On application, exemption from capital taxes may be given on transfers of certain objects, land and buildings. This exemption is conditional and depends on undertakings covering, in general, the preservation of, maintenance and public access to the property. If the conditions (undertakings) are broken or not renewed, then a charge to the deferred tax arises. For the most part, the capital taxes in question are IHT and CGT but still in existence are conditional exemptions from ED and CTT and so it may be necessary to know the rules concerning these taxes as well.

1. Works of Art and Objects of Pre-Eminent Quality

   An exemption may be conferred in respect of pictures, prints, books and manuscripts, works of art of scientific collections (collections or groups of chattels taken as a whole) or other things not yielding income, appearing to the Museums Libraries and Archive Council ("MLA") to be appropriate. The pre-eminent test is significantly higher than the previous museum quality test. Chattels must now constitute a pre-eminent addition to a National, Local Authority or University collection or such other body as is deemed appropriate.

   The most significant undertaking relates to public access and is dealt with at paragraph 4) below, undertakings must also be given to keep the object permanently in the UK (save for Treasury approved purposes), to take reasonable steps for its preservation and maintenance and to give reasonable facilities for its examination by the Treasury.

2. Buildings, Land, Amenity Land & Historically Associated Objects

   The following will also qualify for a conditional exemption to tax:

   • Pre-eminent land and/or buildings with undertakings

   • Amenity land that is essential for the protection of the character of a pre-eminent building

   • Objects might also be conditionally exempted on the grounds of their historical association with a pre-eminent building. To qualify for exemption, an object must have a close association with a particular building and make a significant contribution, whether on its own or as part of a collection or a scheme decoration, to the appreciation of that building or its history. It is worth pointing out that these objects do not need to be pre-eminent in their own right.

   The object need not necessarily be of UK origin, nor would it be expected that it should be contemporary with the building, as changes will have taken place, which reflect the individual taste of different owners. Such a test can be, and often is, given a wide interpretation. Generally speaking the objects would need to have been with the building for at least fifty years.

   It should be noted that special rules apply for "associated properties", such as a building and objects historically associated with it. The basic rule is that any action that breaks up the entity, such as the sale of one out of a group of historically associated works of art, gives rise to a charge to tax on each "associated property". Consequently it may not be prudent to exempt a work of art on the grounds of historical association if it is thought that a sale or gift in the future is a possibility.

3. CGT

   Where a transfer qualifies for conditional exemption for IHT purposes, section 147 Capital Gains Tax Act 1979 provides for a similar relief from CGT. It is confined to gifts and certain disposals by trust. This relief works by treating the donee as acquiring the property at the donor"s base cost so that the CGT charge is effectively deferred.

   In addition, the CGT hold-over relief is also available in some circumstances without the need to give undertakings.

4. Public Access Requirements

   In 1998 there was a significant change to the rules on public access undertakings. HMRC may review and change undertakings given after 6th April 1976 but not if granted before then. These new requirements are accompanied by a requirement to publicise the nature of the new access.

   4.1 Undertakings

   Before 6th April 1976

   Generally there is no requirement to give public access to chattels conditionally exempted before 6th April 1976, in other words under the ED regime. It should be noted that any public access undertakings given under the law relating to ED conditional exemptions for chattels passing on a death before 6th April 1976, may not be varied by HMRC.

   After 6th April 1976 and before 31st July 1998

   The following types of undertakings were granted during this period:

   1. The owner may have arranged to display the object in the owner"s house and provided that house is not tax exempted, access may have been restricted to the chattels only.

   2. The chattel could have been shown in its normal venue if not the same as the owner"s house. The chattel could also have been shown at a museum, gallery or local record office if they are open to the public or indeed the chattel could have been "on tour"

   3. The owner may have lent the object (anonymously if desired) on a long-term loan to a public collection, whether national, local authority or university, or a museum, gallery or historic house run by a charitable trust and open to the public. If the owner required an indemnity against loss or damage, he/she should have applied to the MLA.

   4. The owner may have agreed to allow viewing by appointment and also - where this can be one without physical risk to the object - to lend it (anonymously if desired) for special exhibitions which satisfy certain requirements (for example, as to security). The loan need not exceed six moths in any two-year period, or 25% of any longer period. The availability of an object for viewing by appointment will be publicised by an entry on the Register of heritage property in the National Art Library at the Victoria and Albert Museum. Copies of the Register are held by the national Library of Scotland, the national Museum of Wales and the Public record Office of Northern Ireland. The Register contains a detailed description of the object, the board geographical location (eg. County or metropolitan area) in which it may be viewed, and the name and address of the person to whom an application to view it should be made. There is no need for publicity to identify the owner or the address at which the object is held.

   After 31st July 1998

   Undertakings granted after this date may not include access by appointment only and an owner may be required to publicise the terms of access. However the owner need only provide reasonable public access; what is reasonable will depend on a case-by-case basis. Access to land and buildings is not considered here although the nature of that access might affect access to the chattels if they are in the house.

   HMRC have provided guidance on what it considers to be reasonable access. Chattels exempted in their own right within a building that is itself exempted, should be available between 25 to 156 days a year. Historically associated chattels should be available for the same period. Initially, it was thought that exempt chattels in a non-exempt building could be open to the public for a minimum of 5 days and a maximum of 100 and it might be possible to combine a minimum open access with "by appointment" access, although this more likely to be acceptable for fragile and delicate objects. However, in practice all chattels must be made available for between 25 - 156 days a year

   Examples of reasonable public access are:

   1. Within the residence, which must be so if the building is tax-exempted in it own right, or at the place where they are normally kept;

   2. At a museum, gallery or other public building with public access;

   3. On display on appropriate European Heritage Open Days such as; Heritage Open Days (England), Doors Open days (Scotland), European Open Days (Wales & Northern Ireland); or

   4. At any local, regional or touring exhibition.

   Alternatives to the above examples will be considered.

   Historically associated chattels must be displayed in the relevant house. It is also possible to loan objects provided they form part of the public display of a national institution, local authority, university or independent museum. It is also possible to obtain cover under the Government Indemnity Scheme against loss or damage.

   It appears that relevant factors in deciding what is reasonable access relate to the chattels and not to the health, age or personal circumstances of the owner. However it is possible to negotiate a reduced public access arrangement if the chattel is fragile or other significant factors affect the condition of the object.

   4.2 Variation of Existing Undertakings

   Post-1998 undertakings will be liable to review and may be changed. Variations of their terms will be with the owners consent or, otherwise, by the Special Commissioner.

   If pre-1998 undertakings include reasonable public access, HMRC may vary this undertaking with the owners consent or as agreed by the Special Commissioner. However, the variation of a pre-1998 undertaking should be considered within the terms of the case of Re: A's Undertakings and B's Undertakings [2005] WTLR 1. In this case, the Special Commissioner confirmed that undertakings made before July 1998 but after April 1976 may be reviewed and changed but that the proposed changes must be just and reasonable in all the circumstances; such as the degree of increased costs, increased security risks, the owners circumstances such as health, the nature of the objects and that there are no other viable alternatives for access. The extent of public access agreed under these variations tends to be less onerous in result than the new access requirements under a fresh post-1998 undertaking.

5. When can Conditional Exemption be applied for?

   Conditional exemption for IHT or CGT can be claimed within two years of any transfer on death and any other taxable transfer of value, provided that the transferor and his spouse, separately or together have been beneficially entitled to the property in questions throughout the six years preceding the transfer or the transferor acquired the property on a death and it was then conditionally exempted.

   In the case of a PET, no claim for conditional exemption can be made unless or until the death of the transferor within the 7-year period, and no exemption can then be given if the property has subsequently been sold (other than a heritage sale - see "Heritage Sales").

   A claim for conditional exemption may also be made where the donor has reserved a benefit in heritage property so that it is treated as falling within his estate at this death or where the benefit was released within 7 years before his death.

   There are also special rules enabling the exemption to be claimed in respect of the 10 yearly and exit charges arising in trusts taxed under the discretionary trusts regime (which are then known as "conditionally exempt occasions"). One important distinction here is that property must be designated prior to the date of the ten-year charge as opposed to the usual situation where conditional exemption is claimed following the chargeable event - please see 8) below.

6. Charge to Tax

   There are 3 main categories of event giving rise to an IHT tax charge ("chargeable events"). These are:

   1. failure to observe, in a material respect, an undertaking given in relation to the property;

   2. the disposal of property by sale or gift or otherwise; and

   3. the death of the person beneficially entitled to the property

   When a chargeable event occurs, tax is charged on the value of the property at the time of the event. If there is a sale, then the value is the net proceeds of sale (provided the sale was at arm"s length and not intended to confer a gratuitous benefit) and, if the event causes a charge to CGT as well, then the "value" is reduced by any amount of CGT, before IHT is charged. Sales from a trust subject to the discretionary trust regime are treated differently - please see 8 below.

   Where there are properties associated with each other (that is a designated building with objects or land associated with it) then a chargeable event in relation to the whole or part of an associated property gives rise to a tax charge on the whole of each associated property, which has been conditionally exempted.

   Tax is charged by reference to "the relevant person". Broadly, assuming no discretionary trust is involved, this will be the person who made the last conditionally exempt transfer, save where there has been more than one such transfer within the last 30 years, in which case HMRC can choose any of the transferors (usually the one who causes the higher rate of tax to be paid). For the purposes of applying the currently applicable rules, HMRC only look at conditionally exempt transfers since 7th April, 1976 which is when the rules, in broadly their present form, were introduced. It should be noted that the only function of the "relevant person" is to establish the appropriate rate of tax; her is not liable for any tax. Please see 8 below for the rules for the discretionary trust regime.

   The charge to tax does not arise on a disposal whether by private treaty or otherwise to a public body in Schedule 3 IHTA 1984 (see appendix A) does not lead to a chargeable event. Nor does acceptance of the object by way of payment in lieu of tax. A disposal (otherwise than by way of sale or death) is on a chargeable event if it is in turn a conditionally exempt transfer (by virtue of the transferee providing appropriate undertakings).

7. Calculation of Tax

   The calculation of tax is different depending on whether the event now giving rise to a tax charge relates to an exemption given from IHT, CTT or from ED.

   Current Position

   If there has been a conditional exemption under the present regime (applying from 6th April, 1976 onwards) the rate of tax depends partly on whether the "relevant person" is alive or dead when the chargeable event occurs. If he is alive, the lifetime rates apply to the transfer. If the "relevant person" is dead, tax is charged on the net "value" of the asset in question at the rate that would have been applicable to it if it had formed the "top slice" of the relevant person's estate at his death.

   In principle, the applicable rate is ascertained by reference to the scales in force at death. However, if the "relevant person" died before 18th March 1986 (but after 6th April 1976) the changes introduced by the Finance Act of that year can be taken into account in calculating the tax. (Thus, for example, transfers made within only the last 7 (rather than 10) years need to be cumulated with the death estate in arriving at the approximate tax rate).

   Moreover, although the tax charge is in principle at the rate applicable at the date when the "relevant person" died, if by the time of the chargeable event those rates have been reduced, then the reduced, then the reduced rates can apply in calculating the tax charge. This means that if there had been a conditional exemption given on death since 6th April 1976, whether under the CTT rules or IHT rules, the top rate of tax payable, if there was a chargeable event today would be 40%, irrespective of the top rate at the date of death. The 40% rate may, of course, go up in future.

   Calculation of the rates applicable to discretionary trusts is dealt with at 8) below.

   ED Position

   The rules for calculation of the tax charge under ED differ from the ones outlined above and may still be relevant if a tax charge is triggered by reference to exemptions given under the old rules.

   1. If the exemption was given after 31st July, 1930 and before 16th April, 1969, the exemption would be from ED and the tax rate is determined by reference to the value of the rest of the estate passing under the death by reference to which the exemption was given. The exempted items are not aggregated with the rest of the estate. For example, if the rate of ED applicable to the value of an estate was 60% the latent ED charge on any exempted item is at a rate of 60%.

   2. If the exemption was given in respect of a transfer occurring after 15th April, 1969 and before 6th April, 1976, the rate of duty payable is determined by adding the "value" of the exempted item in question to the value of the rest of the estate and calculating the overall "estate rate" which would have been applicable to an estate of that value. This "estate rate" will be applicable in calculating the charge arising on the loss of exemption on the item being considered. There is no additional charge on the rest of the estate.

      This can best be illustrated by example. A work of art, conditionally exempted from ED on a death in 1972, is sold for £30,000 net i.e. after costs of sale and any CGT has been deducted. The value of the estate subject to duty in 1972 was £110,000.

      The rate applicable on the £30,000 is calculated as follow:

      Value of estate at death	110,000
      Net proceeds from sale	30,000
      	140,000
      Cumulative duty at the minimum of the range (£100,000)	37,250
      Duty on remainder 60% of £40,000	24,000
      (Between £100,000 and £150,000 the rate of tax in 1972 was 60%)
      	61,250

      The overall rate in this notional calculation is 61,250 / 140,000 or 43.75%

      The rate of 43.75% is charged on the £30,000 proceeds from the sale of the work of art. No adjustments are made to the tax on the rest of the estate.

   In certain circumstances the Revenue has a choice between applying the old or new rules in calculating the tax. For example, if an exemption was granted from ED, and before any tax became chargeable in respect of that exemption, a further conditional exemption was given on a lifetime transfer under the current rules, the Revenue has a choice of whether to apply the old or new rules in calculating ht e tax charge. If the subsequent conditional exemption was on death, then the Revenue do not have choice but must apply the current IHT rules.

   The circumstances in which the ED exemption applied, and the events which trigger a charge under that regime, differ from the current rules. However, if undertakings have been given under both regimes, a tax charge can be triggered by a breach of either set of undertakings.

8. Heritage Property and Discretionary Trusts

   The discretionary trust regime is described, briefly, in 2 b) above. There is a 20% lifetime charge on value in excess of the nil rate band going into trust and a 40% charge on a transfer on death. The trust property is then subject to ten-year charges up to 6% on the value over the nil rate band and also exit charges up to 6% when property leaves the trust.

   Sections 78 and 79 of the IHT Act 1984 and the Taxation of Capital Gains Act 1992 introduced rules for heritage property in such trusts. Where property subject to a conditional exemption from ED, CTT, IHT or CGT either before or on settlement, passes into trust the ten-year charge may be ignored altogether.

   If, however, property becomes conditionally exempt once in the trust, tax arising under the ten-year charge may be deferred if the necessary undertakings are given in advance of each anniversary. This is unique, as undertakings are in all other circumstances are given after the claim for conditional exemption. There is a sliding scale rising to a maximum of 30% over a fifty-year period which starts at the earlier of the date of the trust, 13th March 1975 or the ten year anniversary before the heritage property became part of the trust. The incremental rate is applied, 10% for the first ten- year period, then 8%, 6%, 4% and 2% respectively. The Finance Act originally allowed for any deferred ten-year charges to be aggregated with the original deferred tax which was payable on the gross proceeds of sale. This meant that tax in excess of 40% could be chargeable on a sale. Thankfully, net proceeds of sale are taxable and importantly, where these two tax rates are the same, only one will be charged, where the rates are different the higher rate only will be used.

   An exit charge on heritage property leaving the trust may also be deferred under s. 78 IHT Act 1984 provided the property has been within the trust for at least six years and a successful claim to conditional exemption is made. Unlike the ten-year charge the claim for exemption following an exit may be made within two years of the property leaving the trust. Because of the way in which the discretionary trust regime operates, there is no exit charge if property leaves the trust within the first three months following a ten-year anniversary. An exit charge is calculated on the net proceeds of sale.

   If the property is exempted to CGT there can be surprising and beneficial IHT results on a future sale.

9. Whether or Not to Exempt

   The factors to be weighed in deciding whether or not to exempt may not solely be the circumstances of the owner.

   There may be technical reasons for claiming exemption. Where an old ED exemption exists in respect of an item which is passing on another death, a further exemption under IHT rules may lower the latent rate of tax on that item by effectively displacing the previous ED liability.

   Conversely, there may be technical reasons for not claiming exemption. In relation to CGT, the exemption works by treating the donor as making the disposal for an amount of consideration such that neither a gain nor a loss accrues to him. Effectively the donee is treated as acquiring the object for the same value as that for which the donor acquired it. However, this may waste any allowable losses that would have reduced the gain in the hands of the donor.

   Obviously, in relation to either tax, objects that are not pre- eminent in quality, other than those that are historically associated and possibly pre-eminent collections of non-pre-eminent objects, will not qualify for conditional exemption.

   Re-exemption of an earlier exempted item may introduce more onerous undertakings, which may not be acceptable to the owner’s proposed enjoyment of the item.

   Where an item has not previously been exempted, a convenient rule of thumb might be that if the intention is to hold the item throughout the next generation, then provided that the undertakings could be compiled with and were not thought too burdensome, conditional exemption might be acceptable; however, if there is the least likelihood that the item might be sold during the next generation, then it is generally recommended that the exemption should be avoided if at all possible. The reason for this latter point being that, in general, the value of works of art of national importance has increased at a rate exceeding inflation, and as the tax is paid on the value at the time of the chargeable event (i.e. sale or other breach of undertaking) and not on the value at the time of the exemption, on any subsequent chargeable event the exemtped item may carry a tax burden far greater than anticipated.

   However, such an approach will always need to be qualified by the intention (if known) of the testator and of the executors. For example, if a particular gift is expressed in the will to be "free of tax", the application for the conditional exemption may not be appropriate. Where the heritage items fall within the residue, then claiming the conditional exemption may avoid the necessity for selling other assets to meet the tax liability.

   It may be that the decision whether or not to exempt is in effect an "investment" decision - will the work of art produce a better return in the short term that the use of the cash?

   Each estate and beneficiary will be in a different position and expert advice should be sought.

10. Loss or Destruction of Conditionally Exempt Item

    Unless there is a breach of the undertaking to take reasonable steps for the preservation of an item, its loss or destruction should not be a chargeable event and so no liability to tax should arise even if the item is fully insured and insurance monies are paid for the loss. If, however, there had been a breach of undertaking, there would be a chargeable event whether or not insurance monies were available. Please note, however, that loss or destruction may have CGT consequences.