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Adviser Q&A: The Lord Howard case: picture as wasting asset

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What is this about?

Having reached the Court of Appeal, the decision of the judges was released on 19 March 2014 in the case of HMRC v The Executors of Lord Howard of Henderskelfe (decd) [2014] EWCA Civ 278. The essence of the case rests upon why a substantial gain made on an iconic painting should be exempt from capital gains tax (CGT)? The answer takes us back to some very basic principles of CGT.

What is the background to this case?

During his lifetime, Lord Howard lent a number of his paintings to an associated trading company with the business of inviting the general public to view Castle Howard, where the paintings hung.

Following Lord Howard’s death in 1984, his executors continued the lending arrangements for all paintings, but decided in 2001 to sell a Sir Joshua Reynolds classic. The sale realised gross proceeds of £9.4m, and there was a substantial gain above the market value at Lord Howard’s death.

The executors made a claim in their 2001/02 return for an exemption from CGT on the gain under the relief for certain wasting assets in TCGA 1992 s 45(1). HMRC disputed the exemption and the case proceeded through the courts.

What were the main arguments?

The executors claimed the painting was plant and therefore by virtue of s 44(1)(c) it was a wasting asset and exempt from CGT.

In agreeing with the executors, Lord Justice Rimer referred to only one precedent in deciding that the painting was plant. That case is the leading precedent, Yarmouth v France (1887) 19 QBD 647, in which Lindley LJ said:

‘There is no definition of plant in the Act ... it includes whatever apparatus is used by a business man for carrying on his business, not his stock-in-trade which he buys or makes for sale; but all goods and chattels ... which he keeps for permanent employment in his business.’

HMRC appealed to the court on a number of grounds.

One of those grounds was that the ‘permanent’ test in Lindley’s statement had not been met because the arrangement for the company to utilise the paintings in its trade was precarious, i.e. the executors could have withdrawn the paintings from being shown immediately and without notice.

Rimer did not accept this point and stated that Lindley’s reference to permanence was only to differentiate it from circulating stock, i.e. to categorise it as an asset with which the business was carried out.

HMRC’s central argument, however, was that the painting was not plant in the hands of the owners, because the owners themselves (the executors) were not trading.

Again, in denying this point, Rimer referred to carefully drafted legislation in other parts of s 45, ‘which indicates a clear recognition that the disposal may not be by the trader’.

What did the court decide?

Previously, the First-tier Tribunal had found for HMRC, because it couldn’t envisage how an ‘old master’ could be a wasting asset and agreed with HMRC in thinking that the painting couldn’t be plant if its owners weren’t carrying out the business. The Upper Tribunal, whilst finding for the taxpayer for the reasons that Rimer stated, did not make an attempt to understand the objective of the rules in this area.

At the Court of Appeal, all three judges were in agreement in denying HMRC’s appeal and passed down judgment that the gain on the painting was exempt from tax.

However, the most telling statement came from Lord Justice Briggs. Briggs didn’t attempt to go into detail about the actual decision. He framed the case within the objectives of the appertaining tax principles in order to demonstrate why the judges believed HMRC’s case to be flawed.

In stating that ‘the public purse takes the rough with the smooth’, Briggs referred to the fact that losses realised on tangible movable assets (for example, a painting) cannot be claimed as capital losses by taxpayers.

Take, for example, a fictional case of the executors allowing the company to utilise garden furniture (owned by the estate) for a café in the Castle Howard grounds. On disposing of that furniture, perhaps throwing it away, the executors probably wouldn’t have expected to claim a capital loss. Certainly, HMRC wouldn’t expect this.

Briggs stated that the rules as they stand are to stop the ‘widespread disposal of movable wasting assets generating allowable losses’. These comments are likely to give HMRC much food for thought in deciding whether an appeal to the Supreme Court is appropriate.

What will happen next?

If HMRC is ultimately defeated by the court process, then HM Treasury will certainly give careful consideration as to whether the relevant legislation can be amended.

HMRC’s main concern will be that other owners of valuable objects may attempt to convert their asset from a taxable chattel into an exempt wasting asset by implementing a structure such as that encountered in the Howard case.

Also of concern to HMRC will be the uncertainty around whether an asset is still fully exempt, if it has only been plant for a proportion of a taxpayer’s ownership.

A move to prevent future planning of a similar nature will probably have political support, but the key question might be: how would such a rule be implemented?

As Briggs pointed out, the basic CGT principle in TCGA 1992 s 16 is that disposals which produce exempt gains in nature also produce non-allowable losses. Similarly, disposals which produce taxable gains in nature also produce allowable losses.

HM Treasury may have to consider whether a one-sided coin is appropriate to cope with extraordinary cases of this nature.