China has quickly moved up to the number three position in the global art market, behind the United States and the UK. The total annual turnover in 2008 of artwork sold at auction in China, including both antiques and contemporary art, exceeded RMB 20 billion (just under 3 billion US dollars). Even this impressive number is merely the tip of the iceberg, however – the majority of artwork sales in China are private, making it virtually impossible to know the accurate dollar value of all artwork transactions in China. Naturally, such a dramatic boom in the art sector has not escaped the attention of the PRC tax authorities.
As early as 1997, the State Administration of Taxation (“SAT”) promulgated the Notice Regarding Levying Individual Income Tax on Individual Income from the Auction of Paintings, Calligraphy Works and Curiosities (the “1997 Notice”), which specifically focused on the taxation of gains realized by individuals on the sale of art at auction. The 1997 Notice provided that profits earned by individuals on the sale of art such as paintings, calligraphy and antiques were deemed to be “income from the transfer of property,” and such profits would, accordingly, be subject to taxation at a rate of 20% under PRC tax law. “Property transfer tax” (财产转让税) is a sub-category of individual income tax, and the term refers to “gains from the transfer of securities, stocks, real estate, land use rights, machinery and equipment, vehicles, ships and other property.”
The original value of the art, as well as any commission paid to the auction house, may be deducted from the total income before calculating the tax. By illustration, if an individual buys a painting for RMB10,000, sells it at auction for RMB 22,000 and pays the auction house a 10% commission on the hammer price, the individual seller will then be obligated to pay RMB 1,960 in taxes on the income from that transfer of property: ((RMB 22,000 – RMB10,000) – (RMB 22,000 x 10%)) x 20% = RMB 1,960.
The 1997 Notice further provided that if the seller cannot provide documentation evidencing the “original value” of a sold work of art, the “original value” would be determined by the tax bureau or an appraisal institute recognized by the tax bureau.
The 1997 Notice also required auction houses to withhold and pay the profit tax on behalf of sellers. However, in practice, the 1997 Notice was not strictly enforced throughout China. The collection of tax takes place at the local x rather than the national level, making it difficult to comment with accuracy on the performance of every local tax bureau, and some, albeit not many, local tax bureaus did promulgate detailed implementing rules for the 1997 Notice prior to the promulgation of the 2007 Notice.
The lack of energetic enforcement was attributable in great part to the difficulty the tax bureaus had in determining the “original value” of an artwork. This task, in many cases, was seen by the tax authorities as simply an impossible mission, rife with intractable problems. First, the tax authorities had trouble with one of the essential characteristics of an art market, which is that each art “object,” unlike most, if not all, other commodities, is unique, with a value that fluctuates based on a multiplicity of factors at any given time. While determining the value of a work of art at a specific time is routinely carried out in a mature art market, it is more challenging in the relatively young contemporary art market in China. The notable dearth of expert, independent appraisers, much less appraisal firms, in China, clearly contributes to the difficulties of any valuation work in the country.
Moreover, the problems of determining the “original value” of a work of art were multiplied when the work was created by the seller him or herself, and was sold for the first time at auction. While such a determination might be less of a stumper in the case of work by an artist for whose works there is an active and/or historical market, such artists rarely put new work directly into auction. The Chinese contemporary art auction market was unusual in including a large volume of early or recent works by little-known artists, whose work, in other contexts, would normally not have made it to auction, but would likely have spent more time ripening in a gallery setting. Another issue facing the tax bureaus was that many sellers could honestly claim that they had purchased the artwork many years earlier, and strenuous arguments were made by collectors that if a painting bought for RMB100 in the 1950s was sold it for RMB10,000 in the 1990s, it would be grossly unfair to say that the seller made any “actual” profit from the sale.
Such obstacles resulted in local tax bureaus being unable or unwilling to collect taxes on profits earned by individuals from the sale of art for a significant period of time. For example, it is estimated that in 2004, 49 auctions were held in Zhejiang Province, with a total transaction value of RMB 422 million (about US$ 50 million at that time). Deducting 10% for the commission paid to the auction houses, it was estimated that Zhejiang Tax Bureau lost tax revenues of approximately RMB 80 million (about US$ 10 million), because the Tax Bureau simply did not collect taxes on auctions sales by individuals in 2004.
The unsatisfactory enforcement record of the 1997 Notice finally led to the promulgation by SAT in 2007 of the Notice on Issues regarding Strengthening and Regulating the Collection of Individual Income Tax on Individual Income from Auctions (the “2007 Notice”). The 2007 Notice superseded the 1997 Notice and addressed the shortcomings of the 1997 Notice in several ways. First, the 2007 Notice distinguishes between the sale of artworks created by the seller and those not created by the seller. If an artist sells his or her own work at auction, the proceeds from the sale are deemed to be “income from royalties” and the taxable income is equivalent to the total sale price minus RMB 800 if the sale price is less than RMB 4,000, or minus 20% of the sale price if the sale price is over RMB 4,000. In both cases, the resulting income is subject to a 20% tax.
Profits from the sale of artwork not created by the seller are still deemed under the 2007 Notice to be income to the seller from a “transfer of property”, and thus taxable at a rate of 20%.
The 2007 Notice also stipulates that the taxable income from a sale of artwork at auction is equivalent to the hammer price minus the “original value” and “reasonable expenses”. The original value and reasonable expenses must be evidenced by certain documents, such as formal invoices. The “original value” of an artwork is equivalent to:
- the original purchase price, if such artwork was obtained in a shop or art gallery; or
- the actual amount paid, including tax, if such artwork was obtained at auction; or
- the actual incurred expenses if the artwork was obtained through inheritance; or
- the amount of tax paid if such artwork was obtained by the seller by donation.
- the original value of an artwork may be determined according to the above principles if the artwork was obtained through other channels.
If the seller is unable to provide a formal certificate evidencing the original value of the artwork, the seller must pay tax in an amount equal to 3% of the hammer price. Therefore, the standard practice among PRC auction houses is to deduct 13% of the hammer price from the amount due to the seller, of which 10% represents the seller’s commission and 3% is withheld for payment of the seller’s individual income tax. Additionally, profits on the sale of a work of art which is deemed by the provincial-level administration of cultural heritage to be a “returned Chinese cultural relic lost overseas” (海外回流文物), will be taxed at the more favorable rate of 2% as opposed to 3%.
In terms of who is obligated to pay this profit tax, the PRC Individual Income Tax Law (the &ldquIn terms of who is obligated to pay this profit tax, the PRC Individual Income Tax Law (the “IIT Law”) makes two major distinctions: (1) the residence of the potential taxpayer (resident or non-resident), and (2) the location of the source of income (PRC or non-PRC). The IIT Law requires that an individual pay tax on any gains realized “within China” regardless of that individual’s citizenship or place of residence. The IIT Law Implementing Regulations stipulate that any transfer of property in the PRC is deemed to occur within China “regardless of the payment location.” This has obvious implications for non-resident sellers who sell at auction in China from an offshore location and/or receive payment outside China of the purchase price for such sale. With respect to non-resident taxpayers, the payer (in the case of a sale at auction, the auction house itself) is required to deduct and pay the relevant tax on behalf of the taxpayer. Interestingly, this obligation of the part of the auction house to withhold and pay the profit tax applies in the case of both non-resident and resident sellers, a deviation from the general norm in China. If a seller refuses to pay the tax, the auction house has a legal obligation to report it to the tax bureau and withhold the relevant tax.
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