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The fine art of taxation

It is important for advisers to put clients in the full picture regarding

Private investors are increasingly attracted to alternative assets such as fine art and antiques, instead of just traditional assets such as stocks and shares, but few consider the potential tax liability on their investment.

There could be tax consequences if the item is sold, given away or left in an estate on death. This asset class carries a unique set of tax and VAT implications, meaning IFAs should familiarise their clients with the tax rules before any investment is made.

If a private investor buys a piece of artwork or an antique, the purchase does not have to be reported to the Revenue for personal tax purposes but the costs should be noted for future reference. However, if the individual is VAT-registered, it must be reported for VAT purposes. Your client has to decide whether they are going to treat the asset as a business asset or as a private asset held outside the VAT system and inform HMRC.

Tax relief may be available on any expenditure related to the artwork and on insurance premiums but this depends on how the asset is used. Income tax relief for maintenance expenditure is only available when your client uses the item in a business where permissible deduction, relevant to such business use, may be available. Where they have no income tax relief, they should consider carefully whether the expenditure is classified as restoration, in which case they should retain details of the costs against possible future relief from capital gains tax. They can reclaim VAT on maintenance expenses, if and to the extent that it is used for a business purpose, for example, being on display in a house open to the public), whether or not it is a business asset.

The same principle generally applies for insurance premiums as for maintenance expenditure, with no income tax relief unless the item is used in a business. Sales at auction typically incur insurance costs, which are deductible as incidental costs of sale to provide relief from CGT. Your client cannot claim VAT relief against insurance premiums as no VAT is charged on them. Insurance premium tax is therefore better than VAT as the taxpayer gets no VAT deduction.

There is no relief for insurance but the owner of the artwork is exposed to tax on receipts for loss or damage. The insurance proceeds are technically liable to CGT as if the item had been sold or, if only damaged, as if only part of it had been sold. If the proceeds are used to restore or replace the asset, your client can make a claim which reduces the capital gain to the amount not spent.

What is the tax treatment of an artwork on disposal? If an owner sells their artwork, CGT may be chargeable on the gain, which is normally computed as the difference between net sale proceeds and total costs of acquisition. No gain is charged unless the proceeds before sale costs exceed £6,000 and, if they do, the gain cannot exceed five-thirds of the excess. Special rules apply if the item had formed part of a set. The gain can, however, be reduced by taper relief, which varies according to the time the client has owned the asset.

VAT is chargeable in principle if and to the extent that they have treated the item as a business asset. It may be possible to treat it as a secondhand item or as exempt or as zero-rated, depending on the facts.

What happens if the item is given away? A gift is a disposal for CGT purposes and is treated just like a sale but using the market value of the asset, as there are obviously no sale proceeds. Some gifts, mainly into trust, may carry a right to hold over the capital gain and, for important works of art, perhaps an obligation to permit public access. In such a case, the donee will inherit an acquisition value of the market value reduced by the gain held over. If the item is a business asset on which VAT has been deducted, there is likely to be a VAT charge.

Sometimes an item may be owned jointly by your client and their spouse or civil partner. If this is the case, while there is no basic difference from the positions above, the limits stated will apply for each part-owner. Joint owners need not worry about CGT on a non-set item sold for less than £12,000 of gross proceeds. The VAT principles remain the same.

If the piece of art is stolen, lost or damaged and was not insured, your client might be able to offset the loss against other capital gains. This is calculated under rules similar to those applied in the case of disposal but effectively excluding the first £6,000 of loss per item. VAT may be due to the extent that the owner has treated it as a business asset, unless they are able to produce evidence of the theft or loss.

If your client gifts private chattels to a relative who is VAT registered and leases them back for a market rent, they will probably still have to pay VAT on the leasing charge. Furthermore, they will not be able to reclaim it unless they use the chattels in a taxable business.

When an investor dies, all their assets need to be brought into account for inheritance tax by their executors. If they bought a work of art more than six years before their death, it may be possible for their estate to avoid IHT at that time by claiming conditional exemption. This is very complicated and your client’s heirs are likely to need comprehensive advice.

Whoever inherits the item will be treated as acquiring it at the date of your client’s death for its market value.

Normal VAT rules apply to any assets that were treated by your client as business assets. There may be a transfer of a business (no supply of business assets) or complete disposal (possible VAT charge).

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