Can I invest in Art and make more money than in a stockmarket or property?

ART & GLOBAL WEALTH TRENDS

Today’s high net worth individual wealth is over $30
trillion and is increasing by 7% per annum. Currently, $300
billion is potentially available to be invested in art (ABN AMRO report, 2005).

A 2008 study by Mamarbachi, Raya, Day, Marc and Favato, Giampiero, "Art as an Alternative Investment Asset" found that art in
emerging markets [India] has produced 2000% returns over the
past 8 years and by far outperformed returns of the best
performing Hedge Funds like Credit Suisse Tremont Hedge
Fund, Barclay Global Hedge Source Fund, or Hedge Fund
Research Equal Weighed Strategies (Figure 4, page 20). New
York University's Stern School of Business professors have
studied art sales over 125 years and compiled it into the
Mei Moses Fine Art Index.

For example, a J.M.W. Turner view of Venice sold Christie's
in London on May 29, 1897, for $35,000 and then sold at Christie's NY in April 2005 for $35.8
million—which yields about a 6 percent annual return for 109
years. The 1954-2004 fifty year data shows, over the last 50 years, stocks (as represented
by the S&P 500) returned 10.9 percent annually, while the
art index returned 10.5 percent per annum. The most recent
annual five and ten year returns for art, 16.2% and 10.3%, exceed the
returns of stocks often offering investors a safe heaven during stockmarket crashes like we've seen in 2008 and again this year.

AUSTRALIAN ABORIGINAL ART & RETURN OPTIMISATION

More recently, art funds have been created to allow rich people to invest in a
portfolio of fine art assets (e.g. a London-based
Fine Art Fund created by a former Christie's executive).

Art has always followed the money, and money follows the strongest
markets. Dealers like Larry “Go-Go” Gagosian, Daniella Luxembourg and
Jeffrey Deitch, hedge fund moguls and newly born oligarchs want to participate
in $30 Billion Private Art Sales Around the World buying
multi-million dollar works. In the meanwhile,
Professors Moses & Mei found that art purchased for less than
$100,000 produced significantly higher returns than art
purchased for $100,000-$1m or higher.

Professor Worthington of QUT School of Economics and Finance
studied global art markets and calculated returns in Australian art market based on about 36,000 auction sales. In his study at University of Wollongong he identified
Australian Fine Art as a separate Alternative Investment asset class, that produced 30-year average annual returns of 8.23% for all artists as average, in
line with other world art markets, and works costing
$10,000-$35,000 providing highest returns.


AUSTRALIAN ABORIGINAL ART RATE OF RETURN


Prior to 1990s Australian aboriginal art was viewed
merely as part of tourism only to power charge resale values, like
$1.056 million for Emily Kame Kngwarreye's Earth's Creation and $2.4m for
Clifford Possum Tjapaltjarri’s Warlugulong in recent
years. The Warlugulong painting was bought by
Commonwealth Bank of Australia in 1977 for $1200. In 1996, Melbourne art dealer Hank
Ebes acquired the painting for $36,000 and in 2007
National Gallery of Australia acquired the painting at
the Sotheby's auction for a princely sum of $2.4 million. This returned Ebes more than 6,500%
on his investment (1996-2007).
Never mind, if CBA would have held to their $1,200 investment, it
would have returned them 200,000% (1977-2007). Aboriginal art works are called the
outstanding paintings of the 20th century and form a $700 million industry.

With recent success in Bahrain and Musee du Quai Branly in Paris
aboriginal art of Australia is a rather hot investment commodity.



BEAUTY & PORTFOLIO DIVERSIFICATION

Art as an asset class was found to have less volatility and
much lower correlation with other assets as found, hence a
portfolio of artworks may play a somewhat more important
role in portfolio diversification. While the idea – “don’t
put all your eggs in one basket” is timeless, the funds
management principles date back to the early 1950’s. In
June of 1952, a 25-year-old graduate student published a
provocative article in the Journal of Finance that would
have a profound impact on Modern Portfolio Theory. In his
writings, Markowitz discussed risk management through
diversification. He found that by investing your money
across a number of asset classes, there were opportunities
to get more return from a given level of risk, or lower the
risk of your portfolio without compromising returns.



Bill Sharpe took Markowitz’ work and developed the Capital
Asset Pricing Model (“CAPM”), and introducing Beta as a
measure of market risk. Markowitz and Sharpe shared the
Nobel Prize in Economic Science in 1990 for their work
on Modern Portfolio Theory. Building upon the work of
Markowitz and others, Gary Brinson sought to study the
impact of the asset allocation policy decision. The
Brinson Beebower studies, originally completed in 1986
and revisited in 1991, suggested that 93.6% of a portfolio’s
change in returns over time were attributable to
asset allocation policy.

Learn more at ARTBANK

Art and Tax benefits

The tax rules under the Australian Cultural Gifts Program seem straightforward - see recent article.

Giving art to a gallery or other public institution has become an increasingly common activity as the number of wealthy Australians with significant art collections has increased in recent decades. Being a benefactor has a high feel-good rating and there is also a handy tax deduction available under the Australian Government’s Cultural Gifts Program. Using the provisions of the Cultural Gifts Program is one of two ways to get a tax break on an art collection (second is to use a Self-managed Superannuation fund).

The work has to be valued by valuers registered with the program. An average is taken of the valuations and that amount is deductible. This can be used to offset taxable income over five years. Gifts of property made under the program are exempt from capital gains tax. If you sell a painting you pay commission to the dealer or the auction house and you pay capital gains tax. You can end up with about 60 cents in the dollar, depending on your level of income. If you give the work away, you can offset the value of the work against taxable income.


The following is the extract from the Australian Master Tax Guide on Art Gifts

Under the Cultural Gifts Program (formerly the Taxation Incentives for the Arts Scheme), certain gifts of works of art and comparable property qualify for deduction on a more liberal basis than other gifts (s 30-15, items 4 and 5). Such gifts are also exempt from CGT (s 118-60(2)). The program applies to gifts of property with a value of $2 or more for inclusion in the collections maintained by the Australiana Fund, a public art gallery, public library or public museum. Gifts by will are excluded, but may qualify under the companion deduction for cultural bequests (15-575). Gifts of money are excluded. Companies, as well as individuals, are entitled to a deduction under the program (Taxation Determination TD 93/28), although the making of a gift does not create or increase a carry-forward loss (16-880) (Taxation Determination TD 92/195).


Within certain limits, the program allows a deduction for a qualifying gift to be based on the GST inclusive market value of the gift rather than its cost. It also dispenses with the requirement for other gifts (15-510) that the gifted property must have been purchased by the taxpayer within 12 months of the gift being made or be valued by the Commissioner at more than $5,000. A taxpayer must, of course, own the gifted property to claim a deduction (eg Case Y22 91 ATC 257, where a deduction for the value of donated excess film footage in which the taxpayer did not own the copyright was denied). A proportionate deduction is allowed where property is owned and gifted by two or more persons (s 30-225). The deduction for qualifying gifts is generally based on the GST inclusive market value of the gift at the time it was made, determined by reference to the average of two or more valuations obtained from approved valuers. Valuations must be in writing and must state the estimated GST inclusive market value of the property at the time the gift was made or, provided the valuation is made within 90 days before or after the time the gift is made, the GST inclusive value of the property at the time of valuation (s 30-200). The general rule is that the average of the GST inclusive market values specified in the valuations will be treated as the value of the property. However, in some cases an adjustment may be necessary for any input tax credit entitlement (s 30-15(3); 30-215(4)). The ATO feels that the valuation method should determine what price a willing, but not anxious, vendor and a willing, but not anxious, purchaser could reasonably be expected to agree on for the transfer of the property (Taxation Ruling TR 96/1). The ATO does not accept the decision in Case X12 90 ATC 162, that the value of opals donated to a museum was the average of two retail valuations supplied by the taxpayer's valuers, as authority for a contrary view. The cost of such valuations is deductible as a tax-related expense (Taxation Determination TD 93/92).


A person making a gift should send the written valuations to the recipient institution which should then forward them, together with any further documentation required, to the Committee on Cultural Gifts Program. If the Committee accepts that the values and other aspects of the gift conform with the relevant requirements, it will endorse the valuations and return them to the taxpayer. The taxpayer need only produce the valuation documents to the ATO when requested to do so (Taxation Ruling TR 96/1). There are important exceptions to the rule that the deduction for eligible art gifts is based on market value.

These exceptions are as follows:

• Recent or prearranged acquisitions. The deduction is calculated as the lesser of the GST inclusive market value (reduced by any input tax credit entitlement) and the amount paid for the item by the taxpayer where: (a) the property is donated within 12 months of its acquisition (otherwise than by inheritance) by the taxpayer; or (b) the property was acquired by the taxpayer for the purpose of donation or was acquired subject to an agreement or understanding that the property would be donated (s 30-215(3), (4)).

• Artists, art dealers, etc. In certain circumstances, the deduction will be based on the cost of acquiring or creating the property and not on the GST inclusive market value. This will be so in a case where, had the property been sold by the taxpayer rather than gifted, any profits or proceeds arising from the sale would have been assessable to the taxpayer and where the value of that property is not so assessable to the taxpayer as a consequence of the gift being made (s 30-205; 30-215(3)). The ``cost'' method will therefore apply where an artist or art dealer donates cultural property (other than property from the dealer's own private collection), which is created in the ordinary course of business, such as a work of art created originally for sale but subsequently donated. Under the “cost” method, the value of the gift is the amount paid for the property by the taxpayer, reduced by any input tax credit entitlement. Where the property is created or produced, the value is so much of the cost of creating or producing the property as would have been allowed as a deduction to the taxpayer if the property had been sold by the taxpayer, reduced by any input tax credit entitlement. In any other case, if the average of the valuations does not fairly represent market value, the deductible amount is the market value of the property on the day the gift was made.


Deduction may be reduced
The deduction may be reduced by a “reasonable” amount where the recipient does not obtain the right to immediate custody and control of the property or full legal and equitable title to the property (s 30-220). This is also the case where the custody, control or use of the property by the recipient is affected by any agreement entered into in connection with the gift. For example, assume that a gift worth $10,000 is made on condition that the taxpayer retains full rights of possession and enjoyment for the next 10 years. The appropriate discounting factor could be 10%. Using this factor, the present value of the $10,000 gift would be $3,885 and that would be the amount of the reduced deduction allowable (Taxation Ruling IT 295).


Deduction may be spread over five years
Deductions for gifts made under the Cultural Gifts Program may be spread over a period of up to five income years at the election of the taxpayer. The election must be in writing and be made before the taxpayer lodges an income tax return for the income year in which the gift is made. The election must specify the percentage, if any, to be deducted in each income year. A copy of the election must be given to the Secretary of the Department administering the National Gallery Act 1975 before lodging an income tax return for the year in which the gift is made. The election may be varied at any time, although the variation will only apply to the percentage of the original deduction that is to be claimed in income years for which an income tax return has not yet been lodged (Sub division 30-DB: s 30-246 to 30-248).

As this seems to be quite a complex area of taxation I would highly recommend that taxation advice be sought.

Download the Australian Cultural Gifts Program guide on tax incentives

More information on the Australian Cultural Gifts Program
More information on the Australian Cultural Gifts Program approved valuers
More information on the Australian Cultural Gifts Program participating Institutions

More information on forms and certificates

Can I buy ART in my Superannuation?

ART AND SELF-MANAGED SUPERANNUATION (SMSF)

If art is managed correctly, it could be of benefit to generations of your family. Art can make an excellent addition to your self-managed super fund, but you need to keep a close eye on the rules. Whether you're investing in art for love or investment purposes, it does not matter as the same capital gains tax (CGT) ramifications take place just like when buying shares, property or ownership in a business.


INHERITANCE AND CONTINUITY

You can spend a lifetime gathering a collection, but at the end of the day what will happen to it, and who will you pass it onto? Strangely, art institutions aren't that keen to be given bequests because of the cost involved in maintaining them (See an article regarding art Philanthropy in our Media section). By bequeathing a valuable painting to family or friends you could be saddling them with a tax liability if they sell it.

If an artwork was bought before capital gains tax was introduced in September 1985, it would generally not be subject to the tax. But if someone inherits an artwork, then capital gains begins from the date they inherited. If the artwork was bought after 1985, the capital gain is based on the difference between the purchase and sale price. Fifty per cent of that gain is then assessable and added to the vendor's income in that financial year. As a result, clients who may have been in a lower tax bracket are pushed up into the higher marginal tax bracket and can loose a large part of the gain in tax.

That's where a self-managed superannuation fund (SMSF) can be very useful.

SMSF is probably the most effective estate planning vehicle that is available to us today which will allow art collections to go on. One of the major benefits of an SMSF is that during the accumulation phase up until you retire the fund pays lower, 15 per cent, income tax and 10 per cent capital gains tax. Once you reach retirement, the fund moves into pension phase and zero tax is payable on both income and capital gains within the fund.

Clients could actually buy works of art as with their SMSF during the accumulation phase, sell it during the retirement phase and have no capital gains tax implications. Then you have cash reserves to diversify into other types of assets to fund your happy retirement.


SMSF: TAKING CARE OF RULES AND REGULATIONS

While any collectable or unique investment can be in an SMSF the asset has to be valued every year the question is: how do you intend to provide for your retirement if these collectables are still in your fund when you retire?

The trustees are required to make sure the assets are being cared for and insured. To accomplish this, the ATO recommends that the collection is placed in storage or leased to an art gallery or commercial premises. If the collection is leased it will be producing an income. But it's rare that all artworks when leased would produce sufficient income to sustain someone in retirement.

And whatever, you do, avoid buying art with SMSF then hang on the wall in your house.



RESTRICTIONS

Provided the Investment Strategy permits the investment in artworks, the following additional factors must then be considered:

• Where will the artworks be displayed – the Sole Purpose Test prohibits trustees from making investment decisions to obtain a benefit prior to retirement:

a. if a member obtains the benefit at no cost, then the sole purpose test may be breached; or
b. if a member or related party obtains a benefit, but pays a commercial lease entered into after 23/12/99, then the Agreement must be documented and the In House Asset rules must be considered (ensure the artwork is less than 5% of the market value of the fund’s assets).

• Detailed expert advice should be sought if the artworks will be held for capital appreciation purposes (as opposed to deriving an income stream).

• Annual costs such as insurance and storage.

• Valuation costs.

Typically the asset allocation within an SMSF might need to change, especially if you are thinking of using 100 per cent of funds towards art using SMSF. In addition, when you come to retire there may be a need to make more changes to the fund to ensure it is able to produce income, unless there is income from other sources.

When buying art as an investment you should seek good advice. Galleries, the primary market, are a source of information but they invariably promote their own selective artists, hence they are quite biased. Auction houses, on the other hand, are like a stock exchange where people are putting their shares back on the market for sale and the market determines how much the market is prepared to pay. They show art sales historical data and the percentage of growth in any particular artist's work. The draw back that you might pay extra 15-20% extra in ‘buyer’s premium’ for the privilege of buying through an auction house.


Sole Purpose Test

If an investment provides some personal benefit, the trustee will need to consider whether that personal benefit is consistent with the ‘sole purpose test’. As a general rule, the sole purpose test provides that the superannuation fund needs to be run exclusively for genuine retirement purposes. There are a limited number of other purposes that are allowed, such as providing against total and permanent disability, but the pleasure of looking at art is not among them. The Administrative Appeals Tribunal has indicated in previous decisions that it will look to whether the trustee has a secondary purpose to make the assets available for their own use and for the use of family and friends in determining if the investment is consistent with the sole purpose test. Where the trustee stores artwork on their wall at home they may be considered to be deriving personal use or enjoyment from the asset. It is not the storing of the artwork on the wall that is the issue; it is the trustee deriving personal use or enjoyment from the asset, such as looking at it. To avoid any doubt, the trustee may need to put it into storage or even place it on loan to an art gallery in return for the gallery providing storage.


Risk Management

Trustees need to be able to demonstrate from a custodian viewpoint that they are taking adequate precautions to protect any artwork held by the fund – it should be kept in a secure location and be stored to minimise damage. The artworks must be adequately insured (by the fund). All these procedures need to be minuted properly.




SMSF: ART LOAN
The dignity of the sole purpose test set out in section 62(1) of SIS has been strained - severely. The Tax Office has set out its thoughts in Draft Self Managed Superannuation Funds Ruling SMSFR 2007/D1 which recognises that while a SMSF may be maintained solely for the purposes set out in section 62(1), a fund may (incidentally) provide members or other entities with benefits other than those specified:



Example A

Use of work of art at no cost: breach of section 62.

A trustee of an SMSF acquires a work of art and does not seek independent advice in relation to that investment. The investment strategy of the SMSF requires the fund to hold a certain percentage of its asset in a portfolio of listed securities. The trustee liquidates all of the listed securities that the SMSF has invested in to fund the acquisition of the work of art. Soon after the work of art is acquired, it is displayed in the home of a member at no cost to that member.

The trustee contravenes the sole purpose test in these circumstances. Where the work of art is provided for the use of the member at no cost, or at less than market value, it indicates that a purpose of the investment is to provide a benefit otherwise than in accordance with subsection 62(1). The liquidation of a class of assets forming part of the SMSF investment strategy reinforces the conclusion that the provision of the benefit outside of those stipulated in subsection 62(1) was purposeful.


Example B

Lease of work of art to member at market value: no breach of section 62

SMSF maintains an investment in a significant art collection as part of its investment strategy, and commonly leases works of art to unrelated third parties at market rates. The trustee has expertise in investing in works of art, but nevertheless receives independent advice in relation to each of its investments.

The SMSF acquires a work of art after it has received independent advice regarding the soundness of investing in it. The SMSF then enters into an arrangement with a member whereby the member leases the work of art from the SMSF at market rates and subject to normal commercial conditions and controls. The work of art is displayed in the home of the member. There is no contravention of the sole purpose test in these circumstances. The benefit to the member is the opportunity to use the SMSF assets by paying an arm's length amount. There is no cost or financial detriment to the fund as a consequence of the use of the work of art by the member.

Nevertheless, trustees need to ensure that they do not provide a purposeful benefit to the members when undertaking SMSF activities, even if there is no net cost to the SMSF in providing the benefit. Although the impact of an arrangement on the SMSF resources is a relevant consideration, it is ultimately the objective purpose of providing the benefit rather than the net financial impact of the arrangement on the SMSF resources that determines whether the sole purpose test is contravened.


Example C

Loan of work of art to an unrelated party: no breach of section 62

Following on from Example A, the SMSF provides, at no cost, the work of art to a local gallery, for display in a special exhibition that is to run for two months. The work of art provides a benefit for the community at large. However the facts given in this example establish that there is not a
contravention of the sole purpose test as the cost or financial detriment to the fund and the benefits provided by the SMSF outside of those specified by subsection 62(1) are remote and insignificant. The display of the work of art at the exhibition may in fact enhance its future value.


Example D

Loan of work of art to a related party: breach of section 62

Following on from Example A, a related party of the SMSF owns a gallery. The related party charges the general public an admission fee for viewing the works of art at the gallery. It also sells picture cards and pens in the gallery gift store, promoting the paintings currently on display. The SMSF regularly loans its works of art to the gallery at no cost. Its investment choices are also largely determined by the art gallery's desire to acquire certain paintings. In this example there is a pattern of events that result, when viewed in their entirety, in a contravention of the sole purpose test.


Australian Legislative Framework

In Australia Self Managed Superannuation Funds are primarily governed by the rules contained within the Superannuation Industry (Supervision) Act 1993. The relevant sections:

• Section 52(2)(f) - requires Trustees to formulate and give effect to an Investment Strategy that has regard to the whole circumstances of the fund including risk, diversification, liquidity and solvency

• Section 66 – subject to certain exceptions, the Trustee is prohibited from intentionally acquiring assets from related parties of the fund

• Sections 69-85 – outlines the In House Asset rules

• Section 109 – requires the Trustee to operate on commercial terms

• Section 62 – essentially requires the Sole Purpose of the fund to be the provision of retirement benefits and/or death benefits

ATO ID 2004/248 Investment in Art by a SMSF
ATO ID 2004/249 Investment in Art by a SMSF and its display
ATO ID 2004/250 Investment in Art by a SMSF – in house asset
ATO ID 2004/251 Retirement Income Entities – arms length arrangement

Find more at www.ArtBank.ch