An Old Master painting as a wasting asset by Hannah Southon10/04/14
The Commissioners of HMRC v The Executors of Lord Howard of Henderskelfe (Deceased)
The recent Court of Appeal decision in this case ( EWCA Civ 278), heard on 19th March 2014, is of interest to those who own or manage tax-exempt land, buildings and collections of art and other objects within them. Depending on the precise circumstances, it opens up the possibility of such assets, if they are used in a business, being exempted from capital gains tax on disposal. It may also give rise to opportunities in relation to succession planning.
At the heart of the Castle Howard case was the executors’ apparently startling proposition that Sir Joshua Reynolds’ portrait of Omai, painted in about 1775, was a ‘wasting asset with a predictable life not exceeding 50 years’. The Court of Appeal agreed with the executors and therefore the substantial gain the painting had realised when it was sold by the executors at auction at Sothebys for a hammer price of £9.4m in 2001, 17 years after the death of Lord Howard, was not subject to capital gains tax.
To understand how this seemingly counterintuitive proposition is arrived at, it is necessary go in more detail into the facts of the case. Lord Howard died in 1974. Omai formed part of his estate but was exempted from inheritance tax because it was on display on a more or less permanent basis in the part of Castle Howard that was open to the general public (as it had been during Lord Howard’s life). Castle Howard has since 1950 been owned and managed by Castle Howard Estate Limited, which also runs the trade of opening the house to the public. The crux of the argument between HMRC and the executors was this: was the painting ‘plant’? If the painting was plant, then pursuant to s44(1)(c) of the Taxation of Chargeable Gains Act 1992 it was, by statutory definition, a wasting asset and so exempt from capital gains tax under s45(1) of that Act.
In front of Mr Justice Morgan in the Upper Tribunal, the executors argued that the test as to whether or not an item could be said to be plant was purely functional: is it part of the apparatus used by a trader for permanent employment in his business? Given that the painting had functioned as a prominent exhibit in Castle Howard for some 49 years, it had the necessary quality of permanence to be regarded as kept by the trader for permanent employment in its business (having been there on a continuing basis save for a few brief absences for display in exhibitions abroad), and was not part of the premises, so the painting was, they said, plant. HMRC’s key contentions against the painting being plant were first that the arrangement between Lord Howard’s executors and Castle Howard Estates Limited lacked the necessary quality of permanence because there was no formal lease in place between them, and second that, whilst the painting was plant in the hands of the company, it was not plant in the hands of the executors. Mr Justice Morgan upheld the executors’ appeal from the FTT. On the question of permanence he found that this was to be determined on the facts and that a formal agreement was not a prerequisite. As to the definition of plant, based on an examination of the case law and relevant statutory provisions, he found no basis for HMRC’s argument that the reference to ‘plant’ in s44(1) of the 1992 Act was only to plant in the hands of the trader making use of it and therefore that the s45(1) exemption is only conferred on a disposal by such a trader. This would be to impute into statute wording and a restriction that was not actually there.
The Court of Appeal dismissed HMRC’s appeal. Construing the relevant legislative provisions in their historic context, Lord Justice Rimer (with whom Lord Justice McCombe and Lord Justice Briggs agreed) found that far from ss44 and 45 limiting the application of the exemption in the way contended for by HMRC, s45 pointed away from such a limitation. As to HMRC’s argument that there was not, due to the lack of a formal written arrangement, the necessary degree of permanence, the Court of Appeal found that in this context the concept of permanence merely distinguished plant from a trader’s stock in trade and that there was no prescription regarding the type of tenure to which the trader must be entitled in order for plant to qualify as such.
Can we expect any statutory changes?
In the days leading up to the Budget, there was speculation as to whether HMRC might seek changes to s44 in order to bring the legislation in line with their view. It did not and, on reflection, that is not surprising. First, the circumstances in which such a route could be used are limited – due to s45(2) of the 1992 Act, the asset must not have been used solely for the purposes of a trade, profession or vocation carried on by the person making the disposal, and that person must not have claimed or could have claimed any capital allowance in respect of expenditure attributable to the asset. In Lord Howard’s case, no capital allowance could have been claimed on the painting as it was not used for the purposes of a business. Secondly, as the Court of Appeal itself noted, HMRC did not seek to argue, as it could have done, that at the moment of sale the painting was not plant at all as it had stopped being used for the purposes of the trade. Faced with the same situation again, it would be surprising if HMRC did not seek to utilise the objection identified by Lord Justice Rimer, and if such an argument found favour with the Court, a change to the legislation would be rendered unnecessary. Third, Lord Justice Rimer drew attention to the fact that this case of the sale of a master painting was, like the case of the vintage car, an ‘oddball exception’ and it was essential to address interpretation of a statutory provision in accordance with the purpose for which the provision being construed was introduced, rather than with reference to such exceptions.
In conclusion therefore, the case is interesting and should be borne in mind by those operating in a similar factual matrix as the executors of Lord Howard in case an exemption from capital gains tax or an estate planning opportunity can be identified; it seems though unlikely to set a new precedent of more general application. Moreover, although there has been no immediate move by HMRC to amend the 1992 Act in light of this case, given the complexity of the capital allowances and the capital gains tax regimes in their interaction in relation to plant, it is not unlikely that HMRC will at some point in the future review the issue on a more holistic basis.