Erdal v HMRCC [2011] UKFTT 87 (TC)

Analysis

E owned shares in a company involved in the manufacture of paper. E owned 17,131 ordinary shares and 53,476 A shares in the company. A charitable trust owned the majority shareholding in the company and the terms of the trust meant that it was unlikely that the company would ever be floated. The A shares were non-voting. The company’s articles restricted the sale or other transfer of the company shares.

The question at issue was the value of those shares as at 31 March 1982 for the purposes of Capital Gains Tax (CGT). E appealed against assessments in respect of CGT in the years 1995-96, 2000-01 and 2001-02 and also surcharge for late payment of tax. E contended that on 31 March 1982 all the shares were worth £3.29 each. HMRC contended that the ordinary shares were valued between £1.20 and £1.25 and the A shares were then valued between £1.10 and £1.15. HMRC relied on the report of an expert share valuer.

It was common ground that the value was that which would have been achieved on a hypothetical sale on the open market. No reduction was to be made on account of the whole of the assets being put on the market at the same time. In relation to unquoted shares, such as those relevant in this case, it was to be assumed that the purchaser had all the information that a prudent prospective purchaser of the asset might have reasonably required if he were proposing to purchase it from a willing vendor by private treaty at arm’s length, in accordance with s273(3) of the Taxation of Chargeable Gains Act 1992. Any restrictions that prevented the shares being sold in an open market were to be disregarded so that a hypothetical sale was possible in all cases, but those restrictions were not to be disregarded for the purposes of ascertaining a market price. It was also common ground that majority holdings were worth more than minority holdings. It was accepted that the valuer should stand at the valuation date looking forward into the future with reasonable foresight rather than looking back with hindsight. Confidential information known to the directors may be taken to have been available to the hypothetical purchaser.

Held

1. 1. By 31 March 1982 the company had invested in a world-first technology in producing coated gloss paper. This had been commented on in the Financial Times and other publications. It would have been apparent to the prudent prospective investor that the company had invested wisely and was well run. The prudent prospective investor would also have been aware that the company’s profits had improved in the six months to 31 March 1982. This information showed that the company had potential profitability of £1.4m. The dividend paid by the company was low but this had been challenged by some of the shareholders and the company was able to increase its dividend.
2. 2. HMRC’s expert did not have management accounts that would have been available immediately prior to the valuation date and did not ask for those documents, neither did she request information concerning cash flows. This was a material omission as a prudent prospective investor would have sought such information.
3. 3. HMRC’s expert considered that the company had a price to earnings ratio (PER) of 12.6. PER indicates that a company has greater potential than a similar business with a lower PER. This was pessimistic and a PER of 14 was appropriate because the company’s prospects, given its new technology, were strong.
4. 4. An appropriate discount for the minority shareholding was 40%. This took into account the fact that there was a lack of marketability associated with the shares as a result of the restriction on alienation within the articles. Because of the company’s strong prospects in the market, the level of discount applied to the minority shareholding was ten percentage points less than would otherwise have been justified. Although this factor (strong prospects in the market) had already been taken into account in calculating the PER it was also ncessary to take account of it at the discounting stage because the company was likely to be less unmarketable than the average private limited company. There should be no separate discount for the fact that the A shares were non-voting because of the fact that the shareholding did not have any great power within the company given its size. It was not appropriate to compare and contrast other cases where minority discounts had been applied at varying levels although it was noted that the range appeared to be between 25% and 75%.
5. 5. The value market value of the shareholding was £2.24 per share as at 31 March 1982.

JUDGMENT J GORDON REID QC: Introduction [1] This appeal concerns the valuation of shares held in a private limited company as at 31 March 1982. The company is Tullis Russell & Company Ltd (the company). The shares to be valued are 17,131 ordinary shares and 53,476 ‘A’ ordinary shares, held by the appellant. [2] A …

Continue reading "Erdal v HMRCC [2011] UKFTT 87 (TC)"