The treasures of Castle Howard

Castle Howard is one of the great houses of England; a magnificent eighteenth century building set in a thousand acres of parkland in North Yorkshire. It is the epitome of a stately home and known to many as the setting of the well-loved film, Brideshead Revisited. Its many rooms are filled with old master paintings and other fine works of art.

But such wealth of land, buildings and objects comes with enormous financial implications. Land must be managed, old buildings require endless maintenance and objects of art need to be properly preserved and insured.

On top of that, if such assets are sold, gifted or pass on death, there is the potential for large amounts of capital gains tax (CGT) or inheritance tax (IHT) to become payable.

So how are such cultural collections, unique combinations of natural beauty, architecture and art, to be preserved in the face of such financial burdens?

Later this year in July, some ten paintings owned by the Howard family will go under the hammer at Sotheby's, in an attempt to raise an estimated £10m 'to secure the long term future of the estate'. This is one way to approach the problem; disposing of assets to raise funds to maintain what's left.

The portrait of Omai

I referred above to the depredations of taxes on gifts and, capital gains tax is payable on the sale of most types of assets. Such an outcome is difficult to escape, but there are strategies by which the demands of the tax man can be avoided, watered down, or deferred.

A recent case involving the Castle Howard estate, HMRC v The Executors of Lord Howard of Henderskelfe [2014] EWCA Civ 278, concerned a fine painting by Joshua Reynolds; a portrait of Omai.

It was reported that the painting was being sold 'both to assist with the upkeep of the estate and also to deal with the depredations of a divorce', which is another risk to the financial security of such estates. It was sold for £9.4m and the taxpayer, the executors of Lord Howard, succeeded in their argument that no CGT should be paid.

The argument goes like this:

• a wasting asset is exempt for CGT;

• an asset with a life of less than fifty years is a wasting asset;

• plant and machinery always has a life of less than fifty years;

• the painting qualified as a plant as it was used in the business of the stately home; and

• as a result a painting more than two hundred years old was exempt from tax as a wasting asset, notwithstanding the physical evidence to the contrary!

Well done to the legal advisers who ran that argument successfully.

So will the estate run the same argument again? Possibly, but it does depend on the precise structure of the ownership arrangements, not least since the government introduced new rules that would now prevent the executors winning the case, in the particular circumstances of how the Omai painting was owned and used.

Capital gains tax

In respect of CGT, it's worth considering that if the painting or object is used in a business and can qualify as a plant, then it may be possible to claim exemption from CGT.

If an item is gifted and conditional exemption for IHT is claimed, then similar provisions apply for deferring capital gains tax liability.

If the asset passes on death there is no CGT. In addition the cost of acquisition for the new owners will be the value at the date of death, so the previous gain is wiped out and there is an uplift to the current value.

Where trusts are involved, not uncommon in the context of landed estates, holdover relief allows a deferral of CGT liability, both on assets passing into trust and then when they come out. Limitations on the amount which can pass into lifetime trusts without an IHT charge mean that the scope for using holdover relief is restricted, but in the right circumstances, this can be helpful.

Where a pre-eminent item is purchased by private treaty by a specified body, such as public museums and galleries, there is some tax relief. For example, where an item which has been granted conditional exemption is being sold, and tax would thus become payable, there can be an arrangement over the price, known as the 'douceur' (a sweetener).

The vendor gets the net amount (no tax is charged) and the value of the fiscal exemption is shared between the vendor, who obtains a sweetener of 25 per cent and the purchaser 75 per cent, of the tax otherwise payable.

Inheritance tax

There are various ways inheritance can be minimised. Acceptance in lieu applies if the owners are prepared to pass over ownership of the item. Providing it qualifies as an important work of art or heritage object, then if transferred to a public museum, archive or library, such a gift can be accepted in lieu of the tax payable. The tax is saved, but of course the object has gone.

Following the Omai argument,
if an object is owned by a business and is clearly used in that business, then its value along with the value of the other business assets may well qualify for business property relief when it is gifted.

Various conditions have to apply for this relief to be available, and the business does have to be a trading enterprise. The relief would apply to a business as a whole, so would not be available if, for example, one painting was gifted to an individual, but only if the whole business passed as a gift or on death.

Conditional exemption is a
valuable exemption from capital taxation. For this to be available, the object must be pre-eminent for its national, scientific, historical or artistic interest, with comparable criteria for land, buildings and, for chattels historically associated with such buildings.

The relevant owner must give an undertaking as to access for the public, along with taking reasonable steps for preservation of the item. There are requirements regards periods of ownership.

When these conditions are satisfied, the transfer, whether in lifetime or on death, is a conditionally exempt transfer. So long as the undertakings are observed and the property is not further transferred, the tax liability is postponed.

On a subsequent transfer, it is possible to renew the exemption and a further exemption will apply. So provided the family are content to allow appropriate public access, this would allow the passing of objects through generations without any charge to IHT. However it should be noted that this can only apply if the objects qualify as pre-eminent.

Strategic planning

The owners of such objects and such landed estates (and their advisers) face particularly difficult challenges.
Taxation can be heavy, certainly on a cumulative basis over time, and difficult to manage with illiquid assets.

The way in which different structures operate and are taxed varies significantly, and in a typical landed estate, one might see direct ownership, trust ownership, partnership arrangements and trading companies.

The tax laws will apply depending not only on the vehicles used, but the relationship between them. In the Omai case, the taxpayer nearly failed because the painting was personally owned,
but the business it was used in was run
by a company.

It is those sorts of detail where care is needed and where the need for good quality advice is greatest. It may be a small detail which can be of critical importance. There is also the big picture and the overall strategy. Advisers need to be able to look with both a microscope and wide angled lens.

There will also need to be an element of luck. The unexpected divorce, or the dry rot throughout the roofing, can derail the best legal and financial planning. n

Jeremy Passmore is a partner at Thomson Snell & Passmore