In Spring Capital Ltd v HMRC  TC04273 the first tier tax tribunal again rejected HMRC's Shares and Asset Valuation Office's valuation methology.
The FTT were required to determine issues relating to a transfer of trade, including whether relief for losses was available to a successor company and deductions for amortisation of Goodwill under Schedule 29 FA 2002. The case also raised some important Valuation Issues and while dismissing the claim for relief, the tribunal addressed the valuation points because much of the tribunal time had been spent on the valuation issues.
The expert witness presenting evidence on behalf of the company considered the appropriate valuation method was to calculate the maintainable pre-tax profit and multiply by a price earnings ratio.
- The p/e ratio would take into account risk and ratios achieved by other comparable company sales, adjusted to account for the size of the company. In relation to the price-earnings ratio the BDO PCPI for the third quarter of 25 2004 was 14.0, equivalent to a pre-tax price-earnings ratio of 9.4. After discounting the pre-tax price earnings ratio of 7.0 – 8.0 he settled on a ratio of 7.5
- Earnings were based on maintainable profit from historical track record adjusted for material non-arm’s length dealing, non-recurring transactions and directors’ remuneration where not stated at a suitable market value in the accounts.
It was noted that the value of goodwill was considered to comprise of;
- The databases, intellectual property and all other information and intangible assets used in the business; and
- The knowledge and expertise of two key individuals, being director/shareholders of the companies involved in the transfer of trade.
The valuation arrived at using this methodology was around £6.4m.
HMRC’s expert witness evidence was provided by a Registered Business Valuer from Shares and Assets Valuation (SAV) office in Nottingham. The evidence was challenged at the outset as not being from an independent expert witness, a claim which was dismissed in the tribunal’s decision.
SAV's approach was fundamentally different in that it was claimed that goodwill could only be that which attached to the business irrespective of the presence of the two key individuals. The main factors taken into account were;
- the existence of an associated company with which the company traded, the relationship with which could not be guaranteed after a sale
- lack of contracts of employment (neither had service contracts with the company, but both claimed they would enter into such contracts with a potential purchaser).
- no written contracts with customers
- disagreement over the comparable business for providing the p/e benchmark, as being not of a similar size and nature as the company being valued.
The valuation for HMRC was arrived at by applying a much reduced p/e ratio of 6.08% to the turnover in the final period which produced a valuation of £126k, but on the basis that as a standalone business the company was worth very little, the goodwill should be valued at nil.
In essence HMRC’s valuation was based on the proposition that a business had to be valued as it stood at the date of valuation, without alteration, whereas the opposing view was that it should take account of the fact that the key individuals had worked in the business for more than 20 years, would have been willing to enter into service contracts with a purchaser as might be usual in such a sale.
The tribunal considered a number of estate duty cases in reaching an opinion on the valuation method: IRC v Gray (Surviving executor of Lady Fox deceased)  STC 360 and Duke of Buccleuch v IRC  1 All ER 129. Ultimately relying on words delivered by Hoffman LJ in Duke of Buccleuch, that the vendor must be supposed to have ‘taken the course which would get the largest price…’. On this basis the tribunal concluded that the approach adopted by the Appellant was correct and if it had been required to decide upon the point, the valuation of £6.4m would have been accepted.
An interesting case in which it seems that SAV's expert tried to create quite a complex and bespoke valuation model and focused on the idea that goodwill must attach to people rather than the business as a whole, whereas the tribunal preferred the trusted price/earnings method.
Topical guides to this subject
Companies: Share Valuation
When might a tax valuation be required? What are the main principles in valuing unquoted companies? What principles have the courts and tribunals established?
Goodwill and the intangibles regime
How does the Corporation Tax intangible regime work? What is the treatment of goodwill for Corporation Tax? Do companies account for goodwill differently?
Links: Spring Capital v HMRC