Tax planning for art collectors - an overview of UK tax considerations
Art values have continued to rise, in defiance of the general economic gloom, and what for most collectors started as an impulse, then became a hobby, has proved a successful investment. The art collection frequently represents a substantial part of a family’s wealth and has become a key aspect of the family’s financial and succession planning.
Before thinking about financial planning, collectors should consider what they want to do with the collection, both during their lifetime and after death:
- Is it primarily for personal enjoyment?
- Is it a legacy, and if so with what objectives?
- Has it become partially an investment?
- Is it to serve wider philanthropic goals?
Often it is a combination of these things, and for some families the collection becomes a cultural legacy, acting as a focus for involving family members in wider social projects.
The wishes of the original collector may change over time and may differ from those who inherit the collection, so flexibility can be important. It is often wise to consider whether and when to involve the next generation in this area. While tax should never be the sole consideration, its impact can be substantial, so it can be an important influence when selecting a suitable holding structure.
The main structuring choices are whether to hold art in one’s own name, hold it through a trust (possibly with an underlying company) or foundation, or give it away to a charity or to the nation.
Holding art in your own name has the benefit of simplicity. It avoids holding costs, such as trustee and company administration fees, which over time can be expensive. However, it may not always produce the best tax result.
A UK-resident individual, domiciled in the UK, is liable to capital gains tax (CGT) of 28 per cent on disposal and inheritance tax (IHT) of 40 per cent on death. Planning around these taxes can be tricky. A non-domiciled, remittance-basis taxpayer faces the same considerations if they bring the artwork into the UK, unless it is held in an offshore trust structure. In addition, bringing personally held art into the UK on a long-term basis may give rise to a tax charge under the remittance rules (unless it is purchased with clean capital).
It is, however, possible to bring artwork into the UK temporarily without creating a tax liability, either for exhibition by an ‘approved institution’ (generally limited to two years) or for sale (provided proceeds are removed from the UK within 45 days of sale). In both cases, it is vital to study the rules to ensure import documentation is correctly drafted. Moreover, further taxes may be payable in the country of domicile.
Holding art in a trust
Holding the collection in a trust provides continuity, both in lifetime and on death, and sometimes asset protection in the case of divorce or bankruptcy. Whatever happens to the settlor, the trustees can continue to manage, dispose of or distribute the collection in accordance with the terms of the trust. This could suit the needs of an individual who wishes the collection to be maintained intact or as a living collection after death, with or without the involvement of the family.
Prima facie, holding art in a trust also has tax advantages over direct ownership as it places the asset outside the estate for IHT, and CGT is payable only on distribution of sale proceeds to a UK-resident beneficiary, not when the art is sold.
HMRC has eroded the IHT benefits for UK domiciles by imposing a lifetime 20 per cent IHT charge on settlement into a trust and a ten-yearly charge of around 6 per cent on the current value of the trust.
These taxes do not apply to art settled offshore into a trust by a non-domiciled individual, provided that the artwork is not brought into the UK. Even if the work is brought into the UK, it may be possible to mitigate the IHT consequences by holding it through a company owned by the trust. Careful consideration should be given to the following:
It is usually better to keep an artwork in a ‘dry’ trust structure, i.e. one that produces income or capital gains only on sale of the work.
Any enjoyment of the artwork in the UK is a taxable benefit, but its quantification is hotly debated. How do you assess the benefit of being able to show a Hockney or Rothko on the wall at home, without a rental market?
If a dispute with HMRC ends up in the UK courts, sympathy will be given to trustees who have a formal agreement supported by a genuine attempt to value the benefit, even if the trustees’ view differs from that of HMRC.
The tax benefits of trust ownership relative to direct ownership depend on the situation. But if art is structured correctly for non-domiciles, using a trust with clean capital, it should be possible to ensure that no IHT is due on the death of the settlor and that any disposal of the artwork will not create CGT until the trust makes a distribution to UK beneficiaries.
Giving it away
Those minded to give away their art have options. The right approach is best decided by considering the underlying motivation of the gift, combined with the tax benefits it may create. The tax authorities have designed a number of tax benefits that are not compelling on their own, but which provide an extra incentive to those who already have philanthropic instincts.
Holding art in a trust provides continuity, and sometimes asset protection in the case of divorce or bankruptcy
Any gift to a registered UK or EU charity, including one established by the donor, qualifies for full IHT and CGT relief. Moreover, the Finance Act 2012 introduced an extra tax saving: if an individual gives at least 10 per cent of their estate to charity, the remainder of their estate will be subject to IHT at a rate of 36 per cent, as opposed to 40 per cent.
A charitable trust or foundation
A charitable trust will usually be created by a collector who wishes to maintain the collection intact, for the benefit of the public. This type of trust often remains under the control of the family or of independent trustees. It is necessary to define the objectives of the trust to ensure compliance with the Charities Act 2011 and establish proper governance procedures, curatorial policies, etc.
The value of the art will not be inherited by the collector’s family, but family members may be nominated to manage or oversee the collection. This can become a key part of succession planning in ensuring that a cultural heritage is passed on. It also creates a focus for family values and cooperative working relationships.
Outright gift to the nation
This is more restrictive, as to qualify for the relief in the UK the artwork must be accepted by a gallery or museum that is recognised for this purpose by HMRC.
There is no particular tax benefit of giving to the nation instead of a charity. Both gifts are free of IHT and CGT. Non- tax considerations may have greater significance, in that giving to the nation ensures that the art remains in the UK and that the museum has the experience to care for and maintain the works.
Acceptance in lieu
HMRC also accepts heritage property in satisfaction of IHT and CGT liabilities due on death. This is broadly artwork and other property that the UK government considers to be of sufficient national, scientific, historic or artistic interest.
To date, this scheme has not been a runaway success. In the past decade, the average amount of tax relief agreed each year is approximately GBP20 million.
Gifts of pre-eminent objects to the nation
The UK government implemented this scheme in 2012. It aims to encourage individuals and entities to give to the nation during their lives, and runs alongside the acceptance in lieu scheme. A donor can give pre-eminent objects to the nation worth up to GBP30 million per year. The donation creates a tax credit of 30 per cent of the value of the art. This can be offset against any CGT or income tax due within five tax years of the gift.
It is important to think through your objectives for the collection before considering financial planning. For many collectors, this may involve consulting family members or external trustees who may be responsible for taking the legacy forward – indeed, it could be advisable to involve them at an early stage.
Second, you need to select the holding structure that best fits those objectives while achieving optimal tax efficiency, for both the collection itself and its impact on the rest of the estate. It is sensible to make use of tax breaks, and many collectors will be driven by a mixture of philanthropic and financial planning motives.
Third, as tax authorities are becoming more challenging, it is vital not to be caught out by a lack of documentation. This may apply most of all to those who enjoy the benefit of an artwork without a proper agreement in place, or to those who bring a work into the country temporarily.
Following these steps correctly and adapting to changes requires regular review and continuous vigilance.
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