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Inheritance tax and the liquidity of art

Inheritance tax and the liquidity of art
Art for auction at Bonhams, Edinburgh.

“In this world, nothing is certain except death and taxes.”

While Benjamin Franklin may have had the constitution of the United States in mind, it is no less relevant for high net worth individuals and, in particular, the trustees of their estates when assessing inheritance tax liabilities.

This article considers how art finance arrangements can be utilised to provide much needed liquidity where UK inheritance tax is due in respect of estates with illiquid assets.  

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Inheritance tax

UK-domiciled individuals are liable to IHT when they die on their worldwide estate. Non-UK-domiciled individuals are liable to IHT in respect of assets that have a UK situs.

IHT is charged on the value of relevant assets forming part of the deceased’s estate (including real estate, investments and art).

The standard rate of IHT in England and Wales is 40 per cent, which is charged on the part of the individual’s estate that is valued above the tax-free nil rate band of £325,000 – a threshold far exceeded by those generally characterised as ‘high net worth individuals’ (even where unused nil rate allowances of a spouse or civil partner are taken into account).

IHT is due within six months of the deceased’s death, after which HM Revenue & Customs will start to charge interest on any unpaid IHT.

Some estates often have sufficient liquidity to settle the IHT due and then payment can be made directly from the deceased’s bank account(s) through the government’s direct payment scheme.

If there is insufficient liquidity within the estate to settle the total amount of IHT due, however, assets of a sufficient value may need to be sold in order to pay the IHT, and this will need to be done within the six-month period from death if interest charges are to be avoided. 

This can be problematic where estate assets are illiquid (due to their value, size or other characteristics) and more than a six-month period is required to make the required disposals.

While HMRC offers the option to pay IHT in instalments in some limited cases, this concession may not apply for estates with significant real estate assets or art collections.

Art finance – an alternative option 

Obtaining a bridging loan secured against the real estate assets of the estate to settle IHT is not uncommon, however, due to the nature of bridging loans (particularly their relatively short loan term), interest rates and other fees can be unattractive as the finance costs can significantly deplete the residual value of the estate available to the beneficiaries.

Where an estate includes valuable artworks (pieces or collections), art finance can be an attractive alternative method of raising the necessary liquidity to settle IHT payments given that it benefits from:

  • quick execution and funding – similar to many bridging loans;
  • a reduced scope of due diligence (often the artworks are the sole recourse and credit focus for lenders); 
  • flexible terms and structures; and
  • depending on the artworks provided as collateral, comparatively attractive interest rates and finance costs. 

While the terms and repayment structures will vary depending on the needs of the relevant borrower, the relevant lender’s credit criteria and the artwork(s) subject to security, loan terms are usually for periods of between six months and two years, although documentation can often provide for extension options.