Probate practice (3)

In my previous articles I have considered the points that testators need to consider when including chattels bequests in their wills and secondly, what valuation and distribution issues that executors should consider following the testator's death. I now turn to the question of sales of chattels and the taxation implications for executors and beneficiaries.

Sales & capital gains tax:

Sales of chattels are usually subject to capital gains tax (CGT) and special rules apply as to how gains are calculated. Private motor cars are exempt from CGT, but a classic car will not be exempt.

Wasting assets as chattels

Examples of these are clocks and watches, motor cars, other road vehicles and railway locomotives, yachts and other ships or vessels. The reason these are regarded as wasting is that they are items of machinery and have a decreasing value over time.

Heritage property

Special rules apply to the taxation of chattels that are defined as heritage property, because they are works of art, furnishings, sculptures linked to outstanding historical buildings, estates and parklands or paintings, portraits, drawings, watercolours, furniture, sculptures, books, manuscripts, ceramics of artistic, historic or scientific interest in their own right.

Government policy has had two main aims. Firstly, to encourage the retention of such chattels in private ownership in this country. Secondly, for a disposing owner to have incentives favouring a public museum.

Inheritance tax and/or capital gains tax is not paid when an item that qualifies for exemption passes to a new owner on death or is gifted. In order to obtain the exemption, the new owner must agree to look after the item, allow public access to it and, if it is moveable, keep it in the UK. As it is only a conditional exemption, an owner failing to fulfil their side of the bargain will see the exemption withdrawn and tax become payable. Tax is also payable if the item is sold. Owners must sign appropriate undertakings to this effect, the breach of which will trigger an immediate charge to inheritance tax or CGT.

A survey carried out by in 2005, among solicitors known to advise owners of heritage chattels, showed that the vast majority of those surveyed were unenthusiastic about the present exemption regime following the changes made in the Finance Act 1998. As a result, the conditional exemption is unlikely to provide a useful option following a new death for the disposal of heritage chattels in the open market. It also therefore suggested that, as a result, many such chattels will find their way abroad.

These concerns were highlighted by the evidence of the continuing outflow of major heritage chattels from this country contained in the most recent Report of the Reviewing Committee on the Export of Works of Art. This records that over the year 2004-05, of the items before the Committee, 65 per cent in terms of value (£30.2m worth) were exported, and only 12 per cent (£5.6m worth) were 'saved' by purchase by a UK-based
public institution or private individual.

Stemming the flow

Illustration of such an undertaking would be as follows:

1.To keep the painting permanently in the UK and not to remove it temporarily except for a purpose and a period approved by capital taxes (CT);

2. To take reasonable steps for the preservation of the painting;

3. To take the following steps to secure reasonable access to the public:

The public will be able to view the painting which is on indefinite loan for display to the ABC Museum, London. I shall not seek to terminate this loan.

4. To take the following steps to publicise the terms of the undertaking:

(i) to allow reasonable details of the arrangements, to be published by the HM Revenue & Customs (HMRC) on its website, or in any successive publishing medium, and via any other appropriate website and in any other reasonable manner it sees fit;

(ii) to provide, at reasonable cost, a copy of the undertaking, without personal particulars, to any member of the public who requests it;

(iii) to provide CT with details of how the public may obtain copies of the terms of the undertakings as at (ii) above and keeping CT informed of any change in these particulars;

5. To provide, at CT's request, any information that HMRC might reasonably require in order to ensure that the terms of this undertaking are being observed.

6. To notify CT immediately in the event of a disposal of the painting whether by sale or gift or otherwise, and of any material change to any relevant circumstance.

This shows that the main conditions are to keep the property in the UK, preserve the property and to provide reasonable access to the public

All listed heritage property can be found on the HMRC searchable database at the following link: https://www.hmrc.gov.uk/heritage/index.htm

What is clear is that the HMRC discourages public access being restricted to a person's home, due to the significant security and access requirements in showing the work of art. Wherever possible the owner will be encouraged to show the chattel in a museum or gallery either on a long term basis or in regular exhibitions. The HMRC would monitor the viability of an owner's wish to retain the object at home by requesting details of how much access was granted during a year.

Drafting the will

On preparing a will for a client owning a potentially conditionally exempt heritage chattel, consider the terms of the will carefully. The legatee must remain responsible for any resulting tax due on the breach of an undertaking to the capital taxes office. A gift of the chattel as simply part of the residue of the estate will not be sufficient as the executors could remain liable for any tax on such a breach. A suitable clause might be as follows:

'I Give to my son Colin my painting of The Hay Wain by John Constable and I declare that all Inheritance Tax arising in connection with this legacy shall be borne by my son in exoneration of my residuary estate.'

Re Bedford, Russell v Bedford [1960] 1 WLR 1331 illustrated the problem where the testator left various items of historic or artistic interest to his children 'free of duty'. By clause 14 of his will he directed his trustees to pay out of the proceeds of sale of his residuary estate: 'The estate duty payable on my death in respect of any part of my estate real or personal and all legacy succession and other duties payable on my death on any gifts by this my will or any codicil hereto which are made free of duty.' The residuary estate was bequeathed to beneficiaries absolutely. None of the exempt chattels had been sold, but it was held that the duty which would become payable on the proceeds of sale if they were sold, should be borne by the residuary estate and not by the specific legatees.

Pre-owned assets rules

The other area which affects the ownership and use of valuable chattels was introduced by the Finance Act 2004. This provided for a charge to income tax on benefits received by a former owner of property. This applies to individuals who receive benefits from certain types of property they once owned after 17 March 1986 but have since disposed of. This took effect for the first time in the tax year 2005-06. Such property includes chattels

If the chargeable person has either disposed of any chattel by way of gift or, in some cases by sale, or contributed towards the purchase of the chattel in question and they continue to receive some benefit from the chattel, they are potentially liable to the charge. The benefit may simply be of the use of the chattel.

How the benefit is calculated: this is a percentage of the open market value of the chattel. The percentage is the official rate of interest that is currently 5 per cent. The date of valuation is 6 April, in the first year of assessment, or the date on which the taxpayer first becomes liable to pay the income tax charge. The income tax charge on chattels is based on that value for the first and the following four years of assessment. A new valuation is required after the first five years of assessment.

However there is a de minimis amount that may be applicable. If, after you have calculated the benefit, it comes to £5,000 or less for the year of assessment, you do not need to declare the benefit as part of your income for that year. However, if the benefit is more than £5,000, the entire amount is taxable and there is no exemption for the first £5,000. Note that each spouse or civil partner has an exemption of £5,000.

Alternatives to paying the income tax charge

• Treat the use of the chattel as a reservation of benefit for inheritance tax.
• Pay a full market rent for use of the chattel.
• Election to treat the arrangement as a gift with reservation: for inheritance tax purposes the property will be treated as forming part of your estate. Inheritance tax will be payable if the total chargeable value of your estate including previous lifetime gifts made in the last seven years is more than the nil rate band and the reservation of benefit has not ended within the seven years prior to your death. The property on which you elect will remain part of the donee's estate for inheritance tax purposes. Form IHT 500 should be used (Election for Inheritance Tax to apply to asset previously owned). The election must be made before 31 January to make an election in the year following the first year of assessment.
• Pay a market rent for the occupation or use of the property, or to pay the income tax charge. For example, a parent gifts all his chattels to his daughter and pays full market rent for his continued use and enjoyment. The parent will not subject to Pre-Owned Assets tax

Great care needs to be taken with the enjoyment and later disposal of personal chattels. Even though they all may not have intrinsic monetary value they can cause problems if insufficient thought is given to them. They can certainly cause significant problems for executors and beneficiaries alike. However careful thought and consideration will ensure that the testator's objectives can be realised and you have satisfied rather than disappointed beneficiaries.