GUEST COMMENT: The Bigger Picture Of Art Investment - Stephenson Harwood

James Quarmby

Stephenson Harwood

14 July 2014

The following article is written by James Quarmby, who is head of private wealth at Stephenson Harwood. The comments here are a welcome addition to debate and insights on the art investment world but not necessarily endorsed by this publication’s editors. (Separately, to view another article by a firm of experts on art issues and investment, see here.)

Whilst art is now an established investment class it is in some ways unique, as the decision to buy may be motivated not just by economic factors - an investor could buy a very expensive painting just because he loves it, not because he expects a fantastic return - yet the same investor will probably take a completely dispassionate economic approach to his equity portfolio.

Additionally, the art market is disproportionately populated by ultra high worth individuals and is not democratic in the way that the equities market has proved to be. Almost every working adult will have some exposure to equities, either directly or through a pension or savings fund, but very few will be invested in art.

According to the latest report from The European Fine Art Foundation (TEFAF), the global art market reached $64 billion in 2013, which sounds a lot but is tiny compared to the $212 trillion of the global capital markets. Additionally, more than half of all transactions in art are conducted through London and New York, with Sotheby’s and Christies dealing with roughly one-third of all transactions worldwide. This is the definition of a niche market.

There are also unique legal and taxation issues to consider when purchasing art, which this article will seek to explore.

Provenance

Naturally, if you are buying a Picasso then you want to make sure it really is a Picasso – but these days your provenance checks have to go beyond that, as art which has found its way onto the market as a consequence of looting during the period 1933 to 1945 may be taken away from you and returned to its original owners - even if you have purchased it legally.

Import/export regulations

If you wish to take a cultural object out of its country of origin then it is crucial to check whether you require an export licence to do so. There are criminal sanctions if you don’t. In the UK, export control for cultural objects is managed by the Export Licensing Unit of the Arts Council. UNESCO operates a database of cultural legislation around the world, which is worth checking before you attempt to move art across borders.

Assuming you have acquired the art, checked its provenance and, if appropriate, obtained an import/export licence then you next need to consider taxation.

Duties
If you buy art within the EU then you are likely to pay value added tax on the purchase price, much as you would on the purchase of any other ‘luxury’ goods. However, if you buy art outside of the European Union and then import it to the EU, you may be required to pay VAT upon entry.

The UK operates a 75 per cent deduction on the importation of certain art works, thereby leading to an effective rate of VAT of 5 per cent (i.e. 25 per cent of the full rate of 20 per cent).

Rather unfairly, in my view, you can also be subject to customs duties on the art you have just paid VAT on - ranging from zero per cent to 13.9 per cent. It all adds up to an un-pretty picture.

Capital gains tax

The general rule is that art is subject to CGT when it is sold at a profit. The rate of CGT is either 18 per cent or 28 per cent, depending upon the amount of profit and the level of other income or gains you have realized in the tax year in question.

If you are UK resident and domiciled then it matters not where the art is sold, you will always be liable to CGT. If you are resident but non-domiciled in the UK then it would make sense to sell your art in New York, rather than London, as if you keep the sale proceeds outside of the UK you can escape taxation.

If you are lucky enough to be non-UK resident then you will not be liable to CGT, regardless of where you sell the art. This applies whether you are an individual or company, which is one of the reasons wealthy investors often hold their art through non-resident companies as they can then sell it in the UK without any CGT concerns.

Finally, if the art is part of a collection that is on display for a fee then it may constitute "plant and machinery" and thus be exempt from CGT.

Inheritance tax

IHT is charged at the rate of 40 per cent and is payable on the worldwide estates of UK domiciled people, but for non-UK domiciled people the tax is only applied to UK-situated assets. For the latter, therefore, the location and ownership of their art is quite important.

Of the world’s 2,170 billionaires, the average holding of art is $31 million. So, if the “average” non-domiciled billionaire has their art hanging in a London property upon his death, then there could be an IHT charge of $12.4 million. This can be easily avoided by using a classic offshore company leasing arrangement, whereby the art is acquired by an offshore company (either owned directly by the client or by a trust) and is then leased by the company to the client in the UK. Typically the annual “rent” will be about 1 per cent of the value of the art.

Asset protection and estate planning

Often, art collections are built over many years, with great love and care. The owner will not want to be deprived of his art during his lifetime and, after his death, may wish to ensure the collection is kept together. These aims can be achieved by using a trust to acquire and hold the art.

As noted above, a trust can be used to avoid both inheritance and capital gains taxes, but it can also provide a great deal of discretion and asset protection. This is because legal ownership will vest in the trustees, making it difficult to trace the ‘real’ owner. Even if ownership is traced, it is rare for a trustee to be held accountable for the debts of a beneficiary of the trust.

There were an estimated 37 million art transactions last year, which means that the average size of a deal is $1,600 - demonstrating that for most people art is simply a passion or a hobby. At the other end of the scale, art is an investment class that, for the well-advised investor, can be rewarding both emotionally and financially: after all, is there a more beautiful way of making money?