New Valuation Approach Raises Hackles
of Art Donors and Gallery Staff
By Stephen P. Sweeting
Stephen P. Sweeting is a partner with Toronto-based Appraisal
Associates, a personal property valuation firm specializing in fine art,
antiques, and decorative art. The author's articles and commentaries on
personal property valuation issues have appeared in Canadian and American
professional journals, magazines and newspapers.
The following article first appeared in its original form in "Appraisal
Associates Newsline", Vol. 1, No. 6. The article has been updated and
expanded for the readers of Art Business Magazine.
A new approach to the valuation of art property by the Canadian
Cultural Property Export Review Board is drawing criticism from both donors
and the representatives of museums and galleries. The approach -- based
on a valuation methodology known as blockage discounting -- adds a new degree
of uncertainty to the donation procedure. In at least one instance, a fair
market value determination by the Board was significantly less than the
donor's purchase price. Critics fear donors will give up on the donation
program if they are penalized in this manner.
The Board's version of blockage discounting is known as the "Market
Adjustment Factor (MAF). The methodology is used in situations where donation-related
sales constitute the largest share of market activity. Donation package
schemes and other bulk donations appear to fall into this category. The
MAF -- a series of graduated percentage discounts of value -- hinges on
the number of artworks by a given artist donated through the program since
1994. Artists whose work shows up repeatedly in the program suffer the most
significant discounts. These can range from 20% through to 60%.
Blockage is a concept rooted in the valuation of stocks and securities for
estate taxation purposes. It is defined as "...a form of depreciation
resulting from a number of similar properties being offered that is too
large for the normal market to absorb as of a specific date. Blockage discounts
for stocks and securities are estimated through the use of present value
formulae " an income approach to value used by business valuators.
The methodology depends on past performance or market absorption rate, the
homogeneity of the property, and the appropriateness of the discount.
American estate executors and lawyers use the principle with some frequency
to reduce the amount of tax payable to the Internal Revenue Service. The
technique also is used with artist's estates comprised of large numbers
of unsold works. The two most notable art-related applications of the principle
involved the estates of sculptor David Smith and painter Georgia O'Keeffe.
In both cases, the final court-imposed blockage discounts hinged on something
less than clearly articulated valuation methodologies. The judge presiding
over the Smith case fell back on a "Solomon-like pronouncement to establish
the discount. For the O'Keeffe estate, the judge "split the difference
between the proposed blockage discounts argued by the opposing litigants.
The concept of blockage discounting cultural properties is even less clear
in Canada. In the 1980 book "Art Law", lawyers Aaron Milrad and
Ella Agnew postulate that the wording of the Income Tax Act precludes blockage
discounts in the determination of fair market value in estate situations.
The authors maintain that the Act stipulates that each capital property
is deemed to have been disposed of immediately before death. There is no
reference to all properties. This reading of the Act suggests that context
within a collection or bulk of properties may be irrelevant in the determination
of fair market value.
The relevance of the blockage discount principle within the cultural property
sphere was tested in a recent Tax Court of Canada case (Zelinski v. The
Queen). In this case, the appraiser working for the Justice Department argued
that a blockage discount of 50% was appropriate in a donation scenario involving
a large collection of paintings by First Nations artist, Norval Morrisseau.
The appraiser argued that the large size of the collection would impede
its marketability and that even in a best case scenario, it would take a
number of years to sell. The presiding judge rejected the appraiser's use
of blockage, stating in his decision that "the hypothetical open market
in which fair market value is determined contemplates purchasers and vendors
acting without pressures to buy or sell. There was no evidence that the
[donors] were under any pressure to dispose of the Morrisseau art."
This pivotal decision undoubtedly raises questions about the legality of
the Review Board's use of the Market Adjustment Factor. Clearly, as in the
Zelinski case, cultural property donors are under no compulsion to gift
items to recipient institutions. Nonetheless, it is unlikely that the Board
will eliminate the MAF of its own volition. Canadian donors, museums and
galleries probably will have to wait for a court challenge to settle that
score. Although challenging the Board in court is both expensive and time-consuming,
it can produce results. Readers will remember that the Art Gallery of Ontario
successfully challenged the Review Board's handling of the Sarick donation
of Inuit carvings.
An interesting postscript to the current situation is that according to
generally recognized principles of valuation, fair market value and a blockage
discounted value can never be the same. Fair market value must be established
before a supportable blockage discount can be estimated. The two values
are not equivalent. This train of thought suggests that market adjusted
determinations do not provide donors with a full and fair recognition of
fair market value. If this is indeed the case, the Board's actions run counter
to both the Income Tax Act and its own published guidelines.
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