Background
Relevant legislation
Case law on plant
Court of Appeal analysis
Comment
In March 2014 the Court of Appeal determined that Omai, an 18th-century masterpiece by Sir Joshua Reynolds, was an item of 'plant or machinery' and a 'wasting asset', no different from other trade equipment such as tables, chairs and cars. As a result, the gain in value realised on its sale was exempt from capital gains tax. While this decision seems counterintuitive, it rests on a close analysis of the relevant legislation and will be of interest to owners of valuable art where the art is used in a business.
Omai, a celebrated portrait of one of the first Pacific islanders to come to Europe, was painted by Reynolds around 1775. It was taken to Castle Howard in Yorkshire in 1796 and became part of the Howard family's estate. Castle Howard has been owned by Castle Howard Estate Limited since 1950. The company's business is the operation of Castle Howard, including the opening of the house to the public. Omai was displayed in Castle Howard from 1952 as a visitor attraction, but it remained the personal property of the family. There was no formal agreement for the use of the painting and the company paid no fees for its use, although it did pay the costs of insurance, maintenance and security.
Lord Howard died in November 1984. The painting continued to be displayed in Castle Howard until November 2001, when it was sold by the executors at Sotheby's for £9.4 million. This was the second highest price then paid for a British painting and it was substantially more than the picture had been worth in 1984. The executors' tax return for the tax year ending April 5 2002, submitted in January 2003, included the gain in value as one on which capital gains tax was payable at a rate of up to 40%. In June 2003 the executors sought to amend the return on the basis that the gain was exempt from capital gains tax. This led to an inquiry by Her Majesty's Revenue and Customs (HMRC), which ended in a determination in April 2010 that the gain was not exempt.
The executors took the matter to the First-Tier Tribunal (Tax Chamber), which decided in July 2011 that the gain on the sale was not exempt from capital gains tax.(1) The executors appealed to the Upper Tribunal (Tax and Chancery Chamber), which reversed that decision in March 2013.(2) HMRC then appealed the matter to the Court of Appeal.(3)
This long-running history turned on the interpretation of Sections 44 and 45 of the Taxation of Chargeable Gains Act 1992. Under Section 45, gains on the disposal of a 'wasting asset' are not subject to capital gains tax. Under Section 44, a 'wasting asset' means "an asset with a predictable life not exceeding 50 years", but "plant and machinery shall in every case be regarded as having a predictable life of less than 50 years". Gains realised on disposals of plant and machinery are therefore not subject to capital gains tax.
The executors argued that Omai was 'plant' within the terms of the act and thus exempt from capital gains tax as a wasting asset. 'Plant' is not defined in the act and it falls to the court to determine whether a particular item is plant. Although there is no case on the meaning of 'plant' within the act, it was defined in Yarmouth v France(4) in connection with a different piece of legislation as:
"whatever apparatus is used by a business man for the carrying on of his business – not his stock and trade which he buys or makes for sale; but all goods and chattels, fixed or movable, live or dead, which he keeps for permanent employment in his business."
In that case, a horse was found to be plant.
HMRC argued in the Court of Appeal that Omai could not be exempt from capital gains tax on three grounds.
Was Omai in permanent use in the business?
First, HMRC argued that the painting could not be plant because it was not permanently available to the company. At any time since 1952, the painting could have been removed from the company's use. However, the company had believed, both in 1952 and in 1984, that the painting would be available to it for a considerable – even if indefinite – period, as in fact it was. The Court of Appeal considered that sufficiently permanent to satisfy the test in Yarmouth v France.
Was Omai plant in the hands of the executors?
HMRC then argued that even if the painting was plant in the company's hands, it was not plant in the hands of the executors, who were not carrying on a business. HMRC put this argument in two ways. First, it argued that the Taxation of Chargeable Gains Act implicitly required the seller and the user of the plant to be identical in order for any gain on disposal to be exempt from capital gains tax. The Court of Appeal saw no such implication in the legislation, considering that the act showed a "clear recognition that the disposal may not be by the trader". However, the Court of Appeal left open the possibility that an asset in this situation might cease to be plant if it stopped being used in a business for a period of time before disposal.
Alternatively, HMRC argued that the seller and the trader, even if different, had to have the same legal interest in the asset. According to HMRC, the company held only a limited possessory interest in the picture, terminable at any time at the will of the executors, while the executors had legal title in the picture and it was the legal title that was sold. In effect, the former was plant and the latter was not. The court saw nothing in this. In the court's view, there was no requirement for the interest held by the seller and the trader to be the same, and in any event, the company had had the picture itself for use in its business and that was what was sold so that there was an identity of interest.
Could Omai qualify as an asset with a predictable life not exceeding 50 years?
Finally, HMRC argued that even if the painting was plant, it was not a wasting asset for the purposes of the Taxation of Chargeable Gains Act because, at 226 years old, its life was far longer than the 50 years contemplated in the act. This was dismissed by the Court of Appeal. Section 44 of the act provides that "plant and machinery shall in every case be regarded as having a predictable life of less than 50 years" (emphasis added). Therefore, once the painting was deemed to be plant, it would be a wasting asset no matter how long its life.
The Court of Appeal's view was that the legislation was primarily aimed at preventing taxpayers from crystallising losses through the sale of depreciating assets that could be set against other gains so as to reduce tax. Its decision was "an acceptable if unwelcome sidewind" to this legislative intention. Just as a loss crystallised through the sale of an ordinary car cannot be set against other gains to reduce the amount of tax payable, the rare gain realised from the sale of a valuable classic car cannot be used to increase the amount of tax payable.
HMRC has described the classification of an Old Master painting as a wasting asset as defying common sense. It remains to be seen whether it will seek to appeal the case to the Supreme Court – or amend the legislation for the future.
For further information on this topic please contact Davina Given or Rupert Boswall at RPC by telephone (+44 20 3060 6000), fax (+44 20 3060 7000) or email ([email protected] or [email protected]). The RPC website can be accessed at www.rpc.co.uk.
Endnotes
(1) The Executors of Lord Howard of Henderskelfe (deceased) v The Commissioners for Her Majesty's Revenue and Customs [2011] UKFTT 493 (TC).
(2) The Executors of Lord Howard of Henderskelfe (deceased) v The Commissioners for Her Majesty's Revenue and Customs [2013] UKUT 0129 (TCC).
(3) The Executors of Lord Howard of Henderskelfe (deceased) v The Commissioners for Her Majesty's Revenue and Customs [2014] EWCA Civ 278.
(4) (1887) 19 QBD 647.
