A Dirty Business?
The art world is replete with tales of whodunits, forgeries, thefts, money laundering, looting of antiquities, murders, ancient curses, etc. You might say it’s a perfect environment for the more “sophisticated” type of criminal.[i] For the same reasons, it has proven to be a rich source of material for literature and Hollywood – “art” imitating life, as they say.
However, not all illicit activity in the art world is as glamorous as the kind that is packaged and sold for public entertainment. Indeed, some of it is downright mundane, relatively speaking, as we were reminded late last week when the Office of the Attorney General of the State of New York (the “AG”) filed a motion for leave to conduct additional depositions in its dispute with auction house Sotheby’s,[ii] together with a memorandum of law in support of its motion.[iii] The New York Supreme Court, New York County, then ordered Sotheby’s to show cause by May 19, 2023 why the court should not issue an order, as requested by the AG, authorizing the depositions.[iv]
The foregoing submissions represent the latest round in the AG’s dispute with Sotheby’s – The People of the State of New York vs Sotheby’s, Inc. – which began in November of 2020 when the AG filed a complaint in which it claimed that Sotheby’s “enabled” one of its clients (the “Collector”) to fraudulently avoid sales tax on $27 million worth of art the Collector purchased from Sotheby’s for his own collection.[v]
Before reviewing the AG’s complaint in greater detail, a brief discussion on the private collection of art may be in order.
Today, as in times past, many of the benefactors on whom artists, museums, galleries, and auction houses depend financially are the successful owners or former owners of businesses who can afford to indulge their passion for art, who invest in art as part of a balanced portfolio, or who acquire art merely because they can.[vi]
Some of these affluent purchasers will display their pieces in private galleries or at their places of business; others will loan parts of their collections to museums and schools;[vii] most are probably unwilling to share their treasures with the public – to get a glimpse of their “personal museums” one has to be invited to one of their many homes.[viii]
Regardless of what motivates these wealthy individuals to acquire valuable works of art, and regardless of how they enjoy such art, many of these individuals share a deep-rooted aversion to paying taxes, especially taxes that are imposed upon illiquid, often difficult to value, property. In the case of art, that includes the estate tax. It also includes New York’s Sales and Use Tax, which may be imposed at the rate of 8.875 percent of the purchase price for a work of art that is acquired or used in a taxable transaction in New York City.[ix]
Over the years, these folks and their advisers have utilized many strategies to escape the sales tax on their purchases of artwork, with varying degrees of success.[x]
To better understand Sotheby’s alleged trespasses, 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[xi] from every “retail sale” of tangible personal property (“TPP”), including the retail sale of art, such as paintings and sculptures.[xii]
The sales tax is also a “destination tax.” It is imposed in connection with the sale of TPP that is delivered by a vendor (such as a gallery or private dealer) 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.
Of course, this characteristic of the sales tax presents a planning opportunity for avoiding imposition of the tax on one’s purchase of property by taking delivery of the property outside the state. That said, if the property is subsequently brought into the state for use therein, then the use tax would apply, essentially as a backstop to the sales tax.[xiii]
The Use Tax
The use tax[xvi] has been described as the “inverse” of the sales tax. While the sales tax applies to the purchasing taxpayer’s acquisition or taking delivery of property in New York pursuant to a retail sale of the property, the use tax applies to the purchasing taxpayer’s acquisition of the property at retail outside the state – which is not subject to the New York sales tax – which the taxpayer then brings into the state for taxable use therein.
That said, if an individual purchaser was not a “resident” of New York at the time of the purchase – meaning the individual did not maintain a dwelling place in the state (nor was one maintained for them), whether or not owned by them, on other than a temporary or transient basis[xvii] – then their subsequent use of the property within the state would not be subject to the use tax.[xviii]
As indicated above, the sales tax is imposed on retail sales.[xix] Of course,
an outright sale of TPP is subject to the tax; however, the term “sale” also includes rentals, leases, and licenses of TPP.[xx] 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 than for resale.
All sales of property are deemed taxable until the contrary is established;[xxi] that includes a so-called “casual sale.” The burden of proving that a sale is not taxable is upon the seller and the buyer.[xxii] In all cases, the parties to the sale transaction must maintain records sufficient to verify all sales tax-related aspects of the transaction.[xxiii]
Where a person, in the course of their business operations, purchases TPP, such as art, 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 sales tax[xxiv] until it is transferred to the purchaser’s customer.[xxv] 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 such a taxpayer be planning to sell the art?
Contrast the situation of a gallery or private art dealer that is in the business of selling art.
Which brings us back to the claims made by the AG as to Sotheby’s.
According to the complaint filed by the AG, Sotheby’s enabled the Collector to buy art without paying sales tax. It did so, the AG asserted, by accepting the Collector’s representation that he was an art dealer instead of a collector who bought for his own personal use, even though Sotheby’s knew that this representation was false.
The complaint asserted that Sotheby’s was well aware of the rules for accepting resale certificates: “it could only accept them if, according to the head of the responsible department (‘Client Accounting’), there are no red flags or actual knowledge that the property is being used for anything [other] than resale.”
Despite knowing these rules, however, “Sotheby’s accepted the Collector’s resale certificate, and those of his company, even though Sotheby’s in fact possessed knowledge that the Collector and his company were purchasing for the Collector’s personal use and enjoyment, not for sale ‘in the normal course of business.’”[xxvi]
Worse still, the complaint alleged that Sotheby’s employees not only advised the Collector to use a resale certificate to avoid the sales tax but they also helped the Collector complete resale certificates on several occasions. In addition, many more employees of the auction house were aware that the resale certificates were being misused and that the art was being delivered to the Collector’s Manhattan apartment for his personal enjoyment.[xxvii]
Then to top it all off, the complaint continues, Sotheby’s Client Accounting department,
“remained blind to this mass of knowledge, permitting fraudulently obtained tax-free sales for five years, because, with respect to resale certificates, Sotheby’s structure, practices, and policies prevented Client Accounting from learning important facts bearing on resale from the sales force, which had intimate knowledge of its clients.”[xxviii]
Query what motivated these employees to act with such disregard of the law? The AG’s complaint explains their behavior as follows:
“Fixed on courting these major clients in order to increase its sales, Sotheby’s employees recklessly disregarded the company’s obligation to collect and remit sales tax to the State. Not only did they know that the Collector and [his company] were not art dealers using resale certificates to purchase artwork for resale, they played an active role in the creation and use of those resale certificates. In doing so, Sotheby’s employees effectively enabled the Collector and [his company] receive substantial discounts – at the expense of New York State’s taxpayers – and thus remain satisfied and loyal clients.”
In other words, the sales force was competing with rival auction houses for sales, and extended whatever accommodations they could to keep clients happy.[xxix]
The complaint stated that, by knowingly accepting false resale certificates, Sotheby’s submitted sales tax returns to state tax authorities that falsely understated the amount of sales tax due to the State in
violation of the New York False Claims Act,[xxx] pursuant to which Act the State would seek to recover damages plus penalties.
Where Is This Going?
Sotheby’s previously denied any wrongdoing. Moreover, the auction house will certainly argue that it cannot be held liable for the actions undertaken by a relatively small number of “rogue” employees.
In the meantime, discovery, including depositions, will continue. Then perhaps one day, in the not-too-immediate future, there will be a trial that will get to the bottom of it all.
If it turns out that there is some truth to the facts alleged in the AG’s complaint, two words will almost certainly come to my mind: stupidity and hubris. The former is regrettable but forgivable to some degree. The latter will ultimately cause great harm to the one demonstrating the characteristic but society will also experience the adverse consequences of its manifestation, whether in lost tax dollars or in copycat behavior. This outcome should be unacceptable and inexcusable.
[i] The sale of stolen art is one of the largest black-market industries in the world.
[ii] The AG is seeking authorization to take twenty-six depositions, in addition to the fifteen the parties had previously agreed upon. See the Affirmation in support of the State’s motion: https://iapps.courts.state.ny.us/fbem/DocumentDisplayServlet?documentId=ueXFQsmSYP8ZfmjHi3K3Og==&system=prod.
The depositions would cover individuals whom the AG believes were involved in the alleged use of resale certificates for their own purchases.
[vi] The flaunting factor.
[vii] These more publicly minded benefactors often use a private operating foundation to hold, maintain, and circulate “their” art.
[viii] 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.”
[ix] Article 28 of the New York Tax Law. The City Sales Tax rate is 4.5%, NY State Sales Tax is 4% and the Metropolitan Commuter Transportation District surcharge is 0.375%.
[x] For example, see the arrangement described here: https://www.taxslaw.com/2022/03/the-rental-of-art-between-related-parties-applying-the-resale-exclusion-to-the-n-y-sales-tax/.
[xi] 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.
[xii] 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.”]
[xiii] Subject to an exception for certain nonresidents.
[xiv] The customer who cannot shift the liability for payment of the tax to another person or who is not otherwise relieved of such liability.
[xv] 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.
[xvi] New York Tax Law Sec. 1110.
[xvii] 20 NYCRR Sec. 516.15. You will note that “residence” for this purpose does not have the same meaning as for purposes of the income tax or the estate tax.
[xviii] New York Tax Law Sec. 1118(2).
[xix] New York Tax Law Sec. 1105(a).
[xx] New York Tax Law Sec. 1101(b)(5).
[xxi] New York Tax Law Sec. 1132(c).
[xxii] 20 NYCRR 532.4. Both parties may be held liable for a deficiency in sales tax.
[xxiii] As a matter of public policy, certain sales are exempted from the sales tax.
[xxiv] New York Tax Law Sec. 1101(b)(4).
[xxv] 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.
[xxvi] The case of the Collector, the complaint continued, “was exactly like that of the doctor who ‘normally is not engaged in the business of selling artwork.’”
[xxvii] Deliveries were also made to other homes owned by the Collector. The complaint explained that as the Collector continued to spend large amounts of money at Sotheby’s, he continued to put enormous pressure on Sotheby’s to accommodate various requests for special treatment. He even threatened to take all of his business to Christie’s if he was not accommodated. Sotheby’s sometimes bent the rules to accommodate him. By the way, in 2020, Christie’s agreed to pay $16.7 million to settle allegations made by the Manhattan District Attorney that the auction house had failed to collect tax on various sales of art. https://www.theartnewspaper.com/2020/04/09/christies-settles-dollar167m-in-tax-claims-with-new-york-district-attorney#.
[xxviii] The complaint states Key Client Managers (KCMs) were only “cursorily introduced to the use of resale certificates during their initial training.” Once they received resale certificates from clients, they merely forwarded them to Client Accounting without knowing what Client Accounting did with them. Client Accounting personnel knew only that they could accept a resale certificate in good faith if it was complete, they saw no red flags on the document, and they had no actual knowledge it was false.
[xxix] Unfortunately, this kind of behavior is not limited to auction houses.
[xxx] In 2010 (S7169B), New York extended the reach of the Act to include taxes.