Written by John FitzGerald
A recent flurry of donations of notable art or historical items to the nation has significantly increased the exposure of the government’s acceptance in lieu scheme. The scheme is not frequently taken up, and what is not always taken into account is how it operates and how it can, in the right circumstances, serve to provide an effective tax credit to mitigate an estate’s inheritance tax (IHT) liability.
The criterion required to be met for a claim to be successful has a high threshold: the item (or items), which may be, for example, a manuscript, a work of art, a scientific object, or a collection, must be ‘pre-eminent for its national, scientific, historic or artistic interest’ (section 230 of the Inheritance Tax Act 1984). Land and buildings are also eligible.
Recent examples include a charcoal drawing by Edgar Degas; an unfinished self-portrait by Lucian Freud; a collection of medals and insignia relating to the Battle of Waterloo; and a portrait by Sir Joshua Reynolds.
The test is one of merit and significance, rather than value.
The scheme operates by attaching a higher value to the donated property, which can be offset against the estate’s IHT liability, than the agreed open market value. This value uplift (25 per cent of the IHT that would be attributed to the item or 10 per cent of that attributed to land) is known as the douceur and effectively provides a tax credit to the estate.
The net effect is that executors should be able to settle a greater proportion of the estate’s IHT liability (by way of the credit) than if they had simply sold the item on the open market.
There is, of course, a danger in this. Where items are sold at public auction for more than was expected, the value attributed to the collection for the purposes of the scheme would still have been less than was ultimately achieved at auction. Executors must decide whether to run the risk.
Though a claim under the scheme cannot be brought by a testator during their lifetime, there are certain steps that can be taken to assist the executors when the time comes, should they wish to make use of the scheme.
Most importantly, if a testator does have potentially qualifying items, they must ensure that they are not disposed of by the will as specific bequests. Failure to ensure that the items fall into the residuary estate will mean that the items are not available to the executors to settle any IHT liability under the scheme (or indeed on the open market).
If there is a question as to whether the work may be classed as pre-eminent, it may also be worth attempting to locate a museum which would desire the item in its collection. The item could be loaned to that institution during the testator’s lifetime in order to assist the executors’ eventual claim. This approach has the benefit of allowing the executors time to identify easily assets which the testator may have wished to be used under the scheme. While the scheme will not be appropriate in the majority of cases, in those where the estate includes assets of significance, it is worth considering whether the scheme might be suitable and how best to prepare for that.
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