Painting or plant?
On 19 March 2014, the England and Wales Court of Appeal handed down its judgment in HMRC v The Executors of Lord Howard of Henderskelfe  EWCA Civ 278, a ‘wholly extraordinary’ case concerning the wasting asset exemption for capital gains tax (CGT) purposes.
The asset in question was an ‘old master’ painting by Sir Joshua Reynolds, Portrait of Omai, depicting a Pacific Islander brought to England by Captain Cook. It had been owned by the Howard family and kept at Castle Howard since 1796, but, on 29 November 2001, the executors of the late Lord Howard of Henderskelfe sold it for GBP9.4 million, triggering a substantial capital gain. The executors claimed an exemption from CGT under s45 Taxation of Chargeable Gains Act 1992 (TCGA 1992) on the basis that the painting was ‘plant and machinery’ and consequently a ‘wasting asset’ within the meaning of s44(1)(c) TCGA 1992, which HMRC denied. The First-tier Tribunal agreed with HMRC, but the executors appealed to the Upper Tribunal and won. This decision came as a surprise to many and, as expected, there was an appeal. However, the Court of Appeal upheld the Upper Tribunal’s decision that the sale of the painting be wholly exempt from CGT, saving the executors what is sure to be a considerable amount.
A wasting asset is defined in s44 TCGA 1992 as ‘an asset with a predictable life not exceeding 50 years’, but there are several qualifications to the rule, one of which concerns plant and machinery. Under s44(1)(c), ‘plant and machinery shall in every case be regarded as having a predictable life of less than 50 years’ and this is so regardless of the actual predictable life. There are certain exceptions in subsections 45(2) and (3) that apply to assets which qualify in whole or in part for capital allowances (although it was agreed that neither of these applied in this case). The exemption itself is set out in s45 TCGA 1992, which provides that ‘no chargeable gain shall accrue on the disposal of, or of an interest in, an asset which is tangible moveable property and which is a wasting asset’.
The case turned on whether the painting could be classified as plant under s44(1)(c). The definition of ‘plant’ is case-law based, there being no elaboration in TCGA 1992, and the ‘classic explanation’ is provided in Yarmouth v France (1887) 19 QBD 647. ‘Plant’ is there described as including ‘whatever apparatus is used by a businessman for carrying on his business – not his stock-in-trade, which he buys or makes for sale; but all goods and chattels, fixed or moveable, live or dead, which he keeps for permanent employment in his business…’.
The rationale for the decision
Paintings and heritage assets would not usually qualify as plant because of the lack of commercial connection, but the difference with this case was that there was a business involved. The painting had been loaned to Castle Howard Estate Ltd (the company) and exhibited at Castle Howard as part of the trade of opening the house to the public.
HMRC argued that the wasting asset exemption was unavailable because the persons disposing of the painting (the executors) were not the same as the persons carrying on the business (the company). However, Lord Justice Rimer gave a detailed history of sections 44 and 45 TCGA 1992, tracing their origins back to the Finance Act 1965 and Finance Act 1968, so as to examine whether there was any legislative intention that the disposer and trader be the same person, and found no substance in the argument. The legislation did not just allow these to be separate persons, but even envisaged it.
HMRC also argued that the painting did not have the requisite degree of permanence for it to be classified as plant as it was only loaned by the executors to the company informally. The Court of Appeal rejected this, too. The ‘permanence’ aspect of the Yarmouth v France test did not relate to the type of tenure of the plant, but to the very nature of it compared with circulating stock. The long-standing and indefinite nature of the loan in this case was enough to show that the painting was employed by the company with sufficient permanence.
Many will sympathise with HMRC’s argument that an asset with anticipated longevity cannot by its nature be classified as an asset with limited life that wastes away with use. However, the Court of Appeal dismissed this as ‘pointless beating of the air’. An item is capable of passing the Yarmouth v France test whatever its predictable life, and, although it may seem illogical, this is one (albeit oddball) example of the use of the wasting asset exemption where HMRC was advised to take the ‘rough with the smooth’, the smooth being the usefulness of the exemption in preventing the disposal of a moveable wasting asset from generating allowable losses.
Impact of the case
Will this case be useful to other owners of high-value heritage assets? Maybe, but only in so far as the asset is used in a house-opening trade, and this would confine the exemption to assets at heritage properties. However, there are plenty of these: stately homes such as Castle Howard that are occupied (in part) by a family, but open to the public; other historic buildings, such as the remains of priories, abbeys and towers; or homes of famous people (Beatrix Potter, John Wesley, etc). All could qualify if there is a commercial tourist trade involved. The key is that there must be a business, and the asset in question must be employed in that business, and not just part of the setting, but, if this applies, it is not inconceivable that the exemption could extend to heritage assets other than paintings: sculptures, manuscripts and furniture, for example.
One might query, however, how often such heritage assets come up for sale, making CGT an issue. In this case, the family needed to raise cash for a divorce settlement, causing the executors to sell, but generally heritage assets remain in the family to be passed down to future generations. Nevertheless, if a family were minded to sell before this judgment came out, the prospect of a CGT-free sale may now prompt them to do so.
Heritage asset government schemes
If, as we suspect, owners of heritage assets can only make use of this case in limited situations, there are other sources of tax relief to which landed families with such property could look – for example, the government’s schemes for heritage assets, designed to preserve valuable items for the long-term benefit of the nation by giving tax incentives to the owners.
The conditional exemption is one such example. The exemption allows those liable to inheritance tax (IHT) on heritage assets to defer the IHT on those items indefinitely in return for giving HMRC certain undertakings. An IHT charge may arise on death, gifts made into trust and gifts made during the owner’s lifetime that become chargeable on death. The legislative framework is set out in sections 30–35A Inheritance Tax Act 1984 and the Finance Act 1998. The undertakings are designed to ensure that the item is kept in the UK, appropriately maintained and the public is given access. The item must be of a ‘pre-eminent’ standard, judged on what are known as the Waverley criteria, which look at aspects such as the item’s connection with British history and national life and its artistic significance.
The conditional exemption offers owners a way of keeping heritage assets in the family, in a tax-efficient manner, without having to sell them. Even if other landed families can make use of wasting asset exemption following this case, it is expected that the conditional exemption will remain popular; it is likely to be more valuable to keep the asset in the family free of IHT, generating money for the business through tourists, than selling and realising cash (even if free of CGT), which could be chargeable to IHT in the future.
Owners of heritage assets seeking to capitalise on other forms of tax reliefs also have the acceptance-in-lieu scheme and the cultural gifts scheme to consider. The acceptance-in-lieu scheme gives relief for IHT arising on a heritage asset on death, allowing personal representatives to offer the item to the nation in full or part payment of the IHT liability on that asset and/or any other chargeable assets in the estate. The cultural gifts scheme, introduced in April 2012, is the most recent government incentive for the donation of heritage assets. In return for offering a heritage asset to the nation, the donor is entitled to a reduction in their income tax or CGT liability for the tax year of the gift (and up to four subsequent tax years), of up to 30 per cent of the value of the asset donated.
It remains to be seen what impact the Henderskelfe case will have, and whether there are many other potential assets out there that could make use of the exemption – and perhaps this is what HMRC will wait to assess before deciding whether to try and appeal the case further. However, for owners of heritage assets that cannot take advantage of the case, there remain valuable government schemes for tax relief, many of which will be preferable to selling a treasured family heirloom, CGT exemption or not. But the case does at least raise awareness of the scope of the wasting asset exemption and how this need not be confined to typical types of plant and machinery. A little imagination on the part of the executors of Lord Howard went a long way; perhaps this is one aspect of the case of which Sir Joshua Reynolds would have been proud.
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