This article was originally published in Arts & Collections on May 22, 2020.
Is sales tax legislation becoming the 'bane of the art market'? Christie's recent $16.7m settlement to avoid prosecution in the US for sales tax evasion demonstrates once again that it's an increasingly common issue for both American and international art businesses. We turned to the experts from international art law specialists Withers for insight.
It's another taxing lesson in Sales Tax - Christie's' recent $16.7 million settlement to avoid prosecution for sales tax evasion has demonstrated once again that sales tax compliance continues to be the bane of the art market.
Since 2003, the New York County District Attorney's Office and the New York State Attorney General's Office, working closely with the New York State Department of Taxation and Finance, have regularly targeted auction houses, dealers, and collectors who have failed to collect and pay sales and use taxes on sales of multi-million dollar works of art. What is different now is that these prosecutions are occurring more frequently.
With the coronavirus wreaking havoc on local economies and pressure mounting to fill depleted state and local government coffers, we can only expect law enforcement increasingly to target art dealers who run afoul of their sales and use tax compliance obligations.
Art dealers, therefore, should not underestimate the importance of careful compliance with their withholding obligations, particularly when relying on one of the most common reasons for not collecting sales tax - lack of 'nexus', or local tax presence - unless they are willing to risk becoming the latest party surprised to learn that this is an easily detectable infraction.
First, some basic principles. Art dealers must understand that sales and use taxes represent distinct but interlocking regimes that are imposed at the state level, causing rules that can already be quite technical to vary significantly between states. This landscape may be further complicated, particularly for international parties who are less familiar with US law, by the fact that these taxes are sometimes confused with customs duties.
Because of this confusion, art dealers may be misled into believing that they can circumvent the application of sales and use taxes by keeping artwork within storage facilities which qualify as foreign trade zones. These zones are considered to be outside of U.S. Customs and Border Protection territory for purposes of imposing customs duties - but offer no protection for sales and use tax purposes. The use of a foreign trade zone for artworks is often unnecessary anyway, because (with some exceptions) U.S. customs duties typically do not apply to artwork.
In many states, including New York, sales tax is a destination tax: the duty to pay the tax to a state is determined based upon the point where the artwork is physically delivered to the buyer or the buyer's designee. While liability for sales tax ultimately rests on the buyer, the dealer who has delivered the work of art typically acts as a trustee for the state and is required to collect the sales tax and remit it to the state. In this role, the dealer may also become personally liable for the tax.
For this reason, dealers must proceed with care any time they rely on a state's sales tax exception. For instance, even in cases where the dealer does not have a sales tax collection obligation, purchasers should be advised that use tax may apply - because, while sales tax is imposed on transactions, use tax is the backstop to sales tax, imposed on the "use" of artwork.
Most typically, use tax applies where a buyer purchases artwork in one state (or abroad) but takes delivery in another state. If the dealer does not have sufficient ties (the legal term is "nexus") to the state where the buyer takes delivery, the dealer does not have a sales tax collection obligation. Instead, the buyer would have an obligation to self-assess and pay use tax in the state of delivery.
Qualification for this lack-of-nexus sales tax exception is becoming less commonplace since the U.S. Supreme' Court's 2018 Wayfair decision, which gave states a green light to proceed with enacting "economic nexus" statutes requiring dealers to collect sales tax for any state into which they deliver sufficient artwork (determined by number of deliveries and/or value). As a result, each state's Wayfair statute must be reviewed carefully, and art dealers now must collect and remit sales tax in more states.
Similarly, art dealers who are based abroad but who regularly conduct business in New York or who have affiliated companies which do business in New York must closely consider whether local sales tax collection obligations apply to them when they engage in international sales transactions resulting in the shipment of artwork into New York, as nexus may arise in unanticipated ways.
In the Christie's case, London-based Christie's Private Sales and other affiliated Christie's entities were ultimately considered to have had an obligation to collect and pay local sales tax from 2013 to 2017 where artwork was shipped from abroad into New York, even when the transaction itself was entered into abroad.
Finally, where reliance on a sales tax exception is warranted, dealers must take care to retain all supporting documentation evidencing compliance with the exception. If the dealer cannot demonstrate to New York regulators that no sales tax was paid to New York because delivery occurred outside out of state, the transaction would likely be viewed as a sham designed to evade sales tax.
For example, shipping a work first intrastate to a collector's residence to be viewed in situ and then to the collector's second residence out-of-state would quickly raise a red flag, as the pattern suggests the work might soon find its way back within the state. Over the years, and quite recently, well-known figures in the art world have learned this lesson the hard way, facing very public prosecutions. Had they been aware that one of the first things prosecutors do in a sales tax investigation involving the art market is subpoena shipping records, they might have thought twice about more closely assessing their obligations to the taxman.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.