Below is an abridged excerpt from the introductory chapter of our Valuations for Tax Controversies book releasing in January 2017, now available for pre-order. The book is authored by Dr Hung Chu and Wayne Lonergan, who have extensive experience in the field of Valuations.
At the centre of many tax controversies are valuation issues. These cases typically involve either new valuation issues or require a re-evaluation of conventional (but not necessarily correct) approaches to existing valuation issues. The valuation issues discussed in this book arise, in particular, in the context of stamp duty and income tax cases, and in cases which involve what is colloquially referred to as “land rich” assessments.
The conceptual framework established in this book can be applied to, or provide guidance for, value assessment and value apportionment in respect of different types of business or in respect of different tax contexts.
In addition, whilst a significant part of the book is dedicated to valuation issues directly arising from “land rich” cases, it also addresses valuation issues pertinent to different tax contexts.
On the Cutting Edge
Many of the issues raised in this book are at the cutting edge of valuation thinking. They reflect the evolving nature of the valuation body of knowledge and the need for valuers to continuously re-evaluate the existing body of knowledge, particularly in the face of diverse practical circumstances, and apply the broadened or updated knowledge to re-assess and improve existing valuation practices. It is natural to expect that full market acceptance and court acceptance of some of the issues raised will, in some cases, take some time to emerge.
“Land Rich” Assessments
In terms of stamp duty “land rich” assessments, under a land rich landholder taxing regime, a land rich test is performed to determine whether a relevant landholder is land rich. The land rich test involves assessing whether the unencumbered value of the land holdings of the landholder is equal to, or exceeds a specified proportion of the unencumbered value of its total assets, other than certain excluded assets. Under a landholder taxing regime, stamp duty is levied where the unencumbered value of the relevant landholder’s landholdings in the state exceeds a certain value.
Irrespective of whether or not the land rich landholder taxing regime or the landholder taxing regime is in place, the assessment of whether or not a liability to stamp duty or tax arises is usually conducted following the occurrence of a commercial transaction where the market value of the total assets of the relevant landholder is either observable or ascertainable by calculation. Thus, from a valuation perspective what is practically (albeit not necessarily legally) required for stamp duty purposes is the assessment of the market value of total assets, land assets and non-land assets to assess whether the percentage threshold (under the land rich landholder taxing regime) or the absolute value threshold is exceeded and, if so, the dutiable value of land holdings (under the landholder taxing regime).
The Income Tax Assessment Act 1997
In terms of capital gains tax (CGT) implications, under the Income Tax Assessment Act 1997 (Cth) (ITAA 97), a principal asset test (PAT) is required to assess Australian CGT payable by foreign residents. A foreign resident will be liable to Australian CGT arising from a capital gain on a sale of shares in a company if, among other things, the sum of the market values of the company’s assets that are taxable Australian real property (TARP) exceeds the sum of the market values of its assets that are non-TARP. What is legally required for the PAT is the assessment of the market value of TARP and non-TARP assets to establish whether the market value of TARP assets exceeds the market value of non-TARP assets.
Clearly, the market value of such assets (as part of a going concern business) is not always readily observable because they may be rarely, if ever, traded on a standalone basis. Thus, for such specialised assets, there is generally no readily identifiable comparable sale transaction to refer to as a guide to value.
In such cases, from a valuation perspective, although technically not required under the tax legislation, the market value of total assets, which are often ascertainable, is an important reference point for the underlying asset value assessment in that it can either be used as a direct input to the assessment of the market value of TARP and non-TARP assets, or an important cross-check for reasonableness of the assessed market value of TARP and non-TARP assets by imposing a natural limit on the aggregated values of the underlying individual assets/asset classes and also in terms of value relativities.
Underlying Asset Value Assessment
Thus, for both stamp duty and CGT/PAT “land rich” assessments, the required focus on underlying asset (or asset class) value assessment from a legislative perspective inherently involves a total asset value assessment either because it is required by the relevant legislation, or as a practical cross-check.
Although many of the valuation issues raised are in the context of what are generally referred to as “land rich” assessments, what comes out from a discussion of these issues certainly has broader conceptual and practical implications for other valuation driven tax controversies.
From a valuation perspective, what is unique about “land rich” cases is that they require a shift of focus from total asset value assessment to underlying asset value assessment/total value apportionment.
A Shift of Focus
Although controversial valuation issues arise in both total asset and total equity value assessment, the shift in the focus of the valuation exercise from total equity/asset value assessment to underlying asset value assessment/total value apportionment involves multiple additional layers of conceptual and practical complexities and hence requires different and often more complex valuation thinking as compared to total asset value and total equity value assessment.
In fact, shifting the focus to underlying asset value assessment/total value apportionment opens up new conceptual and practical issues, which may be neither present nor apparent when the focus is on total business value or total equity value assessment.
Given that the context in which total asset value apportionment is required typically involves capital intensive businesses which employ specialised fixed and other assets, the issues associated with the underlying asset value assessment/value apportionment exercise are addressed within that context.
Valuations for Tax Controversies fills the apparent gap in the existing collection of valuation and corporate finance textbooks, and is the first to systematically go beyond total business value assessment and addresses the practical issues regarding total asset value allocation which have huge tax, duty and commercial consequences.
About the Authors
Dr Hung Chu is a Director of Lonergan Edwards & Associates Limited. Dr Chu completed his master degree in Finance and Banking (with Merit) from the University of Sydney and his doctoral degree in Finance from the University of Technology, Sydney, where he graduated on the Chancellor’s List for Exceptional Scholarly Achievement in PhD research.
Dr Chu has gained a wide range of practical experience in valuations and valuation- related advisory services. In particular, he has been responsible for numerous assignments and complex litigation and tax dispute matters for both public and private companies as well as various government departments in Australia.
Wayne Lonergan’s professional qualifications include Bachelor of Economics, Doctor of Science in Economics (hc), Fellow and Life Member of the Securities Institute of Australia, Fellow of the Australian Property Institute, Fellow of the Company Directors Association of Australia and a member of the Australian Institute of Arbitrators.
Wayne’s professional work has concentrated on valuation and related assignments, including consequential loss and quantum assessments, business and due diligence investigations and expert evidence in numerous litigation matters.