Steve Z. Ranot, C.A, C.B.V.

In an interesting tax case, yet to be decided, a taxpayer donated 216 paintings by a native Canadian artist to a number of galleries in Canada. Where a gift of Canadian cultural property, say, artwork, is made to "Her Majesty in right of Canada or a province", in this case a public museum or gallery, the donor receives a charitable donation receipt equivalent in value to the fair market value of the gift. Notwithstanding the use of fair market value for donation purposes, for capital gains tax purposes, the donor is deemed to have disposed of these gifts at cost, not fair market value. Accordingly, as a result of this specific provision to encourage such gifts, such a donor faces no capital gains tax liability yet can benefit significantly from the increased value of this property by virtue of an enhanced value of the charitable donation.

In this particular tax case, Revenue Canada has taken the position that the fair market value of the artwork was as much as 50% less than that determined by the taxpayer's appraisal, primarily due, not to a difference of opinion in individual values, but rather as a result of a "blockage discount". A blockage discount is defined as the decrease in market price resulting from the imbalance of supply and demand that results when the market supply is increased pursuant to unusual market activity. Simply, the theory is based on the notion that a large volume disposition of any commodity will lead to a flooded market which will likely depress its price.

Ironically, the blockage argument brought forth by Revenue Canada has in the past always been used by taxpayers as a shield against tax authorities. In the era of estate taxes, tax minimization could be achieved by an estate successfully arguing for a lower value of its assets. In Untermyer Estate v. A.G. B.C., [1929] S.C.R. 84, [1929] 1 D.L.R. 315 (S.C.C.), the estate held approximately 6% of the total share capital of a corporation. The market value per share was $2.20. The estate argued that if all of the shares were disposed at once, the market would be flooded and the highest value per share would be $1.50. The court accepted the theory of the blockage discount in part and allowed a discount to $2.00 per share, representing the cost of disposing the shares over a reasonable period of time in order to avoid the effect of flooding the market.

In a recent number of U.S. estate tax cases involving artists, the tax courts have applied varying levels of blockage discounts, recognizing that the discount, if any, is dependent on the marketability of each particular artist's work and the volume in question.

From a family law perspective, the acceptance by the courts of the blockage discount will affect the value of art collections similar in nature to that described in the current case being decided. More importantly, the discount may also apply to significant but non-controlling corporate interests, especially for thinly-traded public corporations.

It should be noted that Revenue Canada is in a win-lose situation. Should its blockage argument succeed, it will undoubtedly be utilized by estates of deceased taxpayers when determining the value of deemed dispositions on death.

Justice Mogan of the Tax Court has indicated that his decision in this matter will be issued in late autumn. The acceptance of blockage discounts by the U.S. tax courts may bear on the court's decision. Lawyers and valuators will be keeping a close eye on this one.