April 2006

The Art Flip
Good Tax Planning or Abusive Tax Shelter?

The November 2005 Federal Court of Appeal decision denying the tax benefits claimed under a “buy-low donate-high” art donation arrangement or “art fl ip” is only the latest skirmish in the decadeslong battle between taxpayers and tax collectors involving a variety of tax shelter programs. The taxpayers involved in this appeal were Caedmon Nash, Barbara Quinn and Susan Tolley, but these individuals are by no means the only taxpayers with an interest in the outcome. According to a news release issued by the Canada Revenue Agency in late 2003, approximately 5,000 individuals involved in tax shelter donation arrangements had by that time been reassessed and a further 5,000 were in the process of being audited. Current numbers are not known.

This decision is actually the second shoe to fall on art fl ips. The first was the draft legislation announced by the Department of Finance in December of 2003 that effectively put an end to the art fl ip as it had been structured to that point (although mutations of the art donation arrangement designed to avoid the draft legislation have already appeared). So once again we see what has become a familiar pattern. A new tax shelter program, which appears too good to be true, is aggressively brought to market. Litigation and legislation follow, the particular tax shelter is shut down and then the cycle starts to repeat itself. Because of the introduction of the 2003 draft legislation, the Federal Court of Appeal decision may only be of academic interest for most taxpayers, although not for the 10,000 taxpayers referred to above whose numbers may well have swelled in the last couple of years.

The art fl ip was actually quite simple in structure. A promoter acquires a number of limited edition prints from one or more artists and sells packages of these prints to taxpayers. At the same time, the promoter arranges for appraisals and locates charities that will accept the prints as gifts and issue the necessary donation receipts. Upon donating the package of prints to a charity, the taxpayer claims the usual tax credits which, for an individual living in Ontario, results in tax savings of 46¢ on the dollar. The key to the success of the arrangement is that the appraised value of the prints is usually in the range of three to four times the price paid by the taxpayer to the promoter. As long as the appraisal is found to accurately reflect the fair market value of the prints, the tax savings realized by the taxpayer exceeds his or her cost of the prints and the taxpayer thereby realizes a tidy profit. As the taxpayers Nash, Quinn and Tolley found out, these tax savings quickly vanish when the court is unwilling to accept the evidence of the expert appraisers.

The taxpayers in question did not invest significant amounts of money in the art fl ip arrangement and all three invested approximately the same amount. The prints acquired by Mr. Nash, for example, reportedly had a fair market value, based on the appraisals, of $ 29,400 notwithstanding the fact that he had only recently purchased them from the promoter for $8,667. Although the case is lacking some detail, it is safe to assume that upon filing his tax returns, Mr. Nash would have claimed federal and provincial tax credits of roughly $ 13,000. After deducting the $ 9,000 cost to acquire the prints, Mr. Nash would have turned a profit of some $ 4,000 - that is, until the Federal Court of Appeal held that the value of the prints was more or less equal to the cost at which he acquired the prints in the first place. The Federal Court of Appeal concluded that the market value of the prints should not have been based on the collective value of each of the individual prints but, rather, on the value of the package of prints that had been purchased and donated shortly thereafter. The Court held that the best evidence of the value of this package of prints was the specific transaction between the promoter and Mr. Nash by virtue of which Mr. Nash acquired the prints. Mr. Nash?s tax savings dropped to approximately $ 3,900, an amount far less than the price he paid to acquire the prints. If this decision stands, Mr. Nash will have to repay roughly $ 9,000 of tax plus interest. The Globe and Mail reported on November 30, 2005 that Mr. Nash will have to remortgage his home to pay the tax he now owes.

It is difficult to argue with the logic and common sense of the Federal Court of Appeal?s decision. My own belief is that most tax practitioners, and likely most taxpayers, would not have thought at the outset that these arrangements would have succeeded. However, logic and common sense do not always rule the outcome of tax cases and may yet fail to win in this case. The taxpayers, undoubtedly encouraged by tax counsel, have asked the Supreme Court of Canada to hear an appeal of the Federal Court decision. The right of appeal to the Supreme Court is not automatic. The Supreme Court refuses to consider most tax appeals and the number of tax cases it does agree to hear in any one year can usually be counted on one hand. The taxpayers certainly will have their work cut out for them – first, in getting the Supreme Court to agree to hear the case and, if successful, in then getting the Court to agree with their arguments. It will be interesting to see what course the Supreme Court chooses to take and, if it agrees to hear the appeal, what its decision will ultimately be on the merits of the case. There will be at least 10,000 interested bystanders with more than a passing interest in this case. There may even be some words of wisdom for all of us. Stay tuned.

George F. Johnson, CA,
George F. Johnson, CA, is a senior tax partner with the firm of Crawford, Smith & Swallow, Chartered Accountants LLP, specializing in corporate and personal tax planning, estate planning and related areas of service for all offices in the Niagara Region

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