By Piroska Horvath
In Geneva, Switzerland, lies one of the world’s biggest free ports, housing the invaluable assets of unimaginable rich people. The wooden boxes of the special temperature-controlled warehouses, equipped with earthquake and explosive resistant structures, safeguard treasures like bottles of wine and priceless art. The specifics of the inventory are unknown along with the identity of those collectors who choose to store their assets here. Behind the heavy metal doors lies the sinister side of the art world, and it has become increasingly apparent it is being used to create large profits and generous tax cuts for billionaires – making the rich even richer.
Tax avoidance and evasion is no news to the financial world. Profit maximisation remains one of the lead organizational goals within corporations’ practices. Sikka (2009) points out that in the financial world, taxation is viewed as shareholders’ debt to the government, rather than part of a social corporate responsibility of reinvesting money into social capital. He also highlights that traditional accounting language normalizes avoidance of reinvestment of social capital by associating it with negative connotations like cost-fee, whilst dividends and pay-outs are regarded as rewards.
Therefore, the avoidance of taxes is simply common sense in business practice. Enron and WorldCom are obvious examples that come to mind when thinking of such events. Moreover, billionaires alike love to write off assets in tax heavens or offshore accounts or simply put it towards their own private foundations or charities. For instance, George Soros’ charity Open Society Foundation served as a tax shield of almost 18 billion in 2017. Or more recently in October 2020, John McAfee, the founder of antivirus software, has been charged and faced up to 30 years in prison for not filing tax returns for 2014-2018.
However, those billionaires with a more creative mindset, have used the art market to pocket large sums. Many argue that the modern world of art has become a smokescreen for the rich to hide behind while avoiding taxes.
Art has become a commercial product, whereby the purchase price equals the sale price plus sales tax (there are variations of sales taxation, but the concept remains the same). Interestingly, Yves Bouvier, president of Natural Le Coultre, a Swiss firm that specialises in transporting, packaging, and shipping art and closely works with the Genevan free port, points out that the price of art is a subjective matter. Arts are appraised to determine a fair market value, but their prices are highly volatile – subject to bargaining and discussion, as well as depending on the time period. Therefore, there is a lot of secrecy and it is up to the discretion of the seller if they choose to quote a price before the exchange of money takes place.
Art is usually exchanged through primary markets such as museums, and galleries or on secondary markets like auctions. It is a popular choice of asset as the value of art tends to increase.
There are two popular scenarios when a wealthy person buys art. Firstly, if they are art lovers, they might purchase a piece, hang it in their home and enjoy it for ten years while the value of the art creeps upward. After it has been appraised for a fair market value a person can donate the work back to the museum. Beth Smith, executive director at Morgan Stanley, describes how one can claim a reduction equal to the appraised value of the painting on their taxable income, as long as the deduction is 30% less than your income. Depending on the value, the money saved on taxes can be more than the initial investment for the artwork.
Secondly, if the art is bought from a purely strategic point of view, it can be transferred to free ports like the one mentioned above, which are located in tax free zones. While the precious artwork sits in its wooden box, its value increases, or it might be loaned to museums once or twice which makes it theoretically more valuable. After a number of years, it is appraised. There are two options here. The first option is that it is sold to another client who might also choose to store it at the same freeport – the money exchanges hands but the art does not have to move out of the free port. This means no sales tax and the return is taxed as capital gains which means tax rate is lower on the return than on income. This creates a profit for the seller that is also not subject to taxation.
Alternatively, one can choose to auction art off but then sales tax and action fees need to be paid. The art can be sold anywhere between the minimum price the auction agrees to sell it for and infinity or could not be sold at all. Auction houses are not regulated and hence they are often exploited to inflate to future appraised value of art works. They even offer financial services such as offering investors credit to borrow against the valuation of their collection. These activities in turn inflate the prices of art, attracting buyers who are interested in it because of the wealth, making the circle even tighter. Moreover, the high prices contribute to the tax deduction of future collectors. A never-ending cycle.
While this seems a win-win situation whereby society gets art and the rich saves on taxes, it is not as simple as that. Museums receive these donations but at the same time the deductions that fuel donations inflate art prices way beyond their reach. In turn, larger sums, contribute to larger deductions in taxable income for wealthy collectors. This means that it excludes many people from producing and consuming art. For instance, it is only a small number of mid-tier galleries and artists that create incredible art that are recognized on such a prestigious and expensive level. Moreover, it affects what kind of art gets made, shown and recognized in society. This financial exploitation of art as a public good means that it is in no one’s interest to regulate it and even if it were, the closed circles of the unapologetically rich is hard to infiltrate.
“The views expressed in this article are the author’s own, and may not reflect the opinions of The St Andrews Economist.”
References and further recommended sources:
Sikka, P. (2009), “Smoke and mirrors: Corporate social responsibility and tax avoidance”, Accounting Forum34 (2010) 153–168.
The black box of Art Business (2018)
Adam, G.,(2018), “DARK SIDE OF THE BOOM: THE EXCESSES OF THE ART MARKET IN THE 21ST CENTURY”, Lund Humphries.