An art collection can take a lifetime to put together and many considerations can influence a collector's decisions when it comes to planning their legacy and the devolution of their estate. Amongst these considerations may be a number of UK tax incentives which allow art amassed during lifetime to pass to future generations in a way that is tax-efficient while also providing scope for the nation to enjoy important works of art and cultural property.
The schemes either allow public access to privately owned works of art or provide the opportunity for UK museums, galleries and archives, as well as charities, to acquire important works of art that they may otherwise not be in a position to acquire, particularly in the current financial climate.
Generally, these tax incentives apply to assets which are considered pre-eminent. Pre-eminence is a status that is granted to outstanding land and buildings and works of art and other objects that are of importance for their national, scientific, historic or artistic interest or that are historically associated with an outstanding building.
Acceptance in lieu
A collector may plan for certain artworks to be offered to the nation under HMRC's Acceptance in Lieu Scheme which allows an inheritance tax liability which arises on death to be paid (wholly or in part) in kind with art or cultural objects which are considered pre-eminent. The scheme means that many important objects remain in the UK and are protected for the long-term benefit of the nation by placing them in the ownership of public institutions. For example, Paul Gaugin's Avant et Après, considered the most important manuscript in the history of art, was very recently acquired by London's Courtauld Gallery after it was gifted to the nation in lieu of a £6.5 million inheritance tax bill.
There is a specific (and quite complex) calculation to determine how much inheritance tax can be satisfied by a work of art, which is based upon its market value less the amount of tax that would have been payable on an open market sale. A douceur of 25% of that notional tax amount is added back on to give the total amount of tax that an acceptance in lieu can satisfy.
HMRC's Conditional Exemption Scheme provides a tax incentive to private owners of pre-eminent assets, including artworks, as well as land and buildings, who allow the public to access and enjoy them.
A collector could make a gift of a pre-eminent artwork to another individual during their lifetime or plan to do so under their will, and if such a gift gives rise to an inheritance tax charge, and in certain circumstances, a capital gains tax charge, the recipient of the gift could apply for conditional exemption so that the tax liability attaching to the artwork is deferred.
In order to qualify for conditional exemption, the new owner must give certain undertakings to HMRC, the most important of which is to allow reasonable public access. For artworks and other objects, the public access requirement can be satisfied either by granting access in situ or by loaning the work of art or object to a public museum or gallery. It is sometimes possible to make a loan for an extended period so as to satisfy the public access requirement for a number of years.
If the new owner is able to successfully obtain conditional exemption, the deferral of inheritance tax will continue until a subsequent chargeable event takes place when the inheritance tax would become payable. This could be the death of the new owner or the gift or sale by them of the work of art to a third party. In the case of a death, it may be possible to continue the exemption if whoever receives the artwork agrees to continue the undertakings.
If the owner of a pre-eminent work of art which is subject to conditional exemption no longer wishes, or is unable, to comply with the agreed undertakings, it can be sold or gifted to a qualifying UK museum or gallery to deal with the deferred tax charge.
Private treaty sales
A conditionally exempt work of art can be sold to certain qualifying institutions, including most UK museums, galleries and archives, under an arrangement known as a private treaty sale. This is an opportunity for important objects to come into public ownership in exchange for which the seller receives a tax benefit.
A special price is agreed so that the tax payer can benefit from the tax saving and the relevant institution can acquire the work for less than its open market value. The amount of tax that a sale can satisfy is calculated in a similar way to the Acceptance in Lieu scheme.
By contrast, if a conditionally exempt work of art is sold on the open market, the inheritance tax exemption will be lost and there may also be a liability to capital gains tax on the sale proceeds resulting in the seller receiving significantly less. The purchasing institution would also have to pay the full market value to acquire the item.
Acceptance in lieu or private treaty sale?
A practical difference between Acceptance in Lieu and a private treaty sale of a conditionally exempt work of art is that with a private treaty sale, it is necessary to find an institution which wants to buy the item and agree a price, and the institution must also raise the necessary funds for the purchase. By contrast, with Acceptance in Lieu, the item is accepted as payment of tax and then allocated to a museum without the need for fundraising by the relevant institution. Acceptance in Lieu is therefore of particular benefit to institutions in the current climate when cash is in short supply.
Gifts of pre-eminent artworks to UK museums and galleries
The owner of a conditionally exempt artwork might consider gifting it to a qualifying museum or gallery. Such a gift of would bring the conditional exemption to an end but the tax liability attaching to the asset would not become chargeable. Instead, the 'conditional' exemption becomes absolute and the tax liability falls away. Gifts to qualifying museums and galleries are also exempt from any further inheritance tax and capital gains tax.
The Cultural Gifts Scheme
While, unlike gifts of shares and land, a gift of chattels does not qualify under the general charities' gift aid scheme, the Cultural Gifts Scheme is specifically designed to encourage philanthropy among collectors and allows pre-eminent objects to be gifted to a qualifying museum or gallery in exchange for a tax reduction. This scheme is separate from Conditional Exemption and is a way of satisfying an income tax or capital gains tax liability.
The donor can benefit from a reduction in an income tax and capital gains tax liability of up to a maximum of 30% of the agreed value of the object. Similarly, a corporation tax liability can be reduced by up to a maximum of 20%. The donor also has the added satisfaction of seeing their donation on display in a public gallery or museum in their lifetime.
Gifts to charities generally
Gifts of art and other objects to charities in general are free of inheritance tax and capital gains tax, whether or not the item satisfies the tests for pre-eminence. In an estate planning context, gifts to charity on death which represent 10% of the net chargeable value of an estate, will result in an overall reduced rate of inheritance tax of 36% on that estate rather than the usual 40%. An art collector who intends to make a gift of art to charity in their will, which would be free of tax, could consider increasing the value of the gift in order to benefit from a reduced rate of tax on their estate overall.
The test for pre-eminence is not relevant here so a gift of art to charity may be an attractive option if the artwork in question does not meet the current tests for pre-eminence to qualify for the other schemes.
The tax incentives outlined here will be amongst a number of key considerations for an art collector in their tax and succession planning. While tax is not always necessarily the most important factor when planning the devolution of an art collection, the fact that these tax incentives also serve to preserve art and cultural property for the nation and benefit charitable causes may be an appeal, particularly in the current climate.