Matter of Objet LLC

In a decision with significant implications for the sales taxation of artwork, the New York Tax Appeals Tribunal ruled on February 28 that a $7 million painting (at least a one-half share in the painting) was validly acquired for resale resulting in a six-figure sales tax refund for a co-owner of the painting.  Tribunal decisions on sales tax are significant in their own right, since they are somewhat rare and (as opposed to administrative law judge rulings) they become binding precedent.  But the Objet LLC ruling should have particular relevance to the art industry since it tackles two issues that factor prominently in the high-stakes sales and related tax structuring that occur in the industry:  one being the form-over-substance nature of sales tax, and the other being the proper analysis for determining when property is purchased “exclusively for resale”.

The artwork at issue in Objet LLC was a painting by Pablo Picasso worth $7.2 million.  The painting was acquired by two parties who purchased the painting as tenants in common, each paying $3.6 million for a one-half share of the painting.  One purchaser was an individual (a father) and the other was an LLC held by two trusts benefitting the individual’s two sons.  The gallery invoiced both parties for $3.6 million and collected sales tax of $319,500 from each party.  Coinciding with the purchase (actually on the same day) the LLC became registered as a vendor for sales tax purposes, and (also on the day of the purchase) entered into a lease agreement to lease its one-half share to the father—thus giving the father full possession of the painting in his home in New York City.  Under the lease, the father paid an annual lease payment to the LLC, which was calculated as a percentage (1.09%) of the fair market value of the LLC’s share of the painting.  The lease term was one-year, but the lease allowed for renewals, and the lease was in fact extended for two additional terms.  The LLC never issued a resale certificate to the gallery at the time of the sale, but less than a year after the purchase, it filed a refund claim with the Department of Taxation and Finance (the “Department”) claiming that the LLC purchased its one-half share exclusively for resale and thus should not have paid tax.  On its refund claim, the LLC noted that “The taxpayer is a collector of artwork.  On occasion, the taxpayer leases pieces of artwork.”

The Department denied the refund, stating in its denial notice that the lease transaction “has been determined not to be a sale for sales tax purposes.”  The Department argued during the litigation that the painting, therefore, could not have been purchased “exclusively for resale”.  Significantly, the administrative law judge (ALJ) hearing the case prior to the Tribunal rejected the Department’s attempt to look-through and disregard the validity of the lease as a bona fide “sale”.  The ALJ upheld the refund denial nonetheless, concluding that the LLC failed to show it made the purchase exclusively for resale purposes.  Rather the ALJ concluded that the LLC—a self-proclaimed “collector” of artwork—effectively had two purposes for acquiring the artwork: leasing temporarily and (eventually) collecting, and therefore could not meet its burden of proving the intent at the time of sale was solely to lease the painting.  Among the facts the ALJ found relevant other than the “collector” designation were the fact the LLC had never engaged before in leasing artwork, and that the lease only conferred temporary possession to the father, which could be reclaimed at any time.

The Tribunal reversed the ALJ’s determination.  The Tribunal concurred with the ALJ that the lease was in fact valid and represented bona fide “sale” between the parties.  But the Tribunal rejected the ALJ’s characterization of the facts regarding the LLC’s resale intent:  “The fact that petitioner might, at some point, divert a leased piece of art into its own collection is not evidence that petitioner had such intent at the time it purchased the painting.”  The Tribunal noted further that if and when that did happen, the Department’s remedy would be to impose use tax on the LLC.  Nor did the Tribunal agree that a vendor is required to be principally engaged in leasing to obtain a resale exclusion.  And finally, the Tribunal noted that the temporary nature of a lease is not evidence of a lack of an intent to resell, emphasizing that “[t]emporary possession is the essence of a lease transaction and a purchase for the purpose of leasing is a purchase for resale under the Tax Law.”  The Tribunal distinguished the facts at issue from those in Matter of P-H Fine Arts, Ltd. (Tax Appeals Trib., Oct. 13, 1994).  In that case, a business owner set up an LLC to acquire art.  The LLC issued resale certificates to dealers claiming purchased art was to be offered for sale; yet the facts demonstrated the works were “used” by virtue of being hung on the business’s office walls with little attempts to market the works.  But the Tribunal in Objet LLC found as long as there is “evidence of intent to resell and no evidence of a taxable use” at or after the time of the sale, the resale exclusion is properly allowed.

A significant aspect of the Objet LLC decision is the clarity it brings in interpreting the “resale” exemption.  Tax Law § 1101(b)(4) defines a taxable “retail sale” to include a sale to a person for “any purpose other than…for resale as such” (or for use in performing certain taxable services).  The P-H Fine Arts decision had clarified in 1994 that the relevant focus in determining the “purpose” of a sale is “the purchaser’s intent at the time of the sale,” and that, for the resale exemption to apply, a purchaser has the burden to show the item “was purchased for one and only one purpose: resale.”  This, according to the Tribunal, requires proving not only that the item was purchased with the intent to resell it, but “proving that this was the only purpose” for the purchase. (Emphasis added).  The taxpayer failed to prove those elements largely because the evidence showed the artwork was used by the taxpayer (i.e., hung on its office walls, without ample evidence this was solely to market the works for sale).  The Department argued in Objet LLC (and the ALJ agreed) that the LLC had a dual purpose at the time of the sale: to lease the artwork temporarily, and to, at some point, add it to its collection.  But the Tribunal rejected that interpretation of the “one and only purpose” rule, noting that the resale exclusion is properly met “where there is evidence of intent to resell and no evidence of a taxable use.”  Since there was a lease in place and no evidence of any immediate use other than leasing, the Tribunal declined to attribute the possibility of a later “use” to the intent at the time of the sale. 

NY’s legislature actually curtailed the use of the resale exclusion in 2017 by amending the law to make certain purchases ineligible for resale treatment: namely, purchases by a single-member LLC for resale to the sole member; purchases by a partnership for resale to a partner, and purchases by a trust for resale to a beneficiary. (See Tax Law § 1101(b)(4)(v)).  The stated legislative purpose was to curtail the use of structures similar to that in Objet LLC that allowed the sales tax on large purchases such as artwork to be deferred over many years, rather than paid up front.  Notably the resale in Objet LLC didn’t fall within the transactions specified in the 2017 legislation.  For this reason, the Objet LLC decision is also relevant for its re-affirmation (albeit not explicit) of the form-over-substance nature of sales tax.  Even after the 2017 legislation, the Department made it clear that even though the amendment foreclosed the resale exclusion from being claimed on the three referenced transactions, the amendment did not affect the taxability of the leases themselves.  Thus the Department clearly anticipated that artwork leases themselves (even between a single-member LLC disregarded for income tax purposes and its sole member) to be bona fide sales for sales tax purposes.  And indeed, as Objet LLC, demonstrates, art-leasing structures are still used and can have beneficial sales tax implications.  The fact that both the ALJ and the Tribunal refused to ignore the validity of the lease structure here—despite the familial connection between the parties and despite the Department’s argument that the lease was substantively meaningless given the joint right to possess the painting—re-affirms the high hurdle the Department must clear to “look through” otherwise legal entities or agreements for sales tax purposes.

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