“Yes” to Art, “No” to Tax
Private patronage of the arts. For centuries, artists, museums, and galleries have depended, in no small part, upon the largesse of wealthy families.
Today, as in the past, many of these benefactors are the successful owners or former owners of businesses who can afford to indulge their passion for visual art.[i] Others are investors for whom art represents merely one part of a balanced portfolio.
Some of these affluent purchasers will display their pieces in private galleries or at their places of business;[ii] others will loan parts of their collections to museums and schools;[iii] still others are unwilling to share with the public – to get a glimpse of their personal museums, one has to be invited to one of their many homes.[iv]
Regardless of what motivates them to acquire valuable works of art, and regardless of how they enjoy such art, all these individuals share a deep-rooted aversion to paying taxes, including New York Sales Tax.[v]
When one considers the application of New York City’s 8.875 percent sales tax[vi] to the purchase price for a valuable painting,[vii] it is easy to see why someone in the market for such a painting would try to avoid paying the tax.
Over the years, these folks and their advisers have, with varying degrees of success, utilized many strategies to escape the sales tax on their purchases of artwork. One such strategy – a variant of which was recently upheld by the Tax Appeals Tribunal[viii] – tries to take advantage of the so-called “resale” exclusion.
Before considering this decision, and to better appreciate its implications, it would behoove us to briefly review the application of the sales tax law, generally.
The Sales Tax
The sales tax is essentially a “transaction tax,” with the liability for the tax arising at the time of the transaction. The tax is imposed on the receipt of consideration[ix] from every “retail sale” of tangible personal property (“TPP”), including art.[x]
The sales tax is also a “destination tax.” It is imposed in connection with the sale of TPP that is delivered by a vendor to a purchaser (or to the purchaser’s designee) in New York. The point of delivery or the point at which possession is transferred by the vendor to the purchaser controls the incidence of taxation.[xi]
Finally, the tax is a “consumer tax” in that the vendor is required to collect the tax from the “ultimate” buyer[xii] when collecting the sales price for the transaction to which the tax applies.[xiii]
Retail Sale
As indicated above, the sales tax is imposed on retail sales.[xiv]
Of course, an outright sale of TPP is subject to the tax; however, the term “sale” also includes rentals, leases, and licenses of TPP.[xv] Thus, any transaction in which there is a transfer of title or possession, or both, of TPP for a consideration may be covered by the tax if it is also a “retail sale.”
In general, a sale “at retail” means any sale of TPP to any person for any purpose, other for resale.
All sales of property are deemed taxable until the contrary is established;[xvi] that includes a so-called “casual sale.” The burden of proving that a sale is not taxable is upon the seller and the buyer.[xvii] In all cases, the parties to the sale transaction must maintain records sufficient to verify all sales tax-related aspects of the transaction.[xviii]
Resale
Where a person, in the course of their business operations, purchases TPP which they intend to sell, either in the form in which purchased, or as a component part of other property or services, the property purchased will be considered as purchased for resale, and therefore not subject to tax[xix] until it is transferred to the purchaser’s customer.[xx] That is because the TPP has not yet been acquired by its ultimate consumer.
For example, a wholesaler that sells TPP to a retailer will not have to collect sales tax from the retailer, though the latter will be required to collect the tax upon the sale or lease of such property to its customers.
The “Resale” of Art?
At this point you may be wondering how the resale exclusion could possibly apply to the purchase of a work of art by a collector or investor. After all, isn’t this purchaser the “final consumer” of the art? To whom would they be planning to sell the art?
You’d be surprised.
For example, what if the art was purchased by a business entity – specifically, one that is transparent for income tax purposes – for the purpose of resale to one or more owners of the entity? Sounds ridiculous, right? For one thing, can it be said that a vendor who accepts an exemption certificate under these circumstances is acting in good faith, or has exercised reasonable ordinary due care before accepting the certificate?
As unbelievable as it sounds, that is exactly what some folks were doing. A business entity would be formed for the purpose of acquiring the artwork and then leasing it to one of its owners. Relying upon the resale exclusion, no sales tax would be owed on the purchase;[xxi] rather, the tax would be due upon each periodic lease payment, thus deferring payment of the tax.[xxii]
But alas, “all good things must come to an end,” including seemingly cockamamie tax schemes. In 2017, as part of the FY 2018 Budget Act,[xxiii] New York expanded the statutory definition of “retail sale” to cover:
(A) a sale to a single member limited liability company or a subsidiary for resale to its member or owner, where such single member limited liability company or subsidiary is disregarded as an entity separate from its owner for federal income tax purposes (without reference to any special rules related to the imposition of certain federal taxes), including but not limited to certain employment and excise taxes; (B) a sale to a partnership for resale to one or more of its partners; or (C) a sale to a trustee of a trust for resale to one or more beneficiaries of such trust.[xxiv]
Thus, the purchase of artwork by a single member LLC (or by an LLC treated as a partnership), and the lease of such artwork to a member of the LLC – even if done pursuant to an arm’s length rental arrangement – no longer qualifies as a purchase for resale under the circumstances described; what’s more, the lease of the artwork by the LLC to its single member (or to one of its members) will also be a taxable sale.
However, as the saying goes, “when one door closes, another opens,” which brings us to the case of Objet LLC.[xxv]
The Transaction
Trust A and Trust B were the only members of LLC. Child A and Child B were the respective beneficiaries of the two Trusts; Fazha was their father.[xxvi]
On Date 1, unrelated Seller sold a one-half share of a Picasso painting[xxvii] to LLC, and the other one-half share to Fazha; in other words, LLC and Fazha acquired the painting as tenants-in-common. In neither instance was a resale certificate provided to Seller;[xxviii] in both instances, sales tax was paid.[xxix] That same day, LLC obtained a certificate of authority from the Division of Taxation (“Division”), which authorized LLC to collect sales tax on its taxable sales of TPP.
Also on Date 1, LLC and Fazha entered into a one-year lease agreement (automatically renewable for additional one-year periods, unless terminated by either party prior to the end of the then-current term) pursuant to which Fazha leased from LLC the latter’s one-half interest in the painting. The annual rental paid by Fazha to LLC[xxx] included the applicable sales tax.
Refund Claim
Just before the end of the original lease term, LLC filed a refund claim for the sales tax it paid on the purchase of its one-half share of the painting. LLC described itself as “a collector of artwork” which “[o]n occasion, . . . leases pieces of art.” LLC explained that it was entitled to a refund of sales tax “as it had purchased artwork it had agreed to lease to a lessee.”
After auditing the above transaction, the Division denied LLC’s refund claim, asserting that the transaction between LLC and Fazha was not a sale for purposes of the sales tax. In response to LLC’s subsequent petition to the Division of Tax Appeals (“DTA”),[xxxi] the Division answered that LLC’s purchase of the painting “was not a purchase exclusively ‘for resale as such.’”
After finding that LLC had not provided a resale certificate to Seller, the DTA added that the failure to do so did not completely bar LLC’s right to the exemption (though it did give rise to a presumption of taxability). Instead, the DTA continued, LLC could rebut the presumption of taxability through other evidence.
The DTA agreed that the transaction between LLC and Fazha was a valid lease, but it still found that LLC’s case for the exemption fell short “when the transaction is examined in its entirety.”
Specifically, the DTA explained that “[w]hether a certain purchase is entitled to a resale exclusion or exemption requires that the taxpayer show that the purchase was made only for the purpose of resale.”
In the present matter, the DTA stated, LLC “identified itself . . . as a collector of fine art that occasionally enters into leases.” Its certificate of authority was effective the day it purchased and leased the painting; its principal activity until then was that of a collector. Moreover, LLC could restore the painting to its collection merely by terminating the lease.
With that, the DTA determined that LLC had failed to meet its burden, and the Division’s denial of LLC’s refund claim was sustained.
Tax Appeals Tribunal
LLC appealed the DTA’s decision to the TAT, where it argued that the painting in question was purchased for the sole purpose of leasing it to Fazha. According to LLC, because the painting was leased immediately after its purchase, and because LLC had made no other use of the painting, the resale exclusion should apply.
The Division reasserted its position that LLC had failed to demonstrate that its exclusive purpose for acquiring the painting was to lease it. The Division also observed that “the lease arrangement is a blueprint for tax evasion since it would take the lessor 91 years to pay the sales tax on the rental payments in an amount equivalent to the sales tax paid on the purchase of the” painting.
It also argued that the co-tenancy arrangement between LLC and Fazha “could not legally lend itself to a resale agreement because all owners had a co-extensive right to full possession of the [p]ainting and thus could not transfer possession pursuant to a resale by lease.”
After affirming that entitlement to the resale exclusion required LLC to establish that “its only intent at the time it purchased” the painting was to resell it,[xxxii] and after acknowledging that later events may be relevant to ascertain intent at the time of the purchase, the TAT found that LLC had met its burden.
The TAT described how LLC had leased it interest in the painting on the same date it was acquired; LLC’s certificate of authority was validated on that date as well. The lease was a valid lease and Fazha, as lessee, made rental payments, including the associated sales tax, which LLC reported and remitted to the Division.
The TAT also responded to the DTA’s concern, that LLC need only terminate the lease to restore the painting to its collection, by pointing out that LLC would be required to pay use tax in the event of such a termination. The possibility that LLC could make a taxable use of the painting at some point in the future did not, according to the TAT, provide a basis for denying LLC’s resale exclusion claim. At present, there was no evidence, the TAT stated, of any taxable use of the painting by LLC.
With that, the TAT granted LLC’s refund claim.
What Does it Mean?
A taxpayer’s victory in the TAT is final and binding on the Division – there is no appeal to the courts.[xxxiii] Query whether the state legislature will react to LLC’s win as it has previously (described above) when it determined that certain transactions should be treated as retail sales without regard to the subsequent lease of the acquired TPP to a related person?
I was surprised by the TAT’s decision. For one thing, it did not refer to the 2017 amendment to the definition of a “retail sale” that is followed by a lease to a related person (discussed earlier). Although the transaction in question preceded the effective date of such change, I expected to see some discussion of the provision and some effort at distinguishing it from lease to Fazha.
Then again, the Trusts – not Fazha – were the members of LLC; in other words, the subsequent lease of the painting by LLC to Fazha was not a lease to one of LLC’s owners. Thus, the anti-avoidance rule for related party leases did not apply. Why didn’t the TAT at least mention that fact?
Although the DTA and TAT opinions did not provide much information regarding the tax status of the Trusts, and Fazha’s relationship to the Trusts, it is reasonable to deduce[xxxiv] that both Trusts were grantor trusts as to Fazha; after all, why would Fazha increase the income tax burden of the Trusts with the rental payments for the use of LLC’s interest in the painting?
Taking advantage of the resale exclusion allowed the Trusts to shift liability for payment of the sales tax from the Trusts (i.e., LLC) to Fazha, and to defer the payment thereof over time, as rental payments were made, rather than at LLC’s acquisition of its one-half share interest in the painting. By requiring Fazha to pay the significant sales tax, the Trusts were allowed to increase in value without being reduced by the amount of such tax; at the same time, Fazha’s payment of the tax reduced his gross estate accordingly.[xxxv]
The payment of the rental to LLC (assuming a fair market rate) also addressed any IRC Sec. 2036 retained use exposure to which Fazha’s future estate may have been exposed as a result of using LLC’s (the Trusts’) one-half share interest in the painting. It is clear that Fazha intended to hold the painting after its purchase. By purchasing only one half of the painting and paying an arm’s length rental for the half owned by the Trusts, Fazha helped to reduce the risk of inclusion in his gross estate of the one-half interest held by the Trusts, while also reducing the estate tax valuation of his own one-half share interest of the painting.
I tend to agree with the DTA’s statement that the lease arrangement approved by the TAT may provide a blueprint for tax evasion. Stay tuned.
The opinions expressed herein are solely those of the author(s) and do not necessarily represent the views of the Firm.
[i] These individuals appreciate being surrounded by “beautiful” objects; specifically, paintings and sculptures. Depending upon how expansively one defines “fine art,” it may include not only visual art, but also literature and music, for example.
[ii] For a short but impressive list: https://www.architecturaldigest.com/gallery/nyc-office-building-artwork . These folks are often “assisted” by special urban design regulations that seek “to improve the quality of the streetscape and to promote a lively and engaging pedestrian experience.” https://zr.planning.nyc.gov/ . Then there is the city’s “privately owned public spaces” program: https://www1.nyc.gov/site/planning/plans/pops/pops.page#:~:text=Privately%20owned%20public%20spaces%2C%20also,bonus%20floor%20area%20or%20waivers.
[iii] These more publicly minded benefactors often use a private operating foundation to hold, maintain, and circulate “their” art.
[iv] There are a lot of these folks out there. I know – all tax advisers know. These individuals may have explored the possibility of a charitable organization, but quickly rejected the idea of “public access.”
They remind me of other folks who want to “encumber” their real property with a conservation easement but cannot demonstrate a public benefit – no public access or views, no public policy (for example, protection of aquifer), no flora or fauna to protect (though I had one guy erect an “osprey nest” on a bay-side property to bolster his position – build it and they will come?), etc.
[v] Article 28 of the New York Tax Law.
[vi] The City Sales Tax rate is 4.5%, NY State Sales Tax is 4% and the Metropolitan Commuter Transportation District surcharge is 0.375%.
[vii] Auction Prices That Take Your Breath Away, https://www.nytimes.com/2020/09/14/arts/auctions-high-prices.html
[viii] In the Matter of the Petition of Objet LLC, Tax Appeals Tribunal, Decision DTA No. 828673 (Feb. 2022).
[ix] The consideration may include money, a promissory note, or other property; it also includes the assumption of liabilities. The time or method of payment of the consideration is immaterial. When a sale is made for which payment is not received at the time of delivery, the sale must still be reported, and the full amount of the tax must be remitted with the return. There is no installment reporting.
[x] The term “tangible personal property” means physical personal property, of any nature, that has a material existence and is perceptible to the human senses.
20 NYCRR 526.8(a)(3) [“artistic items, such as sketches, paintings, photographs, moving picture films and recordings.”]
The sale of certain services is also subject to the tax.
[xi] Query the implications of the Wayfair decision, at least with respect to states that have only a minimum aggregate dollar value for transactions (as opposed to a minimum number of transactions, or both).
[xii] The customer who cannot shift the liability for payment of the tax to another person or who is not otherwise relieved of such liability.
[xiii] The vendor collects the tax as trustee for, and on account of, the state. This “fiduciary” status forms the basis for so-called “responsible person” liability under certain circumstances.
[xiv] New York Tax Law Sec. 1105(a).
[xv] New York Tax Law Sec. 1101(b)(5).
[xvi] New York Tax Law Sec. 1132(c).
[xvii] 20 NYCRR 532.4.
Both parties may be held liable for a deficiency in sales tax.
[xviii] As a matter of public policy, certain sales are exempted from the sales tax.
[xix] New York Tax Law Sec. 1101(b)(4).
[xx] A sale for resale will be recognized only if the vendor receives a properly completed resale certificate. Receipts from the sale of property purchased under a resale certificate are not subject to tax at the time of purchase by the person who will resell the property.
[xxi] This is to be contrasted with the lease of a motor vehicle, a vessel, or a noncommercial aircraft. NY Tax Law Sec. 1111(i).
[xxii] Meanwhile, the transaction would be neutral from the perspective of the income tax.
[xxiii] Part CC of Chapter 59 of the Laws of 2017, effective for sales made and uses occurring on or after April 10, 2017. See also TSB-M-17(4)S.
[xxiv] New York Tax Law Sec. 1101(b)(4)(v).
[xxv] “Objet” presumably as in “objets d’art” or works of art, in English.
[xxvi] Any Austin Powers fans out there?
Goldmember: Fazha, his dad–dad is fazha.
Dr. Evil: Oh, his dad. Oh, his father.
[xxvii] “Femme a la Robe Verte.” https://picasso-prints.com/products/pablo_picasso-24-6 . Not my favorite.
[xxviii] Form ST-120 “Resale Certificate”; New York Tax Law Sec. 1132(c)(1); 20 NYCRR 532.4.
[xxix] The Seller issued two separate invoices. Each invoice included the purchase price and the related sales tax. The invoice was dated one week before the sale was completed (upon payment).
[xxx] Although it is not stated in either of the decisions described below, there is a good chance Fazher was the grantor of the Trusts, and the Trusts were treated as grantor trusts for income tax purposes. IRC Sec. 671. In that case, LLC would not be treated as a partnership for income tax purposes and the rental transaction with Fazher would be disregarded for such purposes.
[xxxi] In the Matter of the Petition of Objet LLC, Division of Tax Appeals, Determination DTA No. 828673.
It is unclear whether LLC first requested a conciliation conference through the Bureau of Conciliation and Mediation Services.
After a hearing at the Division of Tax Appeals, an administrative law judge issues a determination that decides the dispute unless the taxpayer (or the state), as in the present case, requests further review by the Tax Appeals Tribunal (“TAT”).
[xxxii] Because liability for the sales tax occurs at the time of the transaction, a taxpayer’s intent at the time it purchases the TPP determines whether the resale exclusion applies.
[xxxiii] By contrast, taxpayers who are not satisfied with the decision of the TAT have the right to appeal the decision by instituting a proceeding pursuant to Article 78 of the CPLR to the Appellate Division Third Department of the State Supreme Court.
[xxxiv] I’m surmising. After all, a transaction between a trust and one who is the grantor of the trust (again, I am surmising) is likely undertaken for estate/gift tax purposes, the benefit of which would be greatly reduced by having the trust incur an immediate income tax liability.
[xxxv] The reasoning on which the use of grantor trusts is premised.
