PIVOTAL TAX COURT OF CANADA CASE RELEVANT TO CULTURAL PROPERTY DONATION PROGRAM
Between 1984 and 1986 the donors acquired 215 works of art by Norval Morrisseau in a series of bulk purchases totaling approximately $130,000. At the time, the artist’s market was in tatters as a result of chronic alcohol abuse and lack of representation. The purchases were at bargain basement levels when compared with earlier prices realized. The works of art were divided into five batches and donated to four public galleries. The appraisal service of the Professional Art Dealers Association of Canada (PADAC) supplied valuations totaling approximately $900,000. PADAC’s methodology hinged on a dollar per square inch formula developed as a framework for asking prices by the artist’s former dealer, the late Jack Pollock.
The Points of Conflict
Revenue Canada issued reassessments based on the following assumptions:
i) the PADAC valuation was too high; ii) the fair market value was equal to purchase price; iii) the purchase and donation was an adventure in the nature of trade; iv) the donors suffered a business loss equal to the appraisal costs. The donors appealed the reassessment.
The Position of the Tax Authorities
Although the tax authorities asserted that the fair market value was equal to the purchase price, they commissioned a re-appraisal by a Toronto dealer. Using adjusted auction prices and the advice of a Morrisseau expert, the dealer arrived at a value conclusion of approximately $510,000. The tax authorities asked the dealer if a block discount would be appropriate for a hypothetical owner who wanted to sell the artwork in a short time span. The dealer concluded that a discount of 50% was appropriate, reducing the fairmarket value estimate to approximately $255,000.
As the trial date approached, the donors felt it was necessary to commission a re-appraisal by Morrisseau’s current dealer to support the valuation supplied by PADAC. Using a 1990 price list, sales statistics from 1987-88, and a self-published Canadian art market index as the principal valuation tools, the dealer estimated the fair market value at approximately $1,105,000 — a figure in excess of the PADAC conclusion.
After hearing the testimony of a number of experts, the judge rejected the conclusions of all three appraisals. Utilizing elements from each appraisal, he came up with his own determination of $660,000. The judge also found that the donors had not engaged in adventure in the nature of trade — an adverse decision as far as Revenue Canada was concerned.
Our Reading of the Case
From our perspective, the judge’s 49 page decision is rich in valuation-related commentary. Many of the comments are relevant to the Cultural Property Export Review Board and to museum and gallery professionals. The eight most significant points follow.
1) Formulaic appraisal methods based upon out-of-date retail asking prices are not supportable.
The judge criticised the accuracy of an appraisal based upon a price per square inch formula developed years prior to the donation date. He indicated the formula had absolutely no connection with the state of the marketplace at the date of donation and seriously damaged the validity of the PADAC appraisal.
2) An inherent conflict of interest exists when a dealer values artworks by an artist he represents.
The dealer who provided the donor’s second appraisal (Morrisseau’s current dealer) was criticised as having "a hopeless conflict of interest in trying to be objective about the quality or value of Morrisseau’s works when he is currently the exclusive distributor for Morrisseau’s new works in Ontario." The judge went on to say that the dealer "...had great difficulty in saying anything truly critical of a particular painting."
3) Market transactions after the effective date of a donation are not useful in an estimate of fair market value.
Two appraisals presented during the case used sales transactions that had not yet occurred on the date of donation. The donor’s second appraisal used a price list (and presumably evidence of sales) from 1990. The judge pointed out that there was no evidence that any dealer was selling works at these price levels in 1984, 1985, and 1986 (the donation dates.) Similarly, the dealer working for the tax authorities ventured into unjustifiable hindsight by using "...auction records [taken] back three years and forward one year..." (our emphasis). Strangely enough, the judge did not identify the latter methodological error.
4) Relevant market is crucial in a fair market valuation
The dealer working for the tax authorities used Canadian auction statistics as the basis for his valuation. The judge accepted the unanimous opinion of two dealers and an auctioneer that "the auction market is not the market to obtain the highest price for [the artist’s] works." This reliance on an irrelevant
5) The cost of a donated property can be a factor in the determination of fair market value.
Although the donor’s counsel cited a number of points to argue that the $130,000 cost of the property was not relevant in the determination of fair market value (presumably including the Friedburg decision), the judge noted that "when the property itself is purchased in arm’s length transactions close to the valuation date, cost may become relevant." The judge used the cost of the property as a tool in developing his value conclusion. This opinion supports the Review Board’s assertion that cost can be a factor in determining fair market value.
6) Block discounts are not applicable to donations.
The judge rejected the use of a block discount of 50% used by the dealer working for the tax authorities. He stated that "[t]he hypothetical open market in which fair market value is determined contemplates purchasers and vendors acting without pressures to buy or sell. There is no evidence that these Appellants were under any pressure to dispose of the Morrisseau art." This statement nullifies the argument that the impaired marketability of a large collection impacts on fair market value. In our opinion, the decision could undermine the Board’s use of the Market Adjustment Factor - a methodology hinged on the assumed effect of an unbalanced market.
7) A supportable methodology is pivotal to a fair market value appraisal
Each of the three appraisals introduced as evidence during the trial displayed serious methodological flaws running counter to generally accepted principles of valuation. The judge picked up on most of these and chose to rely on his own opinion of value.
8) Galleries should be circumspect about accepting high opinions of value
In the closing paragraphs of the decision, Judge Mogan noted that he did not think that public galleries would "accept and rely on the same high opinion[s] of value if [they] were intending to purchase...art." He went on to ask the following question: "Would the art be donated if the public gallery were more parsimonious in its acceptance of high value?"
The Zelinski decision contains material that is relevant to all parties involved in the donation process - donors, recipient institutions, appraisers, and the Cultural Property Export Review Board. As the program has demonstrated the ability to evolve in response to court decisions, the changing attitude towards appraisals, and the heightened vigilance of tax authorities, it is hoped that a positive response will unfold.