The initial test cases fighting the Canada Revenue Agency’s reassessments of “art-flip” tax shelters have resulted in some confusion for taxpayers who participated in the arrangements. It may take a Supreme Court of Canada decision to clear up the confusion.

Through art-flip promoters, taxpayers purchased works of art and had them appraised at a higher value, allegedly based on a market of willing buyers. The purchasers then donated the art to a public institution, such as a hospital or a university, in return for a tax-deduction receipt in the amount of the appraised value.

In December 2003, the Finance Department introduced legislation to shut down all “buy low, donate high” tax shelters, including art flips. The CRA then launched a drive to reassess thousands of art-flip shelters that predated the legislation.

Taxpayers are fighting the CRA on the basis that they should be able to buy low and donate high if the appraised value is fair.
Each test case involves one taxpayer who is representing other participants in a particular art flip.

Confusion has arisen, however, after the two Tax Court of Canada judges who heard the initial test cases took completely different views of how to assess fair market value of the art.

In the Federal Court of Appeal’s May 2005 decision in Klotz v. the Queen, the FCA upheld a TCC decision denying a claim made by investment executive Frank Klotz of Toronto. The decision denied a $258,400 deduction Klotz made for a donation of 250 prints to a U.S. university in 1999. He was one of 660 people who participated in a donation arrangement program known as Art for Education.

The appraised value of his donated prints was approximately $1,000 a print. But the TCC decided the total fair market value was about $300 a print, for a total of $75,000 — the amount Klotz actually paid for the art.
Judge Donald Bowman (who is now chief justice of the TCC) said in his March 2004 decision that the best evidence of what the prints would sell for “is what, in fact, they sold for.”

The FCA did not challenge Bowman. “Fair market value and how it is calculated are questions of fact,” it said. Appeal courts do not overturn trial decisions unless the trial judge made a legal error or “a palpable and overriding error” in findings of fact.

Klotz will seek leave to appeal to the SCC. His lawyer, Doug Mathew, a partner in the Vancouver office of national tax law firm Thorsteinssons LLP, argues that Bowman made an error in law, failing to look at the correct market that would yield the highest price. He, therefore, applied the wrong fair market value test, Mathew says.

In another case, the FCA will hear on Sept.
12 an appeal brought by the CRA against Cademon Nash, Barbara Quinn and Susan Tolley, three simultaneous test cases, collectively known as Nash v. the Queen.
This case was brought in 2004 on behalf of 1,850 taxpayers involved in an art-flip donation program run by Toronto-based CVI Art Management Inc.

In Nash, the taxpayers succeeded. TCC judge Ronald Bell distinguished his decision from Klotz by stating that Bowman “was troubled” that many of the prints donated by Klotz had been acquired by the promoter at huge discounts, and had been lying around unsold for a long time.

But in the Nash case, Bell wrote, “The prints purchased and donated were newly published. The images that were reproduced in these prints were fresh and new to the market.”

Despite these factual differences, the CRA’s counsel will no doubt argue that Bell made an error in law. Based on Bowman’s decision, the CRA will no doubt maintain that mass-marketed donation arrangements create their own market.

Cliff Rand, a partner in the Toronto office of Stikeman Elliott LLP and the lawyer representing Nash, Quinn and Tolley, is hopeful his clients will succeed against the CRA. “The FCA decision in Klotz supports our view that Nash should not be overturned. The value of art is a question of fact.”

If the FCA overturns Nash using Bowman’s reasoning, taxpayers will only receive donation deductions that equal the price they paid for art purchased in their donation arrangements — quashing the benefit of these tax shelters.

@page_break@But if the FCA accepts Rand’s argument and decides Bell did not err in law, the determination of fair market value in art-flip arrangements is back to Square 1. Canada will arguably have two streams of judicial thinking from the TCC on how to determine
fair market value in art-flip cases.

Litigation will continue on a case-by-case basis — a headache for thousands of taxpayers and for the CRA. An SCC decision may be the only remedy. IE