Business,  Law

The State of New York Has Sued Sotheby’s For Enabling Sales Tax Fraud

New York’s Attorney General, Letitia James, has filed a lawsuit against Sotheby’s in the state Supreme Court for enabling a major client of the auction house to evade taxes.  According to court files, the client, a contemporary art collector who resides outside of the U.S. and runs a shipping business, illegally obtained tax exemption certificates on art purchases exceeding $27 million for five years.

At the crux of the action is Sotheby’s alleged breach of its responsibility as a vendor under State Finance Law to collect and remit sales tax. In New York, anyone who purchases art for enjoyment in their New York home must pay a “sales tax” – currently at 8.85% – or a “use tax” at the same rate if they display or store art in New York that was purchased elsewhere.

However, an exemption applies to purchasers who, operating in the normal course of business, buy art as part of their inventory for resale to their customers. These purchasers may use a resale certificate, also known as a Form ST-120, issued by New York’s Department of Tax and Finance for “blanket” or “single-use” transactions to purchase goods for resale only. Sellers can only avoid liability if they accept the resale in good faith – that is, they have no reason to believe the purchaser would act fraudulently.

Resale Certificate (Form ST-120). Sections referred to in court file are highlighted.

AG James asserts however, that “not only did Sotheby’s employees fail to exercise reasonable ordinary due care, they at minimum recklessly ignored the resale certificate rules in dealing with the Collector”. The auction house is alleged to have allowed the collector, who owns private residences in New York and abroad, to buy art tax-free through false resale certificates which enabled him to maintain a fraudulent representation as a “dealer” in the business of “selling and exporting art” for “resale outside of the States”. Yet, AG James further contends, it was known to “at least 29 employees” and even written in the clients’ records that he was an art aficionado who runs a shipping business.

The unidentified client – alleged to be Isaac Sultan, president of Atlantic Feeder (Shipping) Services USA LLC in Miami – submitted four false resale certificates to Sotheby’s between 2010 and 2015, initially as an individual but later through his British Virgin Islands incorporated entity ‘Porsal Equities’.

The value of the collectors purchases are estimated at more than $27 million (£21 million) – including a $1.4 million sculpture by Anish Kapoor and a $5.7 million Basquiat painting – of which Sotheby’s allegedly failed to report sales tax, resulting in a total omission of approximately $2.4 million.

Sotheby’s problems are further compounded by what the complaint describes as a lack of adequate “structure, practice and policies” in regards to state tax compliance. Sotheby’s sales representatives – called Key Client Managers (KCMs) – “were only cursorily introduced to the use of resale certificates during their initial training, and, once the KCMs received resale certificates from clients, they merely forwarded them to Client Accounting without knowing what Client Accounting did with them”.

Client Accounting on the other hand, who are responsible for the review and processing of certificates, received periodic training on how to review and process resale certificates but were “simply comprised of administrators, who were not closely – or sometimes at all – familiar with clients. The only way Client Accounting would know if a client was abusing a certificate, is if someone familiar with the client notified them of this fact”.

In contrast, “the sales force competed fiercely with rival auction houses for sales, and learned to extend whatever accommodations they could to keep clients happy”. Allegedly, this particular collector’s KCM went as far as completing the resale certificate on their behalf. Specifically, the KCM filled in the business description line to read “I am in the business of art dealer and principally sell artwork”, even though the collector had not told the KCM he was an art dealer and gave her the form with that part blank. Coupled with the ‘cutthroat’ nature of the auction market, the claim contends that “in the struggle to compete for sales, Sotheby’s either recklessly disregarded the falsity of the resale certificates it accepted from the Collector and his company, or remained deliberately ignorant of that falsity.”

Interestingly, Sotheby’s “refutes the unfounded allegations made by the Attorney General which [it claims] are unsupported by both fact and law”, and dismisses it as a matter between Porsal Equities and the New York AG – both of which reached a $10.75 million settlement in 2018.

The issue, however, lends itself to a more general discussion about rampant sales and use tax scams by art collectors and galleries in New York. “Many people, sometimes in collusion with the galleries, [avoid paying sales tax] by shipping the art to out-of-state locations, only to quickly roundtrip the art back to New York for display or storage without paying New York use taxes, which is illegal” New York whistleblower attorney Joseph Gentile insightfully reveals. “Another more brazen variation of this scheme occurs when galleries or art shippers create fake shipping invoices and/or ship empty “tax boxes” out-of-state while the art is quietly delivered to adorn a New York apartment”.

A possible deterrent? New York whistleblower law. For one, the New York False Claims Act (NYFCA) can result in art tax whistleblowers receiving substantial financial rewards up to 15%-30% of the amount New York authorities recover because of their decision to report a tax fraud. Moreover, the law has a 10year statute of limitations, meaning whistleblowers who are employed or formerly employed by art dealers have time to come forward.

Gentile assures that even if “those that work with galleries, auction houses, wealthy private collectors, and art shippers find themselves in the unenviable position of witnessing or being asked to participate in tax frauds related to art transactions … the NYFCA has specific anti-retaliation provisions to prevent employees and former employees from being fired, harassed, discriminated against or otherwise harmed [should they report it]”. Due to the complexity of these cases, Gentile advises those interested to consult with an experienced whistleblower attorney.

While there is no indication that a whistleblower initiated the lawsuit, Sotheby’s is liable (for damages and the costs, including attorneys’ fees, for the civil action) under State Finance Law § 189(4)(a)(i) and (ii) since the business has a net income or sales in excess of $1 million and the damages pleaded exceed $350,000. “Sotheby’s violated the law and fleeced New York taxpayers out of millions just to boost its own sales.” Attorney General Letitia James said in a statement. “This lawsuit should send a clear message that no matter how well-connected or wealthy you are, no one is above the law.” 

UPDATE 17.11.2020: The NY Supreme Court has given Sotheby’s until 18th December 2020 to responds to the Attorney General’s complaint. Case details: The People of the State of New York, by Letitia James, Attorney General of the State of New York v. Sotheby’s, Inc. No: 452192/2020