Shinebond Ltd v HM Inspector of Taxes [2006] UKSPC SPC00522 (10 February 2006)

SPC00522

CORPORATION TAX – chargeable gains – valuation – unlisted shares - property investment company – 1982 valuation – sections 150 and 152 Capital Gains Tax Act 1979 - asset method – gross yield method

THE SPECIAL COMMISSIONERS

SHINEBOND LIMITED	Appellant

- and -

MRS L M CARROL
(HM INSPECTOR OF TAXES)    	Respondent

Special Commissioner:	Nicholas Aleksander

Sitting in public in London on 29 November 2005

D R Amin of Amin, Patel & Shah, accountants, for the Appellant

Simon Hart of the office of the Acting Solicitor for HM Revenue & Customs for the Respondent

© CROWN COPYRIGHT 2005

DECISION

The Appeal

1.	This is an appeal of Shinebond Limited relating to the gain realised on the disposal of its shareholding in Chas Polsky Estates Limited ("the Company") to Mr Dee of London Limited for £397,365 on 22 December 1988.  An assessment for corporation tax for the accounting period ended 31 January 1989 was raised on 20 September 1989, which included a charge in respect of the gain made on the disposal of the shares in the Company.  The Appellant submitted a Notice of Appeal and Postponement Application on 25 September 1989.  The sole issue to be determined is the market value of Shinebond Limited's shareholding in the Company as at 31 March 1982.

2.	Mr Amin of Amin, Patel and Shah, accountants, represented the Appellant.  Mr Hart of the office of the Acting Solicitor of HM Revenue and Customs represented the Respondent.  There was one bundle of documents. Neither party called any witnesses.

The Background Facts

3.	The background facts have been agreed between the parties and are not in dispute. The Company was incorporated in England and Wales in 1958.  The Appellant acquired all of the issued shares of the Company in an arm's length transaction on 27 November 1981 for a total price of £152,634.  As at 31 March 1982 the entire issued share capital was owned by the Appellant.  The principal asset of the Company on that date was a leasehold interest in a property known as 165-167 Commercial Road, London E1 ("the Property").  The leasehold interest owned by the Appellant was a headlease, which at 31 March 1982 had an unexpired term of 36 years at a ground rent of £150 per annum.  The whole of the Property was sublet for an aggregate rent of £16,800 on fully repairing and insuring terms.  In addition to the Property, the Company had an excess of assets (mainly deposits and the benefit of inter-group loans) over liabilities of £32,257.  As at 5 April 1982, the audited balance sheet of the Company showed no borrowings (other than a modest directors loan account).  The Company's profit and loss account for the year ended 5 April 1982 showed only £17 expenditure on bank charges and interest.  I therefore deduce that the Company had no material borrowings for the year.

4.	The Appellant sold its shareholding in the Company to Mr Dee of London Limited for £397,365 on 22 December 1988.  Included in the bundle of documents is a letter dated 1 May 1990 from Mr Shah, a director of Mr Dee of London Limited, to Mr Joga of Shinebond Limited.  The letter confirms a recent meeting between Mr Joga and Mr Shah at which Mr Joga reminded Mr Shah that Mr Dee of London Limited offered to buy the Property sometime in 1982. Mr Shah states that he has discussed the matter with his other directors, and that they recall that such an offer was made.  I note from the letterhead that the address of Mr Dee of London Limited is at 175 Commercial Road, which is not far from the Property.  In addition, Mr Dee of London Limited were tenants of part of the Property.

5.	On 13 October 2003, the Special Commissioners referred to the Lands Tribunal the question of the valuation of the Property pursuant to s46D(1) Taxes Management Act 1970.  The Notice of Reference provided that the question as to whether or not there was a "special purchaser" as at 31 March 1982, and the valuation effect of the "special purchaser's" interest in acquiring the Property was to be taken to be a question of the valuation of land.   By a consent order made on 17 January 2005, the Lands Tribunal ordered that the value of the Property as at 31 March 1982 was £168,000.

Issue to be determined

6.	The sole issue to be determined is the value of the shareholding of the Appellant in the Company as at 31 March 1982.  That value is relevant to the Appellant's liability to corporation tax for 1988/89 on its disposal of the shares in the Company, since by virtue of s96 Finance Act 1988, the Appellant is deemed to have sold those shares and immediately reacquired them at their market value on 31 March 1982.

7.	"Market value" is defined for these purposes by s150(1) and (2) Capital Gains Tax Act 1979 (now s272(1) and (2) Taxation of Chargeable Gains Act 1992) as follows:

"s150(1) – In this Act "market value" in relation to any assets means the price which those assets might reasonably be expected to fetch on a sale in the open market.
(2)  In estimating the market value of any assets no reduction shall be made in the estimate on account of the estimate being made on the assumption that the whole of the assets is to be place on the market at one and the same time."

8.	The principles to be applied in the valuation of unquoted shares are set out in s152 Capital Gains Tax Act 1979:

"s152 – (1) The provisions of subsection (3) below shall have effect in any case where, in relation to an asset to which this section applies, there falls to be determined by virtue of section 150(1) above the price which the asset might reasonably be expected to fetch on a sale in the open market.
(2)  The assets to which this section applies are shares and securities which are not quoted on a recognised stock exchange, within the meaning of section 535 of the Taxes Act, at the time as at which their market value for the purposes of tax on chargeable gains falls to be determined.
(3)  For the purposes of a determination falling within subsection (1) above, it shall be assumed that, in the open market which is postulated for the purposes of that determination, there is available to any prospective purchaser of the asset in question all the information which a prudent prospective purchaser of the asset might reasonably require if he were proposing to purchase it from a willing vendor by private treaty and at arm's length."

Valuation approaches

9.	I am required to determine how these provisions are applied in the particular circumstances of this case.  I am invited by the parties to choose between alternative approaches to the valuation of the Company.  Mr Amin, for the Appellant, submits in essence that the Company should be valued by applying an appropriate yield percentage to its gross income.  In contrast Mr Hart, for the Respondent, submits that the Company should be valued on the basis of its net assets.

10.  The Appellant submits that the correct valuation of the Company's shares is £252,257.  This is based on annual net rental income for the year ended 5 April 1982 of £22,218 (after adjustment to take account of voids and management expenses) and annual interest income of £4005.  Capitalising these using a yield of 10% gives a valuation of £262,224.  In addition, the Appellant submits that account should be taken of dividends of £3000 which were paid for each of the financial years ended 5 April 1980 and 1981.  This gives £40,000 of value (adopting a yield of 7.5%) in addition to the value of the retained assets (which would, of course, have been depleted by the payment of the dividend).  Mr Amin also drew my attention to the letter from Mr Dee of London Limited referred to above, in which Mr Dee of London Limited confirm that they would have purchased the Property in 1982 for £220,000.  Accordingly Mr Amin submits that the valuation of £252,257 adopted in the Company's tax computations is correct.

11.	In contrast, the Respondent's approach is to aggregate the net assets of the Company as at 31 March 1982 – namely £168,000 for the Property and £32,257 for its other net assets.  This results in a valuation of £200,257.  The Appellants submit that this valuation should be adjusted to take account of the tax liability which would arise in the hands of the Company should it dispose of the Property.  If the Company disposed of the Property for £168,000, it would realise a gain of £145,000.  As at 31 March 1982 the effective rate of corporation tax that would have been charged on the gain would be 30%, and the tax liability would therefore have been £43,500.  Of course this tax liability is contingent.  It would only arise if the Company sold the Property, which might never happen.  Accordingly on the basis that the prospective purchaser acquired the Company with a view to retaining the Property as an investment, a discount should be applied to this contingent liability when valuing the Company's shares.  The Respondent suggests that a 30% discount is appropriate (namely 30% of £43,500, which equals £13,050).  Taking all these factors into account, the Respondent values the Company at £187,207.

12.	I find that the Respondent's approach to the valuation of the Company to be the more appropriate in these circumstances.  The Company is an investment company whose sole business activity is the ownership of the Property.  Its only other assets are modest amounts of cash (or assets similar to cash – such as short term deposits and inter-group loans) and it had no material borrowings. The Company exists solely for the purpose of owning the Property.  The Property has a value which is realisable independently of its use in the Company's business (in contrast, for example, with the fixed assets of a trading business). The shares in question represent the entire issued share capital of the Company.  The owner of 100% of the shares has unfettered control over the Company, and has the ability to force the Company to realise and distribute the value of its assets.  In these circumstances a hypothetical prospective purchaser would have valued the Company by adding the value of the Property to its other assets and deducting its liabilities.

13.	I am supported in this view by Christopher Glover's book, "Valuation of Unquoted Companies" (Gee, 2nd Edition, 1992).  Mr Glover says:

"The asset basis should not be used to determine the value of a company, other than one whose assets have a readily realisable exchange value, such as property investment companies, investment trust companies and so-called "money-box" businesses.  Such companies are investment intermediaries and not economic enterprises.  These remarks apply to controlling interests.  Where minority interests are concerned, the asset basis is generally inappropriate, even when the company is an investment intermediary.  This is because asset values are out of the reach of the minority shareholder." (page 244)

He goes on to conclude that:

"Majority interests in investment intermediaries will usually be valued on the assets basis.  The reason for this is simple.  The assets of such companies are marketable and have a value independent of the earnings of the company.  They are purchased by the company precisely because they are marketable and the dealing in such assets is the main object of the company." (page 265)

14.	I was also referred to the unreported decision of the Hong Kong Supreme Court (Appellate Jurisdiction: Full Court): In re Harry Charrington deceased (26 November 1975), in which the Hong Kong court determined that an approach based on "asset backing" was appropriate in determining the value of a minority shareholding in a trading company which did not pay dividends, but which owned a valuable tenanted building.  I find the decision of limited assistance, as many of the key factors influencing the Hong Kong court in Charrington are not applicable in this case.  In particular the decision was influenced by the "peculiar atmosphere of Hong Kong" at the time where the ordinary investor is attracted more readily by the possibility of capital gain than by the probability of secure annual returns. 

15.	I am not persuaded that the use of the gross yield basis of valuation is appropriate in the circumstances of this case.  No justification was given by the Appellant for this approach which results in a valuation for the shares in the Company which exceeds the aggregate value of the Property and the other net assets by some £52,000.  

16.	The Appellant ascribes this difference to goodwill inherent in the site which arises because of its central location in the garment district of London. I find this explanation unconvincing, as the attractiveness of the location would have been one of the factors taken into account in the negotiation of the value of the Property in the course of the Lands Tribunal proceedings (the District Valuer in his expert witness report in the Lands Tribunal proceedings refers to the location and to rentals paid in comparable properties in the neighbourhood).  Mr Amin further justifies this additional value by reference to the premium Mr Dee of London Limited was prepared to pay for the property in 1982, as the Property was close to their other premises in Commercial Road and as they were an existing tenant in the building.  I also find this argument unconvincing.  The only evidence that Mr Dee of London Limited was prepared to purchase the property in 1982 for £220,000 is a letter written some eight years later.  There is no contemporaneous evidence (such as correspondence or minutes) of any such offer having been received.  In any event, the impact of a "special purchaser" (such as Mr Dee of London Limited) would have been taken into account in the Lands Tribunal determination of the value of the Property given the terms of the Notice of Reference to that Tribunal.  To take the impact of a "special purchaser" into account as further addition to the valuation would give rise to double counting.

17.	Insofar as yields are relevant to the valuation of the Property, they are one of a number of factors which would have already have been taken into account in establishing an agreed value for the Property in the course of the Lands Tribunal reference.  This is apparent from the expert witness report of the District Valuer mentioned above, in which he refers to historic as well as expected future rental income, the wasting nature of the asset, the repairing covenants under the leases, the ground rent payable and the price paid by the Appellant for the Company in 1981.  Insofar as they are appropriate to valuing the Company's other assets (such as cash and debtors), the yield percentage cannot be applied directly to the Company's interest income for the year, as this would depend on its fluctuating balances throughout the year, and would not correspond to the balance actually held on the relevant date (31 March 1982).

18.	In my view capitalising dividends is not relevant in valuing a controlling interest in an unlisted property investment company. As the Appellant owns all of the shares of the Company, it can control whether any dividends are paid, and if so, how much they are.  To a great extent the amount paid by way of dividends in any year by a company which is profitable and has significant distributable reserves (such as the Company) is at the whim of the controlling shareholder.  

19.	It is interesting to note that when the Appellant responded on 26 September 1991 to the standard questionnaire issued by the Shares Valuation Division, it gave as the explanation for the value of £252,225 placed on the shares:

Value of leasehold interest	£220,000
+ Net current assets	£32,225
	£252,225

Thus the Appellant originally valued the Company on an assets basis, but has given no reasons for the subsequent change in its methodology.

20.	 On the question of the deduction for the contingent tax liability, I was referred by Mr Hart to Eastaway, Booth and Eamer, "Practical Share Valuation" (Butterworths, 4th Edition, 1998):

"When the company's assets have been calculated by direct valuation it will be necessary to make an adjustment for taxation in respect of the chargeable gains … which would be taxable if the assets were to be disposed of at the realised value.  This adjustment is normally only made in respect of interests in property and, unless the company is being valued on a break-up basis, it will be necessary to take account of the fact that such taxation would not be immediately payable as there would be no actual disposal.  It could normally be appropriate to discount the potential tax charge to take account both of the fact that it would be over stating the net asset value of the company to ignore the tax charge, but also to recognise the fact that there is no immediate intention to dispose of the properties concerned and therefore no actual crystallisation of the tax charge." (page 134)

21.	However, the Property would have been "rebased" to its market value in the hands of the Company as at 31 March 1982 by virtue of the provisions of s96 Finance Act 1988 – which has been determined by the Lands Tribunal to be £168,000.  In other words, if the Company sold the property for £168,000 at any time after 31 March 1982, the Company would not realise any chargeable gain.  Indeed, after taking account of indexation allowances, it might be treated as realising an allowable loss.  I therefore consider that there is no contingent tax liability to take into account in determining the value of the Company. 

Decision

22.	The value of the Appellant's shareholding in the Company as at 31 March 1982 is therefore calculated as follows:

Market value of the Property as determined by Lands Tribunal	£168,000
plus
Other net assets at agreed amount	£32,257
	£200,257

23.	I therefore determine that the market value of the Appellant's shareholding in the Company as at 31 March 1982 for the purposes of s150 Capital Gains Tax Act 1979 is £200,257.00, or £200.257 per share.

NICHOLAS ALEKSANDER
SPECIAL COMMISSIONER

SC/3102/2001