The quantification of estate taxes: even more obscure than the valuation of art?

A recent decision of the United States Court of Appeals for the Fifth Circuit has been lauded as a victory for art collectors. More accurately, however, it appears to be a victory for the extremely wealthy seeking to avoid paying taxes.

While a lengthy, rather technical, case, it is hoped that the essential elements have been reproduced below.

James A. Elkins, Jr. and his wife collected 64 works of art during their lives. The collection included pieces by Jackson Pollock, Henry Moore, Pablo Picasso, Rene Magritte, David Hockney, Paul Cezanne to name just a few. At the same time, they were thinking ahead, both creating a Grantor Retained Income Trust (GRIT) that held title to their respective interests in the works, and entering into various agreements which also partitioned and allocated their interests in their art.

The result was that at the time of death of Mr Elkins in 2006 (his wife had died in May 1999), the art was jointly owned in varying percentages by Mr Elkins and his three adult children.

In 2007, his children filed a United States Estate (and Generation Skipping Transfer) Tax Return (estate tax return) in which they reported a Federal estate tax liability of over $100million. It listed, among other assets, fractional interests in various items of real and personal property, including the artworks.

In assessing the federal estate tax due on Elkins' estate, the Internal Revenue Service decided that tax should be paid on the full value of the art, refusing a discount based on Elkins' pro rata share—his fractional-ownership interest— of the art.

In 2010, the Executors of the Estate petitioned the United States Tax Court to review the assessment on the basis that there should have been a fractional-ownership discount applied when determining the taxable values of Elkins' fractional interest in the 64 items of art.

The Tax Court rejected the IRS' zero-discount position, but also rejected the quantums of the various fractional-ownership discounts adduced by the Estate through the reports, exhibits, and testimony of its three expert witnesses. Instead, the Tax Court concluded that a “nominal” fractional-ownership discount of 10% should apply across the board to from pro rata fair market value of Elkins ratable share of each of the works of art.

Still unhappy with the decision, the Estate appealed again and the case was heard by the US Court of Appeals for the Fifth Circuit.

The only question to be resolved was whether the federal estate tax due on the artworks was to be calculated based on Elkins' undiscounted pro rata share of the art (as the IRS contended) or should there be a fractional-ownership discount of either (i) a uniform 10% (as held by the Tax Court) or (ii) the various percentages that the Estate advanced through the testimony and reports of its expert witnesses?

The Court found:

• Just as it was obvious to the Tax Court that the IRS had no viable basis for rigidly insisting that no fractional-ownership discount was applicable, it should have been equally obvious that, in the absence of any evidentiary basis whatsoever, there was no viable factual or legal support for the the Tax Court’s own nominal 10% discount. 

• The Estate was entitled to apply a fractional-ownership discount to the tax due on Elkins' ratable share of the each of the 64 works of art. 
• The answer to the question of the correct quantum was to be found with the proper administration of the willing buyer/willing seller test for fair market value: 'the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.'
• The Estate's evidence was that the sale of Elkins' undivided interests in the artworks would produce prices substantially below his pro rata share of the works as any hypothetical willing buyer would demand significant fractional-ownership discounts in the face of becoming a co-owner with the Elkins descendants (given their financial strength and sophistication, their legal restraints on alienation and partition, and their determination never to sell their interests in the art).

• The correct quantums of the fractional ownership discounts applicable to Elkins' pro rata share of the various artworks were those determined by the Estate’s experts. 

The full list of the 64 artworks and the discounts can be found in Appendix B to the Tax Court’s decision. The discounts range from over 50% to just under 80%. A substantial difference from the Tax Court's nominal 10% discount. As a result, the Court ordered a refund payment to the Estate of $14,359,508.21, plus statutory interest, for overpaid taxes.

While apparently "nothing is certain except for death and taxes," you could add to that the certainty that those with enough money will seek to avoid both. And that, in itself, is an art form. But that is just a [reckless] opinion....what do you think?


Source: Forbes, 24 September 2014

More UK tax breaks

Last month I reported on the UK government's 'acceptance in lieu' (AiL) scheme.

This week, the Department for Culture, Media and Sport (DCMS) launched the "Cultural Gifts Scheme." The Scheme, which will be administered by the Arts Council, will allow UK taxpayers who own art or collections of heritage objects, which are considered to be pre-eminent, to be donated during their lifetime (rather than after their death, as with the AiL scheme) in return for a tax reduction to their tax liability.

Culture Minister Ed Vaizey has said of the scheme that it "is aimed at encouraging gifts and donations of wonderful treasures to the nation, where they can be enjoyed by all."

How will it work?

A UK taxpayer who owns an artwork which is considered pre-eminent, can offer to donate the work to the Arts Council. The offer will be considered by the AiL Panel (the “Panel”). If the Panel considers that the object is pre-eminent and meets the relevant conditions, they will agree a valuation and then make a recommendation to the relevant Minister (either the Secretary of State for Culture, Media and Sport, the Welsh Ministers, the Scottish Ministers or the Northern Ireland Department for Culture, Arts and Leisure). If the relevant Minister agrees with the recommendation, the object will then be allocated by the appropriate Minister to an eligible museum or gallery. Alternatively, where an offer is made with a wish that the artwork be allocated to a particular institution, the Minister can agreed to the allocation and the object will be transferred to that institution. If the Panel assesses an object as not being pre-eminent, it will be rejected. There will also be an annual limit of £30 million for both the Cultural Gifts Scheme and AiL Scheme. The Panel may also reject a donation where acceptance would cause the annual limit to be exceeded.

Upon formal acceptance of a donation, the Arts Council will send confirmation of the donation to HMRC. HMRC will not apply the tax reduction to a person’s tax liability unless and until the Panel has confirmed to HMRC that the relevant conditions for the tax reduction have been met. The tax reduction will only be available against the income tax and capital gains tax liabilities of individual donors or against the corporation tax liability (including liabilities on chargeable gains) of corporate donors.

DCMS have produced detailed practical guidance on how to make an application under the Cultural Gifts Scheme. This can be found here.

Tax avoidance for all

With David Beckham being lauded for his savvy tax dodging you may be forgiven for thinking that famous footballers have a monopoly on tax avoidance. Not so.

Also reported today is the news that artist Lucian Freud, who died in July 2011, bequeathed artworks by Corot and Degas in his will to the state under the government's 'acceptance in lieu' (AiL) scheme. Under the scheme, people can offer items of cultural and historical importance to the state in full or part payment of their inheritance tax, capital transfer tax or estate duty. The scheme is said to offer clear tax benefits to owners as items are generally worth 17 percent more if offered in lieu of tax than if sold on the open market at the same price, because tax must be paid on the amount an object is sold for. Once accepted, the works are distributed to museums, galleries and public archival depositories throughout the UK. Thus, in this instance, the Corot works are said to be going to the National Gallery, while the Degas works are to be displayed at The Courtauld Gallery.

So, you don't have to be a famous footballer to get a tax break....being a famous artist is just as good.

More details of the AiL scheme can be found here.

Source: BBC, 4 February 2013

Ai Weiwei to repay money to supporters

Following the loss of his appeal in his tax case (reported here), Ai Weiwei has reportedly started to repay the money that was sent to him by his supporters when the Chinese authorities imposed a $2.4 million penalty for unpaid taxes and fines (as we reported here) on his company, Beijing Fake Cultural Development Ltd.

At the time, Ai reportedly said that he would not treat the money from supporters as donations, but as loans that he would repay. He has now said that said that "We have no more options to keep trying. We've done what we could, and the court's decision has been made. So we should repay the money."


Source: The Associated Press, 31 October 2012

China rejects Ai Weiwei's claim

As we reported back in April, Ai Weiwei filed a lawsuit against the Beijing tax office claiming that it had violated the law when it imposed a $2.4 million penalty on his company for unpaid taxes and fines. Today, a Beijing court rejected his claim.

The Associated Press reports that:

The [Chaoyang District People's] court rejected the lawsuit on the grounds that the reasons given by the design firm in seeking to have the tax penalty revoked did not hold water, according to a copy of the verdict seen by The Associated Press.

The court said, for example, that the company was wrong in arguing that financial accounts seized from Ai's studio by police should not be used as evidence in the tax authority's investigation against the firm. It said tax investigators are allowed to use information sent to it by other departments or organizations. ...

The court ... rejected lawyers' requests to see evidence against the company, produce witnesses and have an independent auditor verify figures.

Representatives of Ai said that the ruling was made "totally without reason" but that it came as no surprise, and vowed that the ruling would be appealed, including the company's legal representative Pu Zhiqiang, who said "We have lost this lawsuit but we believe that our action in reality can serve as a symbol of the awakening of civil consciousness....We do not recognize the legality of the ruling."

Ai, himself, who was not allowed to attend the hearing is said to have told reporters that:

"Today's verdict means that after 60 years of the founding of our nation, we still lack the basic legal procedures, the truth is not respected, and they do not give taxpayers or citizens any rights to defend oneself."

"The whole legal system is in a dark state right now."

This decision is the latest obstacle Ai Wei Wei's freedom from oppression by the Chinese authorities. He remains unable to leave the country and is under constant police surveillance. At this stage, it is difficult to predict what his next move will be.

Source: Associated Press, 20 July 2012

Taking Art law to the MAXXI

Sometimes the legal issues got a little bit blurry

Last Thursday and Friday there was a fantastic international art law conference organised by Massimo Sterpi on behalf of the International Bar Association at the MAXXI art gallery in Rome. There was a huge range of speakers from artists to curators, academics to lawyers.

The speakers gave a fascinating insight into the world of galleries and museums, private collections and provoked considerable debate on some of the issues facing the art world today. The sorts of issues covered included

(1) how you reach a legal definition of art – a particular issue when trying to justify a hefty price tag for what might, to the untrained eye, look like a pile of bricks or a bit of twisted neon light,

(2) how new forms of art such as holograms can fall within old legal definitions,

(3) ownership of digital art, particularly when it includes user generated content or consist of collections of other works gathered from across the internet – pinterest was a particular discussion point,

(4) broader questions of ownership of art, particularly large scale public or performance art primarily in the context of the Burning Man project,

(5) appropriationism including the case law (hello Jeff Koons, Cariou v Prince et al),

(6) the different treatment of art in different legal systems, particularly the relatively open approach of copyright compared to the prescriptive and literal approach of tax laws,

(7) the dangers that museums and galleries face from last minute lawsuits to demonstrations and public being put in danger (fire, falling masonry, falling over in darkness… the list of potential danger is seemingly endless),

(8) controversies surrounding certain types of art, particularly bio art (from glowing green bunnies to pickled human bodies).

The wonderful Zaha Hadid creation that is the MAXXI

Unsurprisingly, given the number of lawyers in the room, there was a lot of talk about copyright and the inherent problems in applying an old system to a new world where digital reproduction is quick and common and appropriationism has become an accepted and almost mainstream art form. 

Suggested solutions included a form of compulsory licensing for copyright works (similar to the approach taken in patent law), a taxation approach (i.e. you have to pay money if your use of a work makes you any money – probably not the favoured approach of the content industries), and a shorter term of copyright protection.

 I will be blogging in more detail on the issues raised in due course but if any of the above are of particular interest please let me know in the comments section below and I will try to cover them first...

More art and tax

In further art and tax news, and by way of an update on much featured artist Ai Weiwei (including here, here and here), after his detainment, and the subsequent imposition of an enormous tax bill, by the Chinese authorities, it seems that Ai Weiwei is now suing the Beijing tax office.




Ai Weiwei is reportedly claiming that the Beijing tax office violated the law when it imposed the $2.4 million penalty for unpaid taxes and fines (as we reported here) on his company, Beijing Fake Cultural Development Ltd, and asking the Beijing court to overturn the penalty. He told Reuters that "In the handling of the whole process for [the company], some of [the tax office's] actions were illegal and violated regulations." In particular, it is claimed that the tax office failed to produce any original documents with evidence of the alleged tax evasion.

However, it seems that dealing with any Chinese authorities is not easy. Reuters reports that:

Ai's wife, Lu Qing, the company's legal representative, was due to hear by Friday whether Beijing's Chaoyang District Court would accept the suit challenging both the penalty and the lack of access to evidence and witnesses.

But the court told Lu on Thursday to produce the seal - a stamp embossed with the company's name which is used in China on all official documents - that was confiscated by police when Ai was detained last year.

"We can't get the seal back," Ai told Reuters by telephone. "It's in the hands of the police. It's very much a Catch 22."

Ai said Lu was giving the court an explanation on why the seal was missing in the hope it will waive the requirement. The court told Lu she will hear whether the lawsuit is accepted within the next seven days.

Given that there are clearly political, rather than legal, motivations behind the penalty, and now the difficulties with the court, it would be very surprising if the case was heard, let alone successful.

Source: Reuters, 19 April 2012

Taxing Art

While Angela reports on art being destroyed as a protest against budget allocation, in the US, artist Chad Person, in his so-called "Taxcut – Money Art" series, has been destroying money to create art, and to lower his taxable income.

ABC News reports that:

The California-based designer is cutting up dollar bills – actual, paper dollars – to create collages of military weaponry, and then deducting those dollars from his taxable income. As materials for his business, the sliced and diced dollars are exempt from some taxes, thereby lowering Person’s overall tax rate.

"Rather than buying $200 of paint today, I withdrew $200 and chopped it up and turned it into paint essentially," Person said, describing his collages. "It greatly reduces my liability."

As well as reducing his taxes, Person's aim is also said to be to reduce his personal contribution to the government's funding of the military. As stated on his website:

I have destroying money for my work for the past two years. As a professional artist, I deduct my material expenditures as a write off. If I slice up a hundred dollars to make an image, or a thousand, or just five, I am taking it out of the IRS coffers. Imaging the weaponry that I'm not buying with those dollars is a reminder for me that a little creativity can be quite empowering.

ABC reports that to date Person has created about 60 to 70 of these collages, and that although cutting up cash likely amounts to defacing of dollar bills, which is against the law and punishable by a small fine and up to six months in prison, offenders are rarely prosecuted.

So, it seems that cutting up your money to make art might be a legitimate way to reduce your taxable income. On the other hand, if tax avoidance is the aim, it may restrict your ability to profit through your art. Indeed, if you became too successful, certainly in the UK, taxes on the sales of such works would be liable to amount to more than those you had originally saved.

A collection of Person's works can be see here.

Source: ABC News, 13 April 2012

VAT man makes light of Flavin tube claim to art

Installation art from B&Q, taxable at the same VAT rate as Dan Flavin's works

Writing for The Guardian ("Call that art? No, Dan Flavin's work is just simple light fittings, say EU experts", 20 December 2010), Maev Kennedy reports on a ruling that will delight tax lawyers everywhere, though it may cast clouds of gloom over the art world.  She writes:

"...  When the lights were switched on at a Dan Flavin retrospective at the Hayward Gallery in London, critics were entranced. "Beautiful," Laura Cumming wrote in the Observer in 2006. "You wonder how it is possible that so much pleasure could emit from such a dismal source: the cold fluorescent tubes of strip lighting."  But the European commission has taken a less poetic view. Brussels has ruled that the work of the American artist, who died in 1996 after half a century of creating pioneering sculpture, should be classified for tax purposes as simple light fixtures. His work, they said, has "the characteristics of lighting fittings … and is therefore to be classified … as wall lighting fittings".

The ruling overturns an earlier UK customs tribunal verdict, and was denounced by one lawyer specialising in arts cases as "extraordinary".

This is no mere academic view. It means Flavin works imported by any museum or gallery from outside the EU are liable to full VAT, which rises to 20% on 1 January [er, not quite, says A&A: the taxman, who is on holiday till 3 January, says the new rate starts on 4 January]. As sculpture the pieces would be subject to only 5% VAT.

The ruling also affects the work of Bill Viola, another American, who became the first living artist to have a major exhibition at the National Gallery in London, and whose video pieces, filmed in extreme slow motion, moved many viewers to tears.

Not the commission, which found: "It is not the installation that constitutes a 'work of art' but the result of the operations (the light effect) carried out by it."

St Paul's cathedral could be among the first victims of the ruling. It has commissioned two altar pieces from Viola, due to be unveiled next year, which could become dramatically more expensive [A&A doesn't think so: St Paul's Cathedral appears to be VAT-registered since it charges VAT on its guided tours.  This being so, it should just offset the extra VAT against the sum it is liable to pay anyway].

... Whether florescent tubes are ultimately ruled rubbish, hardware or the skeletons of magical art remains to be seen.  Meanwhile the ruling should be a great satisfaction to "Barney", one of the few dissenting voices over the Hayward's Dan Flavin exhibition, who posted on artistsandmakers.com: "It was like walking around the lighting department of B&Q".