Monday, 9 July 2012

Art, Tax Shelters and Life

Art tax shelters bother me and they bother the Canada Revenue Agency  ("CRA") as well.  When I speak of art – I am speaking of visual art which includes prints, paintings and sculptures.  And this is the Art – Art tax shelters tend to focus on.

Art has always held a special place in my heart.  I grew up surrounded by Erwin De Vries’ paintings and sculptures.  Lately I have fallen in love with the works of Charles Pachter and that  of Carl Ray.  

Carl Ray was a contemporary of Norvelle Morriseau and a member of the Woodland Groupof Painters.  The other members of the Woodland group are Jackson Beardy, Eddy Cobiness, Alex Janvier, Daphne Odjig and Joe Sanchez.  The image to the left is a painting by Carl Ray - the copyright to the image belongs to the heirs of his estate.
Art tax shelters bother me because it cheapens the inherent value of art – art in a shelter becomes a means to a tax credit instead of a purchase to enjoy.  Art triggers various emotions – Van Gogh’sbales of hay is a beauty to behold and so is Monet’s.  Not sure why I love bales of hay but I do. TheScream by Edvard Munch always raises my anxiety level but not sure if it does the same for the recent purchaser of The Scream who paid $120 million U.S.  And I love Carl Ray`s usage of colours in the attached painting of the Loon and fish swirling around.

An art tax shelter is where you purchase a work of art below fair market value and then donate such work for fair market value to a charitable organization in exchange for a donation receipt thereby allowing you a credit at fair market value.  However how does one determine fair market value – this is rather a subjective test as endless of discussions on the Internet have demonstrated regarding the recent purchase price of The Scream.  The subjectiveness on the determination of fair market value also allows the CRA to challenge the valuation allocated to the work of art in a shelter arrangement.  
To the lover of Art - do note Dear Reader that the Canadian Income Tax Act allows a deduction against business income on the purchase of Canadian Art (print, sculpture and paintings).  A taxpayer is allowed to deduct under the capital cost allowance rules (depreciation rules) the cost of the Canadian art over a period of years against business income earned until the full purchase price has been deducted.

Art tax shelters were common but have mostly been shut down especially with the introduction of proposed subsection 248(35) which states that the cost of a gift is determined by the lesser of the amount paid (cost) or the fair market value of the gift.  However a discussion of art tax shelters is relevant though because other shelters have taken their place.  

In a shelter scenario the taxpayer does not win as illustrated in Klotz v.The Queen, 58 DTC 2236; [2004] 2 CTC 2892 even where such taxpayer relied on legal opinions from large law firms and on the opinion of their accountants.  In Klotz the taxpayer participated in an art flip program marketed by AFE Consultants Limited.  The taxpayer purchased prints and donated the prints to charities in return for a donation receipt.  The donation receipts displayed the market value of the prints to be several times more than what the taxpayers paid.  Tax opinions from large lawfirms confirmed that a tax credit could be claimed for the amount displayed on the receipts.  AFE Consultants Limited also paid a commission to accountants and other tax advisors who recommended the purchase of an AFE print to their client. 

The taxpayers in Klotz were audited by Canada Revenue Agency and were disallowed the credit claimed on the receipts.  The Tax Court of Canada and the Federal Court of Appeal agreed with Canada Revenue Agency but did allow the taxpayer a credit for the cost of the Art not the fair market value.  This was bad news for the taxpayer as they were out of pocket for the credit taken against their income which was twice or more than twice the value of the cost of the art.  Also back taxes, penalties plus interest had to be paid.

The reason for writing this post is that often taxpayers who get involved with tax shelters tend to be individuals of high net worth.  It was to my shock on Friday that I had a consultation as a favour to an acquaintance and learned that these donations shelters are not limited to the very well off but also to the lower income taxpayer such as the single mother I met with.  This single mother works shifts starting very early –  she raised her children on a very small income and heard through her tax preparer about how you could donate $4,000 to a religious organization and receive a $40,000 donation receipt in return.  The shelter came with promotional material and looked legit.  So she donated $4,000 – received her credit and continued to do so for the next few years.  Canada Revenue Agency in an audit discovered this shelter and seized the books and records of the promotor which led to the audit of this poor woman.  Her credits against income were denied and she now faces a tax bill of over $120,000 which includes penalties and interest and taxes owing.  It saddened me to see first-hand an unsophisticated taxpayer getting involved in a fraudulent scheme.  Such taxpayers rarely have access to an accountant or a tax advisor to warn them of the mine field of tax shelters.  Of course she should have known better but it is easy to also see her believing the fancy promotional material waved before her face and the lure of a large credit. 

One of the taxpayers (see Lemberg v. Perris, 2010 ONSC 3690 (CanLII))
 who took part in the 
AFE Consultants Limited shelter successfully sued his accountant for recommending the shelter on the basis that the accountant had breached the accountant – client fiduciary duty owed by an accountant to his or her client.  In Lemberg the accountant was paid a commission by AFE Consultants for recommending the purchase of the prints through the AFE shelter.  

However practically speaking law suits are expensive and if bringing a suit against the promoter of the shelter or the advisor recommending the shelter then one must also ensure that the statute of limitation for bringing such an action has not expired.  For a taxpayer caught in the web of tax shelters, recourse against the promotor, advisor can only happen through a class action law suit - it would be too expensive otherwise - for sure the single mother I met could never afford a suit on her own which in essence illustrates the difficulty of access to fairness for the lesser well off.

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