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Ivana Zivanovic
CMS Francis Lefebvre Avocats, Paris
ivana.zivanovic@cms-fl.com

Olivier Le Goff
CMS Francis Lefebvre Avocats, Paris
olivier.legoff@cms-fl.com

 

Before the Covid-19 crisis halted it, the art market was in a state of constant growth: 550,000 fine art lots were sold at auction worldwide in 2019 for a total of $13.3bn. This is the largest circulation of artworks ever recorded in auction rooms.^[1]

In a low or even negative interest rate climate, investment in the art market appears to be worthwhile. While sales proceeds are concentrated in China, the United Kingdom and United States, many countries have adapted their tax systems to encourage investment and transactions in the art market.

In a global context, where the collector and the artwork are not always located in the same place, collectors must take into account the differences in taxation between jurisdictions when they acquire (see section I), hold (see section II) and transfer (see section III) artwork pieces.

Section I: taxation upon the acquisition of the artwork

In principle, transactions on the art market are treated for tax purposes as with any taxable economic transaction. As such, these transactions are subject in most countries to value added tax (VAT) or to an equivalent indirect tax.

Thus, a collector-buyer who does not invest in art as a regular economic activity is liable for VAT (provided the acquisition is made from a professional) and that VAT constitutes a final cost for the collector. Being fully aware of this final cost, some European Union Member States have implemented reduced rates of VAT when the acquisition is directly made to the creator or their heirs. Eleven Member States have VAT rates of less than ten per cent in this case:

• France (five and a half per cent);
• Belgium and Portugal (six per cent);
• Germany (seven per cent);
• Luxembourg and Poland (eight per cent);
• the Netherlands (nine per cent);
• Slovenia (nine and a half per cent); and
• Finland, Spain and Italy (ten per cent).

Where a Member State has made use of this possibility, the EU Directive on the common system of value added tax^[2] requires that the VAT rates on imports be aligned with these reduced rates, whether or not the acquisition is made from an artist. The applicable VAT is then based on the customs value of the artwork. This import VAT allows the artwork to be freely moved within the EU.

Thus, European collectors who act in a private capacity and who are considering the acquisition of a piece of artwork from a professional reseller, should often proceed with this acquisition from a reseller located in a third country, in order to benefit from reduced import rates (five and a half per cent or another rate – see above). Otherwise, the applicable VAT rate is usually the standard one, in the region of around 20 per cent depending on the Member State.

In the US, most states (45 out of 50) apply a sales tax on the price when the work is delivered to the state in question. The rate of the sales tax varies from state to state (8.875 per cent in New York, for instance). In most situations, original works of art are exempt from import fees or duties. The current trade war between the US and China has prompted the Trump administration to create tariffs for the import of Chinese artworks, be they located in China or not. These tariffs, set at 15 per cent in September 2019, have recently been lowered to seven and a half per cent.

For its part, China applies a VAT rate of 13 per cent (since 1 April 2019), which covers acquisitions on the Chinese territory and imports of artworks from abroad. In addition to this VAT, customs duties apply to imports, which vary depending on the country of origin and can bring the total tax burden in this case to circa 25 per cent.

Collectors may also be interested in freeport storage. Freeports are warehouses, usually located in the vicinity of a seaport or an airport. In addition to security and confidentiality, freeports offer a temporary exemption from custom duties, VAT and sales taxes for as long as the artworks are stored. They are subject to tax as soon as they leave the freeport, and according to their destination. The advantage therefore lies in the postponement of the payment of duties and taxes to a later date, which may enable the owner to build up cash in the meantime. This deferral may even, in some cases, become a de facto exemption, if the artwork is kept permanently in the freeport without ever leaving it. In practice, it often happens that an artwork remains stored in the freeport while sold. In this case, it has changed ownership in a tax-neutral way for both the buyer and the seller (direct taxation may however apply at the level of the seller if they realises a capital gain, see below). Only the last owner to remove the artwork from the freeport is then subject to taxation, while intermediate owners are exempt. The most important freeports in the field of art are Beijing (China), Singapore and Geneva (Switzerland).

Lastly, paid by the seller but passed on in the selling price, the resale right must be included in the total acquisition cost. It constitutes the artist’s remuneration when the artwork is resold on the secondary market, when a professional art dealer intervenes. Progressive and based on the sale price, this right, capped at €12,500, is essentially applied by the countries of the EU and is harmonised at this level by a European directive.^[3]

Collectors also need to consider other costs like those of providers and intermediaries, transportation costs and storage costs, in particular if a freeport is being used.

Section II: taxation based on the ownership

Most countries that had a wealth tax have repealed it. Only a few countries tax the mere ownership of the artwork as an asset. This is the case for Spain and Switzerland, where art is subject to a wealth tax, the application of which varies from one region or canton to another. The Netherlands, for its part, has a special income tax system that acts like a capital tax: taxpayers are taxed annually on a fictitious income deemed to be earned from certain personal investments. On the other hand, the Netherlands does not tax capital gains derived from the disposal of such assets.

When structuring an estate, the artwork can be held directly or indirectly by the collector. In the latter case, the artwork can be held using different structures like a company or a trust. The use of an interposed structure can facilitate the financing of the investment, the division of the ownership of the asset and its management or can be implemented with a view to transfer the artwork.

The way the investment in the artwork is made may have consequences on the taxation of any income arising during the ownership of the artwork when it is, for example, rented. These tax consequences depend on many criteria relating essentially to the source of the income, the type of structure used and its location, and on the residence of the ultimate beneficiary collector(s).

Section III: taxation upon the transfer of the art piece

The transfer of ownership of the artwork can take place in two main ways: for a consideration within a sale, or for free in the context of an estate or a donation.

The sale of the artwork

The sale of the artwork will, in most cases, generate a taxable capital gain in the hands of the transferor. The way the artwork is held will affect the way the capital gain is taxed. If the artwork is directly held by the collector, the capital gain is taxable at the collector’s level according to personal income tax rules. Most countries apply progressive rates of income tax to capital gains realised by collectors on the sale of artworks. If the artwork is indirectly held by a company subject to corporate income tax (CIT), the capital gain constitutes a result of the company and is part of its taxable income for CIT purposes. Where a flow-through interposed entity is used, and according to the applicable legislation, the capital gain is often treated, for tax purposes, as if it had been realised directly by the ultimate beneficiary collector.

France has created a fairly favourable tax regime for sales of artworks performed while managing collector’s private assets, with a flat tax of six and a half per cent of the sale price replacing the taxation of the capital gain on the sale. An option for income tax remains possible. The US tax system provides for, alternatively, a progressive taxation of the capital gain or a flat taxation of 28 per cent, while the UK taxes the capital gain at a rate of 20 per cent. In contrast, Belgium, Hong Kong, Singapore and Switzerland do not levy tax on private investment capital gains.

In the case of an international sale (ie, where the transferor and the transferee are not residents of the same country) double taxation can be avoided under bilateral tax treaties. If the treaty between the two countries follows the Organization for Economic Cooperation and Development Model Tax Convention, the resulting capital gain is in principle taxable in the transferor’s country of residence. Any tax withheld at source in the transferee’s country of residence should form a tax credit that can be offset against the tax due in the transferor’s country of residence. When selling a piece of art abroad, collectors should therefore pay particular attention to the existence of a bilateral tax treaty and to its drafting.

The transfer of the artwork for free

Some countries, such as China, Hong Kong and Singapore, do not tax gifts or inheritances. In the US, when the total amount of both donations made during the lifetime of the taxpayer and their estate assets do not exceed $11.8m, donations and estates are not taxable. Some countries, such as Russia and the UK, do not normally tax gifts within a family context.

Where applicable, inheritance and gift taxes are, in principle, based on the market value of the property transferred. In this respect, the valuation of the asset can often prove difficult. Indeed, in a sale, supply and demand meet to determine the market value of the asset. On the other hand, when it is transmitted for free, the valuation of the artwork is made according to the estimate made by the taxpayers themselves.

In an international context, as each country has its own valuation rules, it is fundamental that the beneficiary take these differences into account when anticipating a donation or inheritance. In the US, for example, heirs or beneficiaries may request a position from the tax authorities on the valuation of the artwork received, based on the opinion of a panel of 25 independent experts.

When the owner of the artwork is an entity, the donation or inheritance relates to the interests in that entity, which must then be valued. The value to be retained is the market value of the shares or rights, which includes the assets and liabilities of the entity owning the artwork. The inclusion of the debts in the valuation usually results in a reduction of the taxable basis.

In the case of an international gift or inheritance, the territoriality rules, which differ from one state to another, also have to be taken into account. Each country applies its own rules of territoriality, and discrepancies may therefore lead to situations of double taxation where two or more countries concurrently exercise their sovereign power to tax the transfer. It is therefore essential to examine the double tax treaties concluded between the involved countries, when they cover inheritance or gift taxes, as these treaties are intended to avoid double taxation.

In France, for transfers between ascendants and descendants, progressive rates apply that vary from five per cent to 45 per cent and beneficiaries may be granted a rebate depending on the degree of kinship. Gift or inheritance rates in Italy vary between four per cent and eight per cent, depending on the degree of kinship. In Luxembourg, between parents and children, donations are subject to a duty of 1.8 per cent and inheritances are exempt. In Switzerland, the taxation varies according to the cantons and the degree of kinship (transfers between spouses and in direct line are exempt in the cantons of Bern, Geneva, and Zug).

Some states have chosen to provide for rules that are specific to artworks. This is the case in Spain, where assets forming part of Spain’s historical or cultural heritage enjoy total or partial exemption. In Germany, the exemption can range from 60 per cent to 100 per cent depending on the family relationship.

Gift and inheritance taxes must generally be paid in cash. Collectors or heirs may also decide to pay them by a transfer in lieu of payment. This original method of payment, which originated in the UK, makes it possible to pay gift or inheritance taxes by handing over to the state artworks considered to be of high historical or artistic value. This method of payment exists in Belgium, France, Germany, Luxembourg and certain Swiss cantons.

Even if they are a passion, works of art are still investment assets that must be treated from a tax point of view.

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