Recent news of “Freeports” opening in Delaware prompts a review of what these facilities are for, what they are not for, and where collectors and dealers can get themselves into trouble. When used carefully there are meaningful tax efficiency opportunities, but no one should think that they are or can be a one-stop way to avoid sales tax in particular. Thoughtful planning is the key.
Best known in Luxembourg and Geneva, “Freeports” are intended to be a kind of bubble within a particular country or jurisdiction where transactions can take place under the legal fiction that they are not crossing borders that might otherwise be involved between the parties to the sale. As David Arendt of the Luxumbourg Freeport explained at “Pure of Love of Art Versus Mere Investment” IBA conference in London last March, that Freeport is located at the airport, in a high-end facility. There is no tax avoidance, only tax deferral. The facility is supervised by Luxembourg customs. Every item is scanned, and customs has the right to inspect anything. Origin, shipper, export license, tax status, consignor and invoice are all recorded. The key advantage is that an object can arrive there, not be subject to customs duties by virtue of it arrival, and then be bought or sold. The legal fiction, under the right circumstances, is that it never entered the country. They are not permanent tax holidays, however, they are rather intended to reduce the number of transactional events at which some customs or tax might be collectable.
Sales tax stands on a slightly different footing. Outside of the Freeport context, the United States operates under a regime of what are called sales and use taxes. If I buy a car in New Hampshire, where there is no sales tax, and keep it at my home there, there is no tax. But if I buy it in New Hampshire to bring to Massachusetts and register it (where there is a sales tax), Massachusetts will charge me what is called a use tax equivalent to what the sales tax would have been.
In the realm of art, this is no theoretical matter. The conglomerate Tyco International, Ltd., was headquartered in Exeter, N.H. Former CEO Dennis Kozlowski was indicted in 2002 for an alleged failure to pay New York sales tax on over $13 million of art. In that case the allegation was outright fraud, the claim that the art never even left New York and that the “shipments” to New Hampshire were fictional. Kozlowski settled with the Manhattan DA in 2006 and agreed to pay $17.9 million in state and city income tax, interest and penalties, of which $8.3 million represented the tax liability.
But even if the art had left New York, that is not entirely enough. The touchstone is the point at which the buyer takes title and possession. If the gallery sells an object in a state with sales tax and ships it to the buyer in a state without one, sales tax will probably not be due. By contrast, if the buyer makes the purchase and assumes title and possession in a state with a sales tax to move the property to its sales-tax-free jurisdiction, it is likely too late to avoid sales tax.
This is where the Freeport potential looms. The foregoing examples all assume that the property is in a jurisdiction like New York where there is a tax. But if there were a sophisticated facility in a tax free jurisdiction, then we see the parallel to the Luxembourg customs example. In effect, the property never touches the taxable jurisdiction.
The first announced facility is called The Delaware Freeport, managed by Fritz Dietl. The site touts Delaware’s central location on the Atlantic coast and status as one of only five states without a sales or use tax (Alaska, Oregon, and Montana being the others besides New Hampshire). Crozier Fine Arts, another well-known art logistics and storage firm, is also scheduled to open a facility in Delaware.
This still requires careful structuring. Again, if a collector buys something in New York and the seller ships it to the Delaware Freeport, it may escape the New York tax collector. But it will not solve the buyer’s use tax analysis in and of itself if the art is immediately taken to a state with use tax. It is all about who has control of the shipment and where it is being delivered for use. The players involved in setting up the Freeports are reputable and experienced, but it is not their responsibility to do the buyer’s or seller’s tax planning. These facilities are an opportunity for efficiency (the Second Law of Thermodynamics tells us, after all, that nothing is truly free), but one that must be used with careful advice and forethought.