Tax planning for heritage assets: portrait of Omai

A case currently before the Court of Appeal (the Executors of Lord Howard of Henderskelfe v HMRC) reminds us of the valuable CGT exemption that exists for certain categories of asset classifiable as ‘wasting assets’.

Unusually, the ‘wasting asset’ in this case is a painting, described by Sotheby’s as “one of the great icons of eighteenth century art”. Painted by Sir Joshua Reynolds, it depicts Omai, a Tahitian brought to England by Captain Cook, and has been owned by the Howard family and kept at Castle Howard since 1796.

In 2001, the executors of the late Sir George Howard sold the painting in a private sale for £9.4m, triggering a sizeable capital gain. The executors claimed an exemption from CGT
under s45 of the Taxation of Chargeable Gains Act 1992 (TCGA 1992) on the basis that the painting was ‘machinery and plant’ and consequently a ‘wasting asset’ within the meaning of s44(1)(c) of TCGA 1992.

HMRC denied the exemption. The First Tier Tribunal agreed with HMRC, but the executors appealed. In a decision released on 11 March 2013, the Upper Tier Tribunal allowed the appeal, coming as a surprise to many. The case is now before the Court of Appeal and we await their decision.

Work of art

The case hit the headlines not only because it relates to such a famous piece of art, but because of the potential significance of the decision. As far as we are aware, it is the first time a court has decided that a valuable work of art – an asset which will undoubtedly increase in value, not depreciate – can be classed as a ‘wasting asset’ for CGT purposes and eligible for a full exemption from CGT. Unsurprisingly, first reactions are that the decision lacks common sense.

However, the rules on ‘wasting assets’ as set out in s44 TCGA 1992 are clear. All forms of ‘plant and machinery’ are ‘wasting assets’ regardless of the particular asset’s life expectancy. The general rule is otherwise that a ‘wasting asset’ is an asset with a predictable life expectancy not exceeding 50 years (s44(1) TCGA 1992). The case turns on the meaning of ‘plant and machinery’ and whether the Omai painting can be accurately defined as such for CGT purposes.

There is no statutory definition of ‘plant and machinery’ in TCGA 1992, and we instead turn to case law. In Yarmouth v France (1887) 19 QBD 647 the court described ‘plant and machinery’ as goods and chattels which are “apparatus used by a business-man for carrying on his business” and “which he keeps for permanent employment in
his business”.

In the Lord Howard case, the painting had been loaned to Castle Howard Estate Limited (‘the company’) and displayed at Castle Howard as one of the tourist attractions at the property. HMRC argued that, as the painting was owned by the executors and not the company, it did not qualify as ‘plant and machinery’; neither was there a sufficient degree of permanence because there was no formal loan agreement between the executors and the company.

The Upper Tier Tribunal rejected these arguments. There was no basis within TCGA 1992 nor any of the relevant case law to apply an ownership restriction to the meaning of ‘plant
and machinery’.

The definition focuses on function (business-use) and permanence, and both of these were fulfilled: the painting was clearly used in the tourism business operated by the company, and there was sufficient permanence to the arrangements as the painting had been displayed at Castle Howard for the duration of the executors’ ownership (17 years) and 32 years prior to that.

The lack of a formal loan agreement and the fact that the owner of the painting and the company were not the same person was irrelevant.

The Upper Tribunal recognised that there was “something surprising” in finding that a high-value asset could be classified as a ‘wasting asset’ but they emphasised that this was a CGT-specific definition and the painting would not be classified as a ‘wasting asset’ in the normal sense.

National heritage

Although the Upper Tribunal decision appears contrary to good judgement, strictly it does not create new law – it reflects the rules as they stand.

However, the application of ‘plant and machinery’ to high-value heritage items has not been addressed at this level before, and this is
why the decision, if upheld, could attract considerable interest.

Not perhaps for owners of paintings and other family heirlooms that are privately kept, but owners of heritage items on public display and used as part of a business (most usually at a stately home) could benefit.

In addition to art, the ‘wasting assets’ exemption could feasibly extend to valuable manuscripts, sculptures and furniture. One of the arguments put forward by HMRC was that there should be a “policy” reason why the definition of ‘plant and machinery’ should not extend to the painting as it would open up opportunities for tax avoidance in future, but this was rejected by the Upper Tribunal.

Nevertheless, the result of the decision (if upheld by the Court of Appeal) is that tax savings could be made by other landed families with similar assets.

Personal chattels

The case is a reminder that the ‘wasting assets’ exemption can apply to certain personal chattels, and may often be missed. Antiques and clocks can attract the exemption, for example, as can motor vehicles not used as private passenger vehicles (such as racing cars and single-seat sports cars).

Fine wines can also qualify, provided it is not unusual for the bottle to be kept for substantial periods exceeding 50 years. Port and other fortified wines are unlikely to be eligible. For chattels that do not fulfil the criteria, the £6,000 chattels exemption under s262(1) TCGA 1992 should be available.

The wasting assets and chattels exemptions are not the only means of tax relief for art and other heritage assets. There are now several government schemes, designed to encourage donations of such assets to the nation and offering the donor tax relief in return.

The Cultural Gifts Scheme, introduced in April 2012, is one such example. It entitles the donor to a reduction in his income tax or CGT liability for the tax year of the gift (and up to four subsequent tax years) up to 30 per cent of the value of the asset donated. Similarly, there is the Acceptance in Lieu scheme, which allows donors to cancel out a pre-existing inheritance tax liability up to the agreed value of the donated asset. There is an exemption from CGT on a donation under either scheme.

A concern we have with the Lord Howard case is that if the decision is upheld, there may be less incentive for landed families with qualifying ‘wasting assets’ to utilise these worthy schemes, opting instead for a private sale and banking the proceeds, meaning important artwork and other heritage items may be lost from public view.

However, irrespective of what the Court of Appeal decides, the government donation schemes have the advantage of IHT savings. A private sale, even if it qualifies for the CGT ‘wasting assets’ exemption, does not solve the problem of the buyer having the asset as part of his estate for IHT purposes, meaning there would be a 40 per cent charge on death subject to any applicable reliefs or exemptions. It is to be hoped that this will remain incentive enough but time will tell.

So we await the Court of Appeal’s decision with interest. Whichever way the case is decided, the judgment could be an important and far-reaching one for tax planning for heritage assets. SJ