UK: Don’t Lose Art

The readers of this esteemed organ are a sophisticated bunch and its content focuses quite heavily on art, so I am assuming that most, like me, are collectors of art. If I'm correct in that assumption, then I hope an article dedicated to maximising the value of your art collection and maintaining it for future generations should be of more than passing interest.

Most Be Beyond readers will travel extensively and many will probably also own multiple homes. This necessarily makes life more complicated. There will be different considerations depending on where the art collector is domiciled and resident and on where their art is actually hanging. An article that tried to cover every different eventuality in every different country would, of course, end up being a very lengthy book. I don't wish to detain you that long so for the purposes of this article I will be writing with particular reference to UK law. The details will therefore be UK-specific but many of the issues will be universal.

The UK charges inheritance tax (IHT) at 40% – above the personal allowance of Ł325,000 – on all assets located in the UK, irrespective of the domicile or residence of the owner. Art that is hanging on a wall in the UK is deemed to be a UK-situated asset. Nasty. It is even worse for those individuals who are actually domiciled in the UK. They are subject to UK IHT on their worldwide assets so they would be liable to pay the 40% on the value of their art collection wherever it is located. And it could even be the case that the country where it is located also wants to charge IHT or estate duty on the same asset. An exception is made if an artwork is owned by a non-domiciled individual and is situated in the UK only for public display or cleaning and restoration, but this provision is unlikely to apply in most cases. With capital taxes it is by no means certain that a credit would be given for tax paid in one country against tax due in another so it is possible that two charges can occur on the same asset virtually wiping out its value to anybody other than the tax man. Not good.

Many long term residents of the UK may not have formally acquired a UK domicile but they may be "deemed domiciled" and therefore subject to UK IHT on their worldwide estates even though they still pay capital gains and income taxes according to the very generous rules applicable to non-UK domiciled persons. A deemed domicile will occur if a person has spent 17 out of the last 20 years resident in the UK. This can often catch out long-term UK residents.

One way to eradicate UK IHT is to bequeath the assets to a recognised charity. Art collectors often tend to be of a philanthropic persuasion so it is quite common for collections to be left to a public gallery or museum. In theory the IHT exemption would apply to a gift to any such institution because most museums are established with charitable status. It would also fall within the "public display" provision noted above but, until recently, UK legislation only applied the exemption to gifts to UK charities. European law has since extended this provision to any charity in the European Union but it is by no means certain that the exemption would apply to bequests to institutions further afield even if it was a charity under its domestic legislation. A solution to this problem may be to set up your own EU-registered charity and make the gift to that. The charity could then loan or gift the collection as it saw fit.

Those collectors who prefer to retain their art collection within the family would still be liable to pay IHT in the UK unless it can be effectively planned out. The standard planning is to transfer the art to discretionary trust, thereby placing it outside the former owner's estate for IHT. The trust would then be at liberty to dictate what should happen to the art both now and after the death of the owner (known as the "settlor" in legal argot). Excellent. The problem is how to get the property into trust.

A simple gift would be subject to the lifetime IHT rules in the UK and would therefore attract an immediate charge of 20% of the current value of the artwork or collection. Further, the transfer would be deemed to be a "sale" for capital gains tax (CGT) purposes. If the owner was resident in the UK, CGT would be payable on the difference between the acquisition price and current value.

Non-UK domiciled persons can eradicate this potential CGT charge by first transferring the art to an offshore company and then gifting the shares in the offshore company to a trust that is based outside the UK. Once this transfer has been accomplished, the art would no longer be an UK asset and so no CGT charge would apply. Another way of circumventing the 20% charge would be to have the trust purchase the art. Sales do not attract the 20% charge but CGT would apply unless the owner was non UK resident at the time of the sale. There are currently plans to extend the CGT regime to include non UK residents transferring UK real estate interests but these proposals do not extend to a sale of chattels such as art.

There are a number of hidden traps depending on the status of the settlor of the trust. For instance, it could be that the trust is deemed subject to a ten-yearly charge of up to 6% of the assets held. Various "anti-avoidance" rules can also be brought into play if the settlor continues to "enjoy" the art by hanging it on their wall without making any payment or providing other valuable consideration. In this case, the gift could be deemed incomplete and remaining within the donors estate for IHT purposes. Both potential traps can be avoided with care.

The only remaining option is a good taxidermist and an electric rocking chair – which actually doesn't sound too far fetched in the context of modern British art.

Failing to take considered and timely action in respect of your art collection could be a profound mistake. The major auction houses frequently have estate sales where a major art collection is sold on the death of the owner. You may even have brought art from just such a sale. This may be because the beneficiaries of the estate have little interest in the collection but often it is simply because they need to generate cash to pay the IHT bill. A little planning now can be of huge benefit to your family or other beneficiaries.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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