Investing in art - Does Pablo Picasso still give pleasure after the tax bill? The fake, the stolen and the real Picasso in the light of civil and tax law

The Picassos are here!

The Picassos were there! Which Picassos were there? The successful Basel entrepreneur and art collector Rudolf Staechelin acquired his first Picasso painting, Les deux frères from 1906, a work from the Pink Period, for 20000 marks at the Galerie Caspari in Munich on 22 June 1917. In 1918, the second Picasso painting was added, Arlequin au loup from 1918, a work from the neo-classical period. Rudolf Staechelin acquired his third Picasso painting from Rosenberg in Paris in 1924, Arlequin assis from 1923, again a work from the neo-classical period.

In 1931 Rudolf Staechelin contributed his art collection to a Swiss family foundation with the condition that a painting could only be sold if a descendant fell into material need. 27 works from the art collection, including Les deux frères and Arlequin assis, were exhibited as a deposit in the Kunstmuseum Basel from 1947. The art collection of Rudolf Staechelin was later transferred to the Rudolf Staechelin Family Trust under American law.02

What happened in Basel in 1967?03 The Basel Picasso Year was triggered by the bankruptcy of the Basel charter airline Globe Air after a plane crash. Main shareholder Peter Staechelin, a descendant of Rudolf Staechelin, got into financial difficulties. On 11 May 1967, Peter Staechelin had to announce the pledging of important works from the Family Foundation, including Arlequin au loup and Arlequin assis. The Kunstmuseum Basel drew up an internal list of works that were of the utmost importance to the museum. First place was taken by Les deux frères, second by Paul Gauguin's NAFEA, third by Arlequin assis, and fourth by Vincent van Gogh's La berceuse. La berceuse was sold to the USA in June 1967 in a lightning operation.

When the public learned of the threatened sale of the paintings abroad, a cry of indignation went through the city centre of Basel. 8.4 million francs had to be raised to enable the two Picassos to stay in Basel. The Grand Council approved a loan of CHF 6 million. The remaining CHF 2.4 million had to be raised privately.

In October 1967, a large collectors' festival was held in the centre of Basel. With this unique campaign, the people of Basel collected 2.4 million francs. A referendum was held against the loan. Two camps were formed: the opposing camp preferred to use the money to build old people's homes. In December 1967, the Basel electorate voted to purchase the two Picassos Les deux frères04 and Arlequin assis05. Pablo Picasso followed the Basel events from Mougins near Nice. The democratic outcome of the referendum moved him so much that he donated three paintings and a sketch to the Kunstmuseum Basel: Home, femme et enfant06Venus et l'Amour07, Le couple08 and Esquisse pour les Demoiselles d'Avignon09. Thereupon Maja Sacher-Stehlin (formerly Hoffmann-Stehlin) also donated the painting Le poète10. And two years later the Verein der Freunde des Kunstmuseums Basel donated the pen-and-ink Études pour Les deux frères11. Within two years, the Kunstmuseum Basel had an increase of eight Picasso works.

From 17 March to 21 July 2013, the Kunstmuseum Basel presented a large-scale retrospective. All eight works from the Picasso year 1967 were exhibited.

The fake Picasso

Picadores y Toros

In 2005 our Zurich art collector bought the Picasso ink work Picadores y Toros (German: Lancers and Bulls) from a Zurich art dealer.12 In 2016 the Zurich art collector wanted to have the ink work exhibited as a deposit in a museum. The museum wanted an expertise and presented the ink work to Maya Widmaier-Picasso. Pablo Picasso's daughter lives in Paris and, like her brother Claude Picasso, is considered a Picasso expert who can distinguish originals from her father's hand from fakes. Because of stylistic and motivational errors, she did not recognize the ink work as genuine. The Zurich art collector immediately took legal action against the Zurich art dealer.

The following questions arose: Can the Zurich art collector claim the purchase price back from the Zurich art dealer? Can the Zurich art collector reclaim the wealth tax from the Zurich Cantonal Tax Office?

Civil law considerations

So far, the Federal Court has had to deal with forged images in three landmark decisions.13 In the opinion of the Federal Supreme Court, the buyer of a falsified image has the option of bringing an action for material warranty (Art. 197 et seq. CO) and an action for invalidity due to a fundamental error (Art. 24 para. 1 no. 4 CO).14

‍With the action for material warranty, which goes back to Roman law and was developed within the framework of market jurisdiction, the buyer can sue for the rescission of the purchase contract.15 The problem of the action for damages in kind is the short limitation period.16 The action for material warranty expires two years after the delivery of the forged picture. In the case of cultural goods (Art. 2 para. 1 CPTA), a thirty-year period applies, which could be applicable to Picasso's sketch Picadores y Toros in the case of a broad understanding of culture.17

Even with an action for invalidity due to a fundamental error, the buyer can still sue for rescission of the purchase contract.18 The action for annulment shall not be time-barred until one year after the discovery of the forgery.19 The problem of the action for annulment is nevertheless the limitation period. The recovery of the purchase price is subject to an action for enrichment (Art. 62 et seq. OR).20 The action for enrichment expires ten years after payment of the purchase price.21

Back to our Zurich art collector and the forged Picasso Picadores y Toros: In 2016, the Zurich art collector filed a lawsuit against the Zurich art dealer immediately after the forgery was discovered. The two-year period for the action for damages in kind had already expired. The ten-year period of the action for enrichment had also already expired. Thus, once the forgery has been discovered, neither of the two legal remedies is available to the Zurich art collector to hold himself harmless.

Tax considerations

The Zurich art collector has taxed a worthless Picasso ten times as an asset. The legal remedy that could help the Zurich art collector is an appeal (§ 155 ff. StG-ZH). The audit assumes overtaxation. This condition is met. The Zurich art collector has paid wealth tax on the worthless Picasso, and there are no longer any legal remedies available against the Zurich art dealer.

In addition, the revision presupposes a significant and new fact which already existed at the time of the property tax assessment but was only discovered subsequently. A glance at the casuistry shows that this does not help the Zurich art collector.22 The casuistry relates to reversed legal transactions due to material warranties or invalidity due to a fundamental error. Such legal transactions are not recognised for tax purposes. Our case does not involve a reversed legal transaction. A look at the doctrine shows a meagre picture: After following up on chains of quotations, the old doctrine from 1953 contains a brief reference to the fact that an expert opinion on a falsified image is a significant and new fact that was only discovered afterwards.23

The Zurich Art Collector must submit the request for revision to the Cantonal Tax Office Zurich 90 days after discovery of the reason for revision and at the latest 10 years after notification of the assessment decision. These conditions are also met.

In the light of civil law considerations, in particular because the Zurich art collector no longer has any legal remedies against the Zurich art dealer, I come to the conclusion that by means of an appeal, the property taxes paid can be reclaimed from the Zurich Cantonal Tax Office.

The stolen Picasso

Femme se coiffant

In 2005 the Zurich art collector bought the Picasso painting Femme se coiffant from the Zurich art dealer.24 In 2016, the Zurich art collector wanted to have the painting exhibited as a deposit in a museum. The museum wanted an expertise and commissioned an expert. The result of the expert: The painting was stolen! The 1940 oil painting Femme se coiffant shows Picasso's muse Dora Maar. The painting was stolen from a New York art collector. The Zurich art collector immediately took legal action against the Zurich art dealer.

The following questions arose: Does the Zurich art collector have to return the Picasso to the original owner and possessor? Does the rule of Roman law apply in Swiss private law: "Nemo plus iuris ad alium transferre potest quam ipse haberet"?25 Does the original owner and holder have to refund the purchase price? Can the Zurich art collector reclaim the wealth tax from the Zurich Cantonal Tax Office?

Civil law considerations

The buyer of a stolen painting can alternatively bring an action for legal warranty (Art. 192 ff. OR) and an action for invalidity due to fundamental error (Art. 24 para. 1 no. 4 OR).26

With the legal guarantee action, which in turn is based on Roman law and was developed within the framework of market jurisdiction, the buyer can sue for the rescission of the purchase contract in the event of a defence (because of the assertion of the ownership claim by the original owner and holder).27 The legal warranty claim expires ten years after the conclusion of the contract or handover of the stolen picture.28 In the case of cultural goods (Art. 2 para. 1 CPTA), there is again a thirty-year period, which could be applicable to the Picasso painting Femme se coiffant in the case of a broad understanding of culture.29 Even with an action for invalidity due to a fundamental error, the buyer can still sue for rescission of the purchase contract.30 The significance of the action for legal guarantee and the action for annulment due to fundamental errors is not too great in practice. Although the rule of Roman law "Nemo plus iuris ad alium transferre potest quam ipse haberet" is in principle also valid in Swiss private law, it is not always the case that the same rule is applied in Swiss private law. However, the Roman rule is limited by special acquisition rules (derivative bona fide acquisition of property):31 Restrictions apply to the acquisition of entrusted property (Art. 933 ZGB), lost property (Art. 934 ZGB) and money and bearer securities (Art. 935 ZGB).32 In the case of the acquisition of lost property, the bona fide purchaser becomes the owner, not immediately, but after five years of loss. The original owner of the lost property can claim the property back from the acquirer for five years (action for possession).33 If the lost property was purchased at the market or from a dealer, the original owner can only claim the lost property against payment of the purchase price paid by the purchaser.34 In the case of cultural goods (Art. 2 para. 1 CPTA) there is again a thirty-year period which could be applicable to the Picasso painting Femme se coiffant.35

Back to our Zurich art collector and the stolen Picasso Femme se coiffant: The Zurich art collector filed a lawsuit against the Zurich art dealer immediately after discovering the theft. The ten-year period of the legal guarantee action had already expired. The ten-year period of the action for enrichment had also already expired. The crucial point, however, is that the painting was stolen from the original owner and possessor more than five years ago and the Zurich art collector bought the painting from a Zurich art dealer, so it can be assumed that it was acquired in good faith.36 The Zurich art collector thus became the owner of the stolen painting after five years of disappearance. The original owner, i.e. the New York art collector, can no longer do anything against the Zurich art collector.

A comparative legal view is surprising: The Roman rule applies in principle in common law countries, but not in all continental European countries. The English collector William Winkworth had the same experience in 1977.37 The Italian Marchese Dottore Paolo dal Pozzo D'Annone bought Japanese woodblock prints in Italy without knowing that they had been stolen from William Winkworth. Marchese Dottore Paolo dal Pozzo D'Annone later sold the woodcuts at Christie's in London. William Winkworth was unlucky and could not prevent the sale. Marchese Dottore Paolo dal Pozzo D'Annone was lucky: he had become the owner under Italian law.

Tax considerations

The Zurich art collector has taxed a stolen, but not worthless Picasso as a fortune ten times. The Zurich art collector has become the owner of the painting, and the original owner can no longer do anything against the Zurich art collector. Overtaxation is not apparent. In the light of civil law considerations, particularly because the New York art collector can no longer take action against the Zurich art collector, in my opinion there is no reason for an appeal.

The real Picasso

Lump

In 2005 the Zurich art collector bought the Picasso plate Lump from the Zurich art dealer. Lump - also called Lumpi or Lumpito - was the dog of Pablo Picasso.38 Lump is considered one of the most important animal models in art history. The dachshund was originally owned by the photographer David Douglas Duncan. In 1957, the photographer and his dog visited his friend Pablo near Cannes. Lump decided spontaneously to stay with Pablo Picasso. The day they met, Pablo Picasso portrayed his new roommate on a plate and later immortalized his dog in a series of 45 paintings. The Zurich art collector hung the Picasso plate Lump on his kitchen wall and did not declare the plate in his tax return in the following years. In 2016, the Zurich art collector sold the plate to a Basel art dealer via an auction house. Before the sale, the Zurich art collector transferred the plate to a duty-free warehouse.

The following questions arose: Did the Zurich art collector have to pay tax on the Picasso plate as a fortune? Can the Zurich Cantonal Tax Office levy a supplementary and penalty tax on the Zurich art collector? Does the Zurich art collector have to tax the capital gain as income? Does the Zurich art collector have to pay value added tax on the sale proceeds?

Tax considerations

Tax-free household effects vs. taxable art collection

In connection with art objects, the Zurich Administrative Court has on several occasions had to deal with the distinction between taxable art collections and tax-free household effects.39 For a long time, the demarcation was based on personal financial circumstances and the size and equipment of the apartment or house.40

In 2012, the Zurich Administrative Court, in its Giacometti ruling, threw out the previous delimitation criteria and thus caused nationwide confusion:41 It has stated that a picture whose value exceeds the usual measure belongs to the taxable assets. The administrative court also immediately set an absolute limit on the amount: a picture with a value of over CHF 150,000 is always part of taxable assets.

The Zurich art collector has not taxed the valuable Picasso plate ten times as an asset. The legal remedy that could help the Zurich Cantonal Tax Office is the supplementary tax (§ 160 ff. StG-ZH). The Cantonal Tax Office of Zurich must initiate post-tax proceedings against the Zurich art collector no later than 10 years after the end of the relevant tax period.

The after-taxation presupposes undertaxation. This condition is met. The art collector has not paid any wealth tax on the valuable Picasso plate. In addition, the post-taxation presupposes a substantial and new fact which already existed at the time of the property tax assessments but was only discovered subsequently. This condition is also met: The cantonal tax office in Zurich only learned about Lump during the auction.

In the light of the facts, according to which the Picasso plate was part of the art collection of the Zurich art collector, it is obvious that the Cantonal Tax Office of Zurich can collect the unpaid property taxes (in addition to a fine for tax evasion) from the Zurich art collector by means of an additional tax.42

Tax-free capital gain vs. taxable capital gain

The Federal Supreme Court and the Zurich Administrative Court have had to deal with the distinction between taxable and tax-free capital gains in connection with works of art on several occasions.43 A glance at the casuistry shows that a one-off occasional transaction is tax-free.44 One risk, however, is the sale via an auction.45 The tax authorities could claim a systematic and planned approach. Assuming that the Zurich art dealer has not sold any works of art in recent years, it is obvious that the sale of Lump is not a commercial act, even if the plate was sold at auction.

Tax-free supply vs. taxable supply

As far as can be seen, the Federal Supreme Court first had to deal with the distinction between entrepreneurial and non-business supplies in connection with works of art.46 A risk is again the sale via an auction. A glance at the casuistry also shows that a one-off occasional transaction is tax-free.

Our Zurich art collector transferred Lump to a duty-free warehouse before selling it.47 Deliveries from a duty-free warehouse are exempt from value added tax.48 The supply of Lump to the Basel art dealer is therefore not subject to VAT.49

Concluding remarks

Back to the beginning of Basel's Picasso Year 1967: a referendum was held against the loan to purchase the two Picassos Les deux frères and Arlequin assis. The pro camp said, "all you need is Pablo," and it was right. The investment in art had paid off: two purchased Picassos became eight Picassos - real Picassos.