First published on ThoughtLeaders4 Private Client Magazine Tax Edition

Art collections are usually amassed with no small degree of emotional connection by their owners. Collectors are therefore inclined to think carefully about how best to pass on works of art to the next generation, either during lifetime or on death. Tax considerations usually come into play at this stage. One tax incentive which applies to heritage assets generally, including works of art, is the Conditional Exemption Tax Incentive Scheme (the 'Scheme'). The aim of the Scheme is to encourage collectors to keep pre-eminent heritage property in the UK and to make that property available to everyone. Critically, the Scheme allows the deferral of the payment of both UK inheritance tax ('IHT') and UK capital gains tax ('CGT') which would otherwise arise on such a disposal. This article sets out the main features and benefits of the Scheme as it applies to works of art.

Tax issues

A collector will usually have views on future of their art collection once they are no longer around. If the owner wishes for their art collection to remain in their family following their death, they will need to consider the tax implications of doing this. If a collector is domiciled in the UK or 'deemed domiciled' in the UK on the basis of having been UK resident for 15 out of the previous 20 tax years, they will be subject to IHT on their worldwide assets. This will include any personally held works of art. Broadly speaking, IHT is currently charged at 40% on any assets owned above the value of the 'nil-rate band' which is currently £325,000, subject to any available reliefs and exemptions.

If an art collection comprises a large part of an individual's estate then that individual could have a significant IHT exposure on death.

In that situation, an individual may consider making one or more lifetime gifts of their works of art to younger family members so as to reduce the potential IHT liability. A gift from one individual to another is treated as a 'potentially exempt transfer' for IHT purposes, meaning that the gift will be free from IHT provided that the donor (a) survives for seven years from the date of the gift and (b) does not 'reserve a benefit' in the work of art once the gift is made. If the donor dies within the seven year period, this will result in an IHT charge of up to 40% of the value of the work of art. The rate of IHT charged on the gift will reduce if the donor survives for three or more years from the date of the gift. For UK resident individuals, CGT will be due on a gift of a work of art if the value of the item has increased during the individual's period of ownership (unless the individual can claim the remittance basis of taxation and the asset is kept outside the UK). The current rates of CGT are 10% (basic rate) and 20% (higher rate). Each individual has an annual CGT-free allowance, which is £6,000 in the 2023/24 tax year. This allowance will reduce to £3,000 for any disposal made after 6 April 2024. Any CGT charge arising on the disposal of a work of art will be what is known as a 'dry' tax charge, as it will not result in the realisation of any cash which can be used to pay the tax.

Care therefore needs to be taken to ensure that a CGT liability on a disposal can be met from other funds.

The Scheme

Both IHT and CGT can be delayed if a work of art qualifies for conditional exemption under the Scheme. For a work of art to be eligible for conditional exemption, it has to be 'pre-eminent'. In practice, this means that HMRC must consider it to be 'pre-eminent' for its national, scientific, historic or artistic interest. Works of art as well as objects, land and buildings all fall within the potential scope of the Scheme. The item in question can be a single item or part of a group of items, which, when, taken together, are 'pre-eminent'. For the Scheme to apply, the new owner of the work of art (the recipient of the gift or inheritance) must undertake to:

  1. Keep the object permanently in the UK and not remove it temporarily, except for an approved purpose and period;
  2. Take agreed steps to preserve it; and
  3. Secure reasonable public access to it.

In this context, 'public access' does not mean access only with a prior appointment. It requires the owner of the work of art to open up their home to the public for a certain number of days per year. In practice, this means that access usually has to be given for at least 28 days of the year and outside of those days, the item must be available for visits by appointment. Conditionally exempt works of art which are on display to the public are listed on HMRC's database of tax-exempt heritage assets, which is publicly available. If an owner does not wish to, or cannot, open their home up to the public in this way, an alternative is to loan the object to a museum or gallery that may wish to display it. This may come with its own challenges, which are outside the scope of this article. As the name suggests, the exemption under the Scheme is conditional. If the exemption ceases to apply then any IHT or CGT deferred will become due at that stage. The exemption will cease to apply on the occurrence of any of the following events:

  1. A material breach of an undertaking, eg careless damage to the item, removal from the UK or a failure of the public access requirements.
  2. A sale or other disposal of the item. It is possible for the disposal to be a conditionally exempt transfer, if the new recipient gives new undertakings in respect of the item.
  3. The death of the owner. Any passing of a conditionally exempt item will be a chargeable event which could result in IHT or CGT being due, unless the recipient reapplies for conditional exemption and fulfils the requirements for conditional exemption to apply at that time.

Practical considerations

Despite the available tax deferral, owning a work of art which is conditionally exempt is practically difficult, not least because of the requirement for securing public access to the item, which will be unpalatable to some. Collectors will therefore need to decide whether the potential tax deferral merits taking the steps required to benefit under the Scheme.

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.