Investing in Art. Facts and Myths

Art and its position on the investment market

The art market in Poland has recently taken on a new dimension: investment. It is slowly forming an offer directed to individual investors who are interested in channelling their resources towards this segment as yet another way of diversifying their portfolios. One of the basic commandments for all investors wishing to keep their wealth is not to put all eggs into one basket. It means that the portfolio needs to be diversified in such a way that one wrong decision cannot jeopardise the entire capital invested. An old stock market wisdom says that it is more important to protect oneself against losing the capital than to multiply it. Diversification consists in both acquiring varied securities within one market and purchasing assets listed at separate investment markets. In this context, experts usually recommend putting one’s money into enterprise shares, bond markets (state, municipal and company), real estate and precious metals, mainly gold.

However, history shows that works of art are one of the best carriers of economic worth. Art is the safest object of investment, especially during crises and scares. Works of art never fall prey to state and company bankruptcies (as is the case with bonds and shares), and their uniqueness gives them an edge over gold, a precious metal considered to be an effective carrier of economic worth, but nevertheless extracted on an ever-increasing scale as new deposits are discovered and technology develops. From a historical perspective, the art market shows an upward tendency, while the emergence of a new, large group of wealthy investors from highly populated countries, such as China and Brazil, allows us to assume that it is going to continue to grow. This is why we need to look at works of art as investment commodities and ascertain whether the Polish legal and tax system may actually foster art investment.

 

Investing in art – institutional and tax framework

Individual fine arts investment (when a natural person purchases a work of art and then sells it) may be an advantageous form of investing from the point of view of taxes. Polish tax law, in contrast for instance to French regulations, does not distinguish between selling art works and other movable goods. As a result, if the sale takes places six months after a natural person purchased the work of art and is not effected as part of his or her business activity, it is exempt from income tax. It is a case of a tax-free investment, which gives individual art investment an edge over shares and bank deposits.

Regardless however of this taxation benefit, the nature of art market investment makes it difficult for a natural person to take up such an activity. The knowledge barrier, the amount of money required and specific trade risks may prove to be too high for individual investors. Such a situation creates an opportunity for the establishment of collective art investment entities. And indeed, the Polish market has recently seen the birth of several products for individuals wishing to invest in fine arts. Some of these projects were abandoned at preliminary stages of their formulation, some finally turned into slightly different products than was first advertised. Others are in fact not a form of investment in art but rather a sort of a financial deposit based on civil law contracts. The entire investment offer of the Polish market (already existing or planned) consisted of the following elements:

-        special purpose vehicles investing in art,

-        funds investing in the art market,

-        deposits based on works of art,

-        investment consulting (art banking).

Unfortunately, although there have been attempts to construct a collective art investment offer and the demand for such services is increasing, it is my opinion that a reasonable product for individual investors has yet to be created. There is one basic obstacle however: Poland still lacks adequate institutional and tax regulations.

One of investment market companies drafted an offer of investing in art through a special purpose vehicle. Its design was quite straightforward: the vehicle was to be founded by investors and the organiser for a limited period of time, selected works of art purchased, and then the profit was to be distributed among the participants. The organiser would be entitled to a certain share and remuneration for managing the vehicle. The form of investment enabled overcoming the main obstacles faced by individual art investors – combining the total capital in one entity allowed for investing in renowned and valuable pieces, while the organiser’s expertise helped reduce the risk of purchasing forgeries of overpaying. The organiser also secured the appropriate maintenance of the purchases. However, the first obstacle encountered by the creators was the issue of double taxation. The investment profit would be subject to tax at the level of the special purpose vehicle (the entity would become a corporate income tax payer upon gaining first profits), as well as at the level of partners, who were to receive dividends. In order to eliminate this problem, the organiser wanted to set up a vehicle in the form of a private unlimited partnership with share capital (spółka komandytowo-akcyjna), i.e. a tax-transparent partnership. In this case, any gains would be subject to tax directly at the level of partners. However, the Ministry of Finance went against this plan, publishing a draft bill to subject such partnerships to corporate income tax. These changes will probably enter into force in 2014, which means that the collection would be sold and the profit acquired according to the new, less favourable regulations. The attempt to remodel the investment by selecting the form of a general partnership (spółka jawna) also failed, since partners had to pay mandatory social security premiums. As a result, the project of forming the special purpose vehicle was dropped, as the existing and anticipated tax regulations effectively precluded any art investment of this type.

The option of buying certificates in a fund that worked with the art market had in fact nothing to do with true art investment. Media coverage was full of inaccurate information that suggested that the fund would actually invest in works of art. Meanwhile, investment fund law is quite strict about the catalogue of assets which such an entity may select. Nowhere does it mention movables, let alone works of art, which means that closed-end funds may not be a vehicle of collective investment in art, as it simply is not able to acquire any art works. In reality, this offer consisted in investing, by means of a closed-end fund, in the shares of companies operating on the art market. In my opinion this product was created prematurely, as Poland’s art market is as yet underdeveloped, which means that the segment of art market entities is in its preliminary stages of evolution. The stock market lists but a few entities from this sector and their securities are rarely sold or purchased. Its parameters are just too low to enable any real collective investment in the sector. More importantly, however, there is a crucial difference between investing in works of art and investing in the shares of art market entities. Works of art bring a key advantage in that they enable investors to diversify their portfolios and move a part of their resources away from capital markets and towards material items characterised by an outstanding capability of carrying and preserving value over time. Investing in the shares of art market entities is still a form of capital investment, subject to the same risks as in the case of other securities. In this way, investors fail to achieve their goal defined as diversifying the portfolio and distributing risk among its elements.

The Polish market also offers a unique civil law structure, described by its creator as a ‘deposit’. This product consists in selling a work of art (painting) to the investor for a specified period of time, and then repurchasing it at a price increased by a ‘coupon’, i.e. a prefixed percent. Although there is an option that the work may be repurchased at a higher price point to reflect its increased market value, transaction parameters render it rather unlikely. Preliminary press analyses suggest that the first transaction value, i.e. the price at which the offering party sells the work to the investor, is already higher than market values. In fact, the offering party fixes the price of the ‘deposit’ quite arbitrarily, and even if this amount is actually paid in particular ‘deposit’ transactions, it can hardly be deemed to constitute the true market price, since real market transactions do not come with a promise of repurchase or any coupon. Also, the investor cannot be said to be investing in art, since in reality the object of transaction does not even matter. The seller promises to repurchase the item at a price increased by pre-fixed interest, so it makes no difference whether one buys a piece of art or any other item. The analysis of prices offered for the first transaction (i.e. for the purchase of a painting by the investor from the seller) raises doubts as to whether they reflected market prices, or at least such doubts were voiced by investment market experts. It is therefore a more or less arbitrary amount and it can be completely out of touch with the real value of the object. Therefore, the economic meaning of this transaction is more similar to a loan secured by a transfer of ownership, where the object of ownership may not cover the actual value of the loan.

Art banking consists in providing services such as assistance in the selection of works of art, their appraisal and authenticity verification. They may also include storage, transport, insurance and maintenance. This option is therefore not suitable for collective investment, and although investors gain access to expert market knowledge and thus bypass many risks, art banking is not directed towards a broad spectrum of addressees. The high amount of capital required still remains a crucial entry barrier in this form of assisted investment.

 

Evaluation of the investment offer

The steps undertaken by Polish investment market entities to create a high quality investment product that would be affordable to an average consumer have so far been unsuccessful as a result of the lack of adequate institutional and tax regulations. The Polish law does not provide for any form of collective investment in art, and any potential partnerships established by investors for this purpose are subject the same tax rules as production companies or commerce. This creates an unfavourable environment and could actually be described as legislative negligence, as it makes it difficult for citizens to diversify their portfolio and hampers the development of the art market. The legislator should respond to the needs of market actors by introducing appropriate institutions and instruments to facilitate collective art investment. Art investment funds, modelled on existing funds, may act as one of such institutions. In combination with more convenient import rules for works of art (free harbours), such funds could turn Poland into an important art market player, both in Europe and globally. Such solutions are necessary and feasible, as exemplified by Luxemburg, a country that works on a legal framework that would be favourable to art investment. In my article, I tried to treat art only as an object of investment  in order to ‘cleanse’ the economic analysis of any cultural sentiments. However, when formulating the demands to be presented to the legislator, one should mention also other benefits that a well-developed art market may bring. Art has a community-building role in relation to society. Interpreted as a universal language that creates a community of references and symbols, it may not only act as a factor of social integration but even help build a state. This is why the legislator should be interested in moving towards a well-developed market.

Grzegorz Goleń (b. 1979) – tax advisor, graduate of the Warsaw School of Economics and the Faculty of Law and Administration, University of Warsaw. Member of the Warsaw Seminar in Administrative Axiology. Partner of the Polish Tax Institute. He is currently writing a doctoral thesis on tax law.