, are published online by HMRC.

Central to the arrangement between the owner and HMRC is the requirement that the owner will care for the conditionally exempted works of art; should the owner breach the undertakings, the exemption ends. On a breach of the undertakings, HMRC will assess the deferred IHT by reference to current rates and thresholds. This can be an unwelcome surprise to owners. In a climate of rising values for works of art, this has the potential drawback of increasing the amount of tax payable. Should the owner breach the undertakings by disposal of the work of art, there is, in addition to the IHT, a potential charge to CGT. Any CGT due is deducted from the proceeds of disposal first and IHT is charged on the net amount.

A unique feature of the IHT regime is that a taxpayer may be able to settle an IHT liability by offering a chattel or work of art to the nation in lieu of that liability.26 The scheme, known as the acceptance in lieu scheme (AIL), has become increasingly popular as a method of settling an IHT bill.27 The government allows an annual budget of £40 million28 for tax to be met in this way, although that budget must be shared with the Cultural Gifts Scheme (CGS) (see below). As an incentive to use the scheme, the government provides an inducement for using the AIL scheme, in the form of a douceur (literally, a sweetener). The douceur is a fiscal incentive of 25 per cent of the total tax otherwise due on the object or objects being offered, so that their tax settlement value is increased. The AIL scheme can be used whenever an IHT liability arises, in lifetime or on death and the offeror can express a wish or condition as to the ultimate destination in the United Kingdom for the work of art. To that extent the scheme acknowledges the appropriateness of certain works of art for particular institutions (a good example is material relating to Captain Robert Scott RN, allocated to the Scott Polar Research Institute), but in expressing a wish or condition, the offerors must be mindful that the nominated institution must qualify for this purpose.29

The mechanics of making an offer are comparatively straightforward and are designed to ensure the United Kingdom only accepts objects for which the offeror has good title and that the agreed value is fair. The offeror must provide a statement of pre-eminence, a justification of the gross value of the object, a calculation of the 'special price',30 a condition report and due diligence statements in support of ownership and competence to make the offer. Together with high-quality photographs of the object, the offer documents are submitted to HMRC who advise whether the offer is competent and that a tax liability has arisen; however, HMRC delegate the evaluation for pre-eminence and gross value of the chattels to Arts Council England (ACE). A panel of experts at ACE advises HMRC on whether the pre-eminence test has been satisfied and the value is fair. Some negotiation over the value may arise during the process. An essential point when considering whether to make an offer is the question of timing, since to obtain the grant of probate any IHT due on the death must be paid first. It is not possible for the deceased's personal representatives to anticipate the success of an offer and thereby pay a reduced amount of IHT to obtain probate. This point is often a surprise to those making an offer and inevitably impinges on the cash flow of the personal representatives.

iii Private treaty sales

For some owners of works of art, there is the possibility of negotiating a private treaty sale of their objects to public institutions. A private treaty sale provides vendors with the opportunity to enjoy the same tax incentives as an offer in lieu, but without the restriction of having to use the proceeds to settle an IHT liability. The work of art is bought for a tax-remitted sum by the acquiring institution, having taken into account any applicable CGT and IHT. The key difference between a private treaty sale and an AIL is that the vendor receives cash for the work of art rather than having a tax liability settled. The likelihood of private treaty sales taking place in the current financial climate is comparatively limited, although institutions will make special efforts for works of art that are especially appropriate to their institution (good examples of which would be the sale of a watercolour to a gallery in the location depicted or the sale of a portrait to a gallery that already owns the pendant to it).

From the vendor's perspective, the private treaty sale has much to recommend, as cash is paid for the acquisition, net of all tax, and, as the negotiations are conducted simply between the parties concerned, this can allow the process to conclude comparatively quickly. Private treaty sales have no bearing on the annual budget for other tax reliefs and HMRC is involved only to confirm the tax computations but otherwise is not party to the negotiations. The difficulty for many owners and indeed the acquiring institutions, is that while both parties may be willing to transact, the inevitable fundraising required to complete the sale can be difficult and time-consuming; institutions are, therefore, wary of conducting private treaty sales negotiations unless they are confident of success.

iv The Cultural Gifts Scheme

The CGS is a new tax incentive to encourage the gifting of works of art and cultural objects to the nation was introduced in the Finance Act 2012.31 With the introduction of this scheme, the government enacted fiscal support for the donation of pre-eminent objects to the nation for the first time. The incentive takes the form of a reduction against income tax or CGT for individuals and corporation tax for companies. The tax reduction is set at 30 per cent of the gross value (for an individual) or 20 per cent (for a company). The CGS rules permit the donor to spread the tax reduction over five consecutive years starting with the year of donation, as the donor wishes. Crucially the scheme does not allow the reduction against liabilities from earlier years, so there is no repayment of tax already paid, despite lobbying from interested parties during the consultation period. The scheme is not open to trustees or joint owners of objects, which limits its application further. The budget available for tax reduction under the CGS is shared with the AIL scheme. While a very welcome reward for those who are philanthropically minded, the level of relief means that 70 per cent of the value of the object is foregone and to that extent a donation made under the CGS should perhaps be seen as an act of philanthropy rather than as a significant tax saving. As a comparatively new tax-reduction scheme in the United Kingdom, it will be some time before an assessment of its success can be made.

III Outlook and CONCLUSIONS

The art market and heritage sectors in the United Kingdom are significant sectors of economic activity and drive much of the UK's tourism industry. The importance to the UK, especially London, of maintaining its position as the leading art market is a consideration for successive governments and to this end fiscal policy is comparatively benign; where possible, the government seeks to encourage private retention of works of art, thus reducing the public costs associated with keeping them in the United Kingdom. The government seeks a pragmatic solution to the competing needs of the market, the need to raise tax and the wish to retain outstanding works of art in the United Kingdom. More recently, philanthropy using cultural objects has been recognised and rewarded. It remains to be seen how much the changes in the relationship with European countries will affect the art market or if successive governments will continue in this comparatively benign approach. Nevertheless, while the art market prospers, the United Kingdom will continue to attract buyers and sellers from across the world to its experts, art dealers and auction houses.


Footnotes

1 Ruth Cornett is the director of the Heritage and Taxation Advisory Service at Christie's.

2 See, for example, the results of Christie's New York auctions: 'Looking Forward to the Past', 3 May 2015 and Post-War and Contemporary Art, 13 May 2015.

3 See, for example, the reported drop in the sale results of both Sotheby's and Christie's in the first half of 2016, with results dropping by approximately 27 per cent.

4 Christie's auction sales results for the first half of 2017 showed a 29 per cent increase over the same period in 2016, with sales overall of £2.35 billion. In November 2017, Christie's sold Leonardo da Vinci's Salvator Mundi for US$453.3 million, the highest price ever achieved for a single work of art at auction. The sales of the collection owned by Peggy and David Rockefeller at Christie's in spring 2018 generated proceeds of US$832.6 million. Christie's results for the first half of 2018 showed a rise of 26 per cent over the same period in 2017 and the highest level in the company's history.

5 The post-war and contemporary art market rose overall by 87 per cent in the decade from September 2008 to June 2018. Source: Art Market Research index data results.

6 See, for example, the policy document 'Heritage Means Business' launched by the UK Historic Houses Association (HHA) in March 2014 and the HHA's own survey of members in 2015. The HHA's 2015 survey estimated that visits to historic houses and gardens in private ownership exceeded 24 million per annum.

7 See, for example, the conditional exemption rules (Sections 30–35A Inheritance Tax Act 1984
and Section 258 Taxation of Chargeable Gains Act 1992).

8 Section 20 Finance Act 1896.

9 See, for example, Section 63 Finance Act 1910, Section 40 Finance Act 1930 and Section 39 Finance Act 1969.

10 The Reviewing Committee on the Export of Works of Art and Objects of Cultural Interest (RCEWA) was set up in 1952 following the Waverley Report issued in the same year. The Waverley Report was commissioned in response to the perceived loss of works of art through sales from the United Kingdom in the immediate post-war period. The most recent annual report of the RCEWA was published in April 2018 and it, together with more details about the rules for the export of works of art, can be read online at:
www.artscouncil.org.uk/publication/export-objects-cultural-interest-201617.

11 From 6 April 2016 the rate of CGT was reduced from 28 per cent and 18 per cent for higher and basic rate taxpayers respectively, to 20 per cent and 10 per cent for most disposals.

12 Open market value must be used for this purpose (Section 160 Inheritance Tax Act 1984).

13 The first £325,000 of a chargeable estate is taxed at zero per cent.

14 Section 262 Taxation of Chargeable Gains Act 1992 contains the details of the exemption and the restrictions that may be applicable on its use in certain circumstances.

15 The law in this area changed following the decision in Revenue and Customs Commissioners v. Executors of Lord Howard of Henderskelfe (deceased) [2014] All ER (D) 176 (Mar). The Finance Act 2015 introduced restrictions on the ability to claim this relief, limiting it to those owners who are also carrying on the trade in which the plant or machinery are used. A further restriction is that the relief is not available if capital allowances have, or could have been, claimed on the chattels. HMRC provides a full explanation of this in their manual, which is published online at https://www.gov.uk/hmrc-internal-manuals/capital-gains-manual/cg76722.

16 HMRC sets out its specific views on this in the CGT manual (at CG76631), which is published online at https://www.gov.uk/hmrc-internal-manuals/capital-gains-manual/cg76631.

17 Section 10A Taxation of Chargeable Gains Act 1992.

18 Section 742D(2) Income Tax Act 2007 and/or Section. 97B(2) Taxation of Chargeable Gains Act 1992 (in both cases, as inserted into the legislation by Schedule 9, Finance (Number 2) Act 2017).

19 Section 809X Income Tax Act 2007.

20 Section 832 Income Tax (Trading and Other Income) Act 2005.

21 Section 809X Income Tax Act 2007.

22 Section 809YA Income Tax Act 2007.

23 Land and buildings have been capable of being accepted in lieu of IHT (initially estate duty, the forerunner of IHT) since 1910 and chattels since 1956. The full details of the exemption are provided in Sections 30–31 Inheritance Tax Act 1984. Chattels may also be offered in lieu if they are historically associated with buildings that are pre-eminent (i.e., listed for their historical or architectural importance as grade I or II*).

24 The requirement is 28 days per annum for England. In Scotland, Wales and Northern Ireland the requirement is only 25 days per annum.

25 The experts also opine on the acceptance in lieu scheme (see below) and the procedure is administered by Arts Council England (ACE), which works closely with HMRC (heritage team) and the professional advisers to those taxpayers involved.

26 Section 230 Inheritance Tax Act 1984. Note that only a liability to IHT or its forerunner, estate duty, can be settled; the scheme does not extend to any other tax liability, though no CGT is charged on a disposal of an object as an acceptance in lieu scheme (AIL), a notional CGT liability can affect the AIL special price calculations in some circumstances.

27 The increased use of the scheme is reflected in the tax settled through its use, which has risen from £4.9 million in 2010/11 to £26.6 million (including cultural gifts settling tax of £319,000) in 2015/16. and £25 million in 2016/17, the last year for which statistics are available.

28 The annual budget for tax settled via the scheme until 31 March 2014 was £30 million.

29 The definition of a qualifying institution is given in Schedule 3 Inheritance Tax Act 1984.

30 The special price is the tax-reduced amount that the offeror will receive for the object.

31 Schedule 14 Finance Act 2012, which came into effect in March 2013.