Tax: How to avoid an art attack

20 Oct 2013

Well-advised estate planning is important for everyone. For artists, or those who have (or intend to build) an art collection, it is even more essential that they consider all of the planning options available to them. Often, a major concern is to protect works of art from either heirs or the taxman.

Below are a few of the things that art collectors should consider when making a Will and structuring their affairs.

Donating to charity

If the collection is worthy of preservation, collectors of a charitable bent may decide that they would like to leave it, or certain pieces, to charity. It is possible to leave pieces to a specific museum a testator would like to support.

Such charitable gifts are exempt from inheritance tax ("IHT"). In addition, if a person leaves at least 10% of their estate to charity then the remainder of their estate will be taxable at 36% rather than the usual 40%.

Artwork in lieu of tax

An IHT liability may be satisfied by an individual transferring a work of art or heritage object to HMRC in satisfaction of the tax (known as the acceptance in lieu scheme). In order to do this, the offeror (who must be the person liable to pay the IHT) will have to show unencumbered title to the work of art in question and so evidence as to the provenance of the artwork will need to be submitted.

An additional benefit of this scheme is that the offeror is entitled to a "douceur", effectively a tax credit of 25% (or 10% in the case of land) of the tax that would have been payable on the open market value of the item. In order to qualify for this scheme, the items must be pre-eminent because of their national, historic or artistic significance.

Conditional exemption

If a person decides to leave their collection to their heirs, there can still be IHT advantages. Where a work of art is of national, historic or artistic interest, it is possible to defer an IHT liability on the transfer of that work (either on death or in lifetime).

In order to qualify for this deferral, the new owner must give certain undertakings. They must preserve the item, allow the public access to the item and keep the item in the UK. The IHT will only become payable if the new owner breaches one of the undertakings, or the property is sold or given away.

Holding through a charity

Holding artwork and other cultural property through a charity has tax advantages and a regulated regime through the Charity Commission and through Companies House (if the charity is a company). A donor may also be a trustee of a charity which s/he sets up, and in that way can continue to exercise some control over the collection.

Registration with the Charity Commission is obligatory, although certain small charities (those with income of £5,000 per year or less) do not need to register. The charity must show that it has exclusively charitable purposes. Charitable purposes are those which fall into a specific list set out in the Charities Act 2011 (one of the charitable aims prescribed by the legislation is the advancement of arts, culture or heritage). In addition to the charitable purpose, the charity must show that it has a public benefit, for instance the collection is open to viewing.

Simple gift to heirs

A person could simply make a lifetime gift of artworks to his/her heirs. If the donor survives the gift by seven years then there will be no IHT to pay on the gift.

However, it is important to establish before making such a gift what capital gains tax ("CGT") there may be. If the pieces have increased in value significantly since they were acquired then the CGT bill (usually 28%) may make the gift unattractive. It should also be borne in mind that, once the gift is made, the new owner can do what they like with the pieces, including selling them.

Trusts

Lifetime trusts can be created very tax efficiently by individuals who are not domiciled in the UK. In short, if structured correctly, the trust can be completely outside the IHT net. Such a trust can be a very attractive vehicle in which to hold an art collection, both for tax and asset protection purposes.

There are complex rules concerning possible tax charges where a UK resident beneficiary receives a benefit from a trust, for example the use of artworks. However, it is possible for a beneficiary to lease artworks from the trust, with limited tax consequences for the trust and the beneficiary.

By Daniel Simon, Partner and Peter Daniel, Senior Associate

Additional information