Asset Management

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How to master art diversification

As London gears up for its annual Frieze Art Fair, we explore how to break into the contemporary art market as a collector and the tax considerations to bear in mind.

2 October 2018 / Investing
Author
Dolfin

In the first week of October, more than 60,000 art enthusiasts will gather in Regent’s Park for Frieze London 2018 – one of the world’s biggest international contemporary art fairs. Visitors will have access to more than 160 of the world’s leading galleries and be able to view and buy art from over 1,000 of today’s leading artists.

As one of the few fairs dedicated to contemporary art and living artists, Frieze London taps into a market that has witnessed significant growth over the last 15 years or so. According to ArtTactic, an art market analysis firm, total sales of contemporary art by Sotheby’s and Christie’s increased by 549 per cent between 2000 and 2017. That’s more than for other categories such as Old Masters, and Impressionist and Modern works.

For those wishing to diversify their portfolio of investments, contemporary art is a potential option. Unlike many assets, collectors can enjoy its aesthetic benefits while it grows in value and, compared to other alternatives such as commercial or residential property, art is less costly in tax terms. However, barriers to access and the tendency for value to be created over the long, rather than short, term makes it a complex asset to diversify into.

Investors who are new to the art world should learn about how it operates and be aware of the tax implications before taking the plunge and buying that first piece.

The right motives

Anders Petterson, founder and Managing Director of ArtTactic, says the most successful art collectors are motivated by three factors: a passion for art; an enjoyment of the social aspect of being part of the ‘art world’; and an interest in art as an investment.

This cocktail of ingredients makes art an interesting alternative asset in which the benefits of investment start to outweigh the potential risks, Anders observes. “If you’re only in it to make money, there are probably quite a few other assets that are much less complex and much easier to potentially make money out of,” he says.

In fact, the art world positively discourages speculators who are interested in short-term gains. In the contemporary segment, in particular, speculation can push up the price of a young artist’s work to unsustainable levels, limiting their future potential to sell pieces.

To become a successful collector, says Anders, you need to view it as a long-term activity in which you’re actively engaged.

Getting started

Even within contemporary art, there are hundreds of segments to choose from. Spend some time exploring and discovering a category that interests you and build in-depth knowledge of it.

Petterson recommends starting your journey at a place where there is a reputation for knowledge and a physical entity that you can visit. The well-known auction houses – Sotheby’s, Christie’s, Bonhams and Phillips – all fit the bill.

When selecting galleries to buy from, reputable art fairs – where exhibitors go through a rigorous vetting procedure – are a good place to start. Around 500 galleries apply to exhibit at Frieze London each year and that number is whittled down to just over 150 by a committee of experienced gallery owners.

“It’s an educational experience to go to an art fair and talk to galleries,” says Anders. “It’s also a great way of starting to build relationships that might lead to you acquiring a work or several works from some of these galleries.”

Alongside face-to-face events, advances in technology mean that companies like ArtTactic can now use data analytics to help collectors make informed buying decisions. Aggregating and analysing data from key participants in the art market can help to uncover trends and assess how they might affect value.

Anders believes data analysis will provide a more level playing field for new entrants, instilling confidence in the market and generating further growth. “However, data is not a substitute for the experience of seeing an exhibition, going to an artist’s studio and developing relationships with experts,” he stresses. “It’s only a tool.”

Building your reputation

The work you put in to developing your knowledge and network will lay the foundations for a reputation as an informed collector, which in turn will help you to gain that all-important access to artists and artworks that have the potential to generate value.

However, your reputation as an informed collector also affects the value of the artworks that you eventually own. As Anders says: “Collectors who spend not only money but time and passion, and have done it for a long time, have a status within the art market which allows them to add value.

“I think this is very different from other assets where, if you have the money, you typically are able to buy something. In this case, there is almost another layer which might prevent you from buying something because you might not be the right person to own that work in the eyes of the art world.”

When you do find a piece that you fall in love with, several external factors can offer clues about its potential to increase in value in the future. Most notably, where is the artist on his or her career trajectory? Where have they exhibited, which prestigious industry prizes have they won, and is there an expectation that they are going to ‘make it’ in the art world?

As a collector of an artist’s work, you can actively support the development of their career – and the corresponding increase in the value of their work – by lending the artwork to galleries for public display.

Tax considerations

Craig Davies, a partner at Rawlinson & Hunter, a firm of chartered accountants and tax advisers, says the financial implications of diversifying into art can be both broad and deep. Much depends on the purpose of diversification. Is it purely an investment that will be held in one place or is it to feed a passion that will involve moving the artworks around for you and the wider public to enjoy?

“Artwork is very often a moveable asset and this opens up planning opportunities,” Craig says. “In embarking seriously upon a collection, individuals should be taking appropriate legal and tax advice to ensure that the collection is held in an appropriate vehicle.”

Regardless of the reason for diversification, certain tax implications will need to be considered.

Where you live, where you are a tax resident and the funds you use to acquire an artwork are all relevant. For example, if you are a UK tax resident but domiciled overseas and you decide to acquire an artwork in the UK using untaxed overseas funds, bringing those funds into the UK will likely trigger a tax charge. If you decide to conduct the entire transaction overseas but then bring the artwork into the UK, a tax charge could arise if you used untaxed foreign funds to acquire the work originally.”

The other three key areas where tax charges are likely to apply are capital gains tax (CGT), inheritance tax (IHT) and VAT – a tax on goods supplied in, or imported into, the EU.

VAT is the most difficult of the three areas, says Robert Field, a partner and Head of the Tax Practice at law firm Farrer & Co. “Works of art tend to move about and, for VAT purposes, they are simply classed as goods and will incur a VAT charge when imported into the EU from another country.”

There are numerous instances when special VAT reliefs can apply, including when an artwork is more than 100 years old or when it is being imported for exhibition, display or sale at an auction.

Currently, art can move freely between EU member states without incurring a VAT charge. After Brexit, importing works into the UK from the EU and vice versa could trigger a VAT charge. However, Craig observes: “Should a deal [between the UK and the EU] be struck, it is likely that the VAT regime will remain largely as it is, with no noticeable impact on collectors.”

Passing works on

When it comes to divesting a work, art is treated like any other asset and may incur a CGT charge on any gains made at the point of sale. There are special rules and a form of exemption for lower value works, though this may have limited application for some collections.

Inheritance tax liabilities can also arise if your art collection remains part of your estate when you die. To minimise IHT liabilities on art, you can gift the works more than seven years before you die. However, gifting a work means physically removing it from your estate, Field stresses. If you don’t do so, and continue to enjoy its benefits, it will still be considered part of your estate at the point of death. When gifting, ensure you generate some official documentation to prove that ownership has been passed on. There may also be CGT implications of lifetime gifts, which will need consideration.

In rare circumstances, artworks can be given to the nation in lieu of an IHT payment if the nation believes the piece is worth retaining.

While the tax implications of diversifying into art may be complex, tax experts don’t see them as an obstacle. “In my experience, people collect because they like the object that they’re buying. That’s much more of a driver than thoughts about tax,” Robert observes. “You can manage the taxes around buying a collection of assets – and it’s essential to seek specialist professional advice on this – but the central driver is always to buy what you like.”

With ArtTactic’s Anders observing that the contemporary art market has developed from being a Western to a global phenomenon in recent years – thanks to rise of international events and online art markets such as Artnet – the opportunities to buy are only going to grow.

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