Crane, Executors of Estate late M.C. v. Federal Commissioner of Taxation.
Judges:Stephen J
Court:
High Court
Stephen J.: I am here concerned with the value, for the purposes of Commonwealth Estate Duty, of the deceased's holding of 6,250 ordinary shares in Winsley Pty. Ltd., a holding which represents some 20% of its issued capital. Winsley's sole asset is a large parcel of shares which it holds in a listed public company, G.E. Crane Holdings Ltd.
The executors of the estate of the deceased returned the Winsley shares as worth $9.77 each at date of her death on 4th November 1969 but the Commissioner, having originally placed a value of $32.93 on each share, later allowed in part an objection to assessment and reduced their value to the sum of $23.10 per share. It is from an assessment involving this valuation that the executors now appeal.
This considerable discrepancy in valuation was maintained in the evidence of experts on this appeal. The three experts, Messrs. Young, Mutton and Bagnall, called on behalf of the executors, valued the shares at $8.18, $9.79 and $11.24 respectively whereas the Commissioner's expert valuer, Mr. R.G. Alexander, adhered to the Commissioner's amended value of $23.10 per share. All but Mr. Young were very experienced chartered accountants; Mr. Young was a qualified accountant and the general manager of an Australian company associated with English financial houses whose sole business consists of the investing of funds in the acquisition of less than a controlling interest in the capital of Australian private companies.
The reason for the gross discrepancy between the appellants' three valuations and that of the Commissioner lies principally in the selection of the appropriate percentage rate at which estimated maintainable annual dividends or, in Mr. Alexander's case, estimated maintainable annual profits should be capitalized so as to ascertain the value of shares in Winsley. Mr. Young's valuation involved a substantial discounting of maintainable annual dividends to take account of lack of negotiability; Mr. Alexander used profits rather than dividends as the startpoint of his capitalization calculation; there was, however, general agreement upon the appropriate method of valuation. Asset backing of the shares played no direct part in the calculations, the method adopted being to estimate maintainable profits of Winsley and then, in all but the case of Mr. Alexander, to calculate from them the likely maintainable annual dividend applicable to the deceased's shares. To that calculated figure was then applied what was considered to be the appropriate percentage capitalization rate, the resultant amount being the value of the deceased's shares.
I tabulate below the respective estimates of maintainable annual dividends or profits from these shares, the rates of capitalization applied and the resultant values arrived at:
The difference between Mr. Alexander's figure of 5% and the range of much higher capitalization rates used by the other valuers is explained by the different approaches which they reflect. Because Mr. Alexander was much influenced by Crane Holdings' market price of $4.70 per share, showing a dividend yield of only some 3.2%, by what he regarded as its good prospects of future profit growth, aided by its high rate of retention of profits, and by its high ratio of asset backing per share, he treated an increase in yield from 3.4% to 5% as sufficient to take account of the difference between direct ownership of shares in Crane Holdings and the acquisition of an indirect interest in that company per medium of a shareholding in Winsley, accompanied as it is by a variety of special disabilities. In substance his point of commencement was the market value of a Crane Holdings share because he regarded a purchase of Winsley shares as, in reality, an indirect mode of acquiring an interest in Crane Holdings.
The approach of the three other valuers was markedly different; each compared the purchase of Winsley shares with what they regarded as other somewhat comparable investments, in two instances shares in listed investment companies and, in the third instance, fixed interest securities. They substantially disregarded the market price and yield of Crane Holdings shares and instead were concerned with the yield offered by other investments, deducing from these the yield which a potential purchaser of Winsley shares would regard as satisfactory.
It is not surprising that each approach produced very different results since each began with quite dissimilar starting points. Moreover Mr. Alexander's sanguine estimate of the growth prospects of Crane Holdings and his regard for the asset backing for its shares combined to minimize the extent of the adjustments which he then proceeded to make to arrive at an appropriate rate of capitalization for Winsley shares, whereas the others thought it necessary to make extensive adjustments to arrive at their much higher rates of capitalization.
The principles applicable to the valuation of the assets of an estate have been closely examined in the precedent cases in this Court; in the two recent decisions.
Gregory & Anor. v. F.C. of T. 71 ATC 4034; (1971) 45 A.L.J.R. 136 and
Executors of Bruce-Smith v. F.C. of T. 73 ATC 4137; (1973) 47 A.L.J.R. 569, these authorities are referred to and discussed. The present case calls for no restatement of principles but rather for their application to the special facts of the case.
The task of valuation involves the postulating of a hypothetical sale to a purchaser as at the date of death and in circumstances in which neither party is anxious but each is willing to become a party to such a
ATC 4004
sale; the value will be the price at which such a sale would, after proper negotiation between the parties, have been concluded.It is clear from the evidence that a purchaser of the estate's minority holding of Winsley shares would be buying them for the income which he would hope to receive by way of dividends in the future rather than for any prospect of realizable capital gain and he would necessarily regard that income as wholly dependent upon the dividends which Winsley might derive in the future as a shareholder in Crane Holdings. Winsley's dividend distribution for the year ended 30th June 1969, suitably adjusted to eliminate minor factors thought to be peculiar to that year of income, was in the vicinity of $32,500. The question is, then, what sum would vendor and purchaser, after negotiation, be likely to settle upon on the sale of these shares, representing 20% of the issued capital of this unlisted company and which were producing dividends at the rate of about $6,500 per annum.
The use of comparables having a known market value is perhaps the most commonplace and the most reliable of all aids in the valuation of an asset but the evidence in this case discloses no investment in any way truly comparable to the deceased's shareholding in Winsley. Since Winsley derived its income from its shareholding in Crane Holdings, a company whose shares have a market quotation, it is natural, as did Mr. Alexander, to pay some regard to the price and dividend yield of Crane Holdings shares. However, as the appellants' witnesses pointed out, the purchaser of a minority holding of Winsley shares acquires very different rights from those of a shareholder in Crane Holdings. Perhaps the major difference is that he lacks all mobility of investment; not only must he anticipate that, because of the Crane family's control of Winsley, Winsley's only asset will continue to consist of its present investment in Crane Holdings, he must also recognize that his own right to quit his investment in Winsley will be greatly restricted by the terms of that company's articles of association. Whereas a Crane Holdings shareholder may see prospects of realizable capital gains, all that he can look forward to is a flow of annual income. He is unlikely ever to be able to realize any capital gain in respect of his shares in Winsley.
Shares in listed investment companies appear to me also to afford no true comparability; their chief characteristics are a widely spread portfolio combined with what is, presumably, thought to be wise portfolio management policy; Winsley's assets, on the contrary, consist of shares in only one company and its management has no intention of changing that mode of investment.
Again any comparability between Winsley shares and fixed interest securities appears to depend exclusively upon one factor, what was said to be the lack of growth prospects affecting Crane Holdings, which operates to assimilate its income potential to that of bonds or debentures. On the other hand, the yield calculated from the price which the market placed upon Crane Holdings shares suggests that its assessment of that company's growth potential may not have been so adverse; in my view shares in Winsley would, in 1969, have been regarded as providing some measure of protection against inflationary erosion of money values whereas fixed interest investments will always necessarily wholly lack that quality.
Whichever ascertainable measure of yield in the market place may be selected so as to arrive ultimately at an appropriate yield for Winsley shares, some adjustments will require to be made to it and these will involve the difficult task of quantifying, in percentages or money sums, qualities not readily convertible into those terms. The expert witnesses, by the very methods of valuation they adopted, tacitly acknowledged this difficulty. Mr. Bagnall used a capitalization figure of 9.25%; this he arrived at by assuming that the seller's minimum price would involve a yield of 8.5%. He constructed this 8.5% by taking an average yield of 4.8% for shares in listed investment companies and adding to it.7% to take account of the absence of any widespread portfolio, of the likely permanence of Winsley's holding of Crane Holdings shares and of the absence of access to capital gain. To the resultant figure of 5.5% Mr. Bagnall added 3% for the disabilities arising from the fact that Winsley was an unlisted company with restrictions upon
ATC 4005
transfer of its shares; he thus produced a yield of 8.5%. The evidence did not satisfy me that these two additions, of.7% and of 3%, were necessarily a proper reflection of the factors which they purported to represent. Mr. Bagnall then assumed that the purchaser would require a yield of 10%, apparently because this was somewhat above the return then available on first mortgage security, a mode of investment which he considered that the purchaser might regard as analogous to Winsley shares. His ultimate figure of 9.25% he arrived at by splitting the difference between 10% and 8.5% Mr. Bagnall's valuation may no doubt be open to criticism as relying too much upon personal judgment and too little upon assumptions the correctness of which is capable of proof. I would have been more receptive of such criticism had I not myself, in common with the expert witnesses, been obliged to undertake a largely unavailing search for appropriate methods of applying the available valuation data to the facts of this case in a manner which might be regarded as logically satisfying.Mr. Mutton, who also used listed investment companies as a starting point, had, from his differently composed group of such companies, obtained an average yield of 5.6%,.8% higher than that used by Mr. Bagnall; this is a remarkable disparity when it is recalled that it is greater than the.7% adjustment which Mr. Bagnall thought appropriate for the various factors to which he referred. Mr. Mutton, beginning with his 5.6% yield, explained his final result of 11% simply by referring to the many differences between Winsley and listed investment companies without attempting any explanation of why he regarded them as calling for a doubling of the yield; indeed he frankly attributed his choice of 11% to informed judgment rather than to any explicable process of informed logic or mathematical calculation.
The result of this body of evidence is to suggest that the task of adjusting the average yield of shares in listed investment companies (whatever that may be thought to be) so as to take account of the difference between them and Winsley shares is no easy one.
Mr. Young's approach was to regard a minority shareholder in Winsley as entitled to no more than a perpetual stream of dividends, derived from an investment having no fixed maturity date, liable to erosion by inflation and offering less security than 8% company debentures. He arrived at an appropriate capitalization rate by adding to the risk-free 6% rate then applicable to 20-year Commonwealth bonds a premium of 4% for risk; he also, alternatively, took a rate of 8%, being the yield on debentures and unsecured notes of companies in good standing, and added 2% for risk and lack of maturity date. Because he regarded the Winsley shares as having no growth potential, he did not make any deduction on that account from the resultant rate of 10%. In addition to this yield calculation Mr. Young also reduced by 25% his estimate of future annual dividends so as to reflect the disadvantage resulting from the restrictions on transfer imposed by Winsley's articles of association. This disadvantage he regarded as distinct from what he described as the absence of any redemption date; the one reflects the fact that Winsley will probably always retain its Crane Holdings shares, the other the difficulty a purchaser of Winsley shares will have in selling those shares at any price satisfactory to him. The discounting of dividend income by 25% was said by Mr. Young to accord with conventional practice in the purchase of minority interests in unlisted companies; had Mr. Young made no such 25% reduction he would have had to apply a capitalization rate of 13.3% to arrive at his particular valuation per share. For his capitalization rate of 10% Mr. Young simply relied upon his experience in this field of investment.
There are, I think, dangers in placing too much reliance upon Mr. Young's opinion in these matters. He enjoys, it is true, the advantage of practical experience as a purchaser of shares such as those in question; but the very fact that he is accustomed to bargaining as a purchaser and this from a position of great financial strength, represented by the control of large funds which are sometimes made available to companies in which a minority holding is to be acquired, coupled with the fact that, as he said, his company would not in any event be interested in acquiring an interest in a company such as
ATC 4006
Winsley, tended, I think, to incline him to an unduly unenthusiastic view of these shares. Such a bias, no doubt unconscious, will be of marked significance in a valuation which necessarily depends so largely upon subjective factors.Mr. Alexander's valuation does not, on its face, disclose any reasons for his adoption of a 5% capitalization rate but it emerged in the course of his evidence that he began with a yield of shares in Crane Holdings of about 3.2% and then added 1.8% on account of restrictions upon transfer applicable to Winsley shares; he regarded Winsley's tax free retention allowance of 10% of the dividends it received as an advantage to its shareholders which those who held shares in Crane Holdings directly would not enjoy but acknowledged the disadvantage involved in the absence of any prospect of realized capital gain from Winsley shares. He explained his relatively low yield of 5% as due to his expectation of exceptional growth prospects, including growth of income, in Crane Holdings shares, which would be reflected in Winsley shares. He was, I think, fortified in his conclusions by the fact that the value he placed upon Winsley shares represented a substantial discounting of the company's net tangible assets.
In my view the evidence afforded little justification for Mr. Alexander's view of the growth prospects of Winsley shares. The document which Messrs. Alexander and Bagnall ultimately agreed upon as correctly stating the ratio of consolidated profits to subscribed capital, reserves and unappropriated profits of Crane Holdings demonstrates, I think, that that company would not have been regarded, in November 1969, as a company likely to provide increased dividends, in real terms, in the future. I accept the view of the three other valuers that in November 1969 the level of dividend declared by Crane Holdings would be regarded as unlikely to be much surpassed in the future. The relatively low market yield of these shares may suggest a market anticipation of growth but it may, on the other hand, be explained by quite other factors of which I am unaware, there having been little or no expert evidence directed to explaining the cause or significance of the low yield, of about 3.2%, shown by Crane Holdings shares.
In the outcome I find none of the proffered bases of valuation to be wholly satisfactory although I have derived much assistance from the valuation evidence of each of these expert witnesses. I acknowledge the unsuitability of any method of valuation concerned not with the capitalization of profits or dividends but instead with asset backing. But what does clearly enough emerge, in the rather special circumstances of the present case, is that it may be misleading to seek to refine the process of valuation by the adoption of methods and calculations suggestive of an ability to arrive at any high degree of accuracy of result; the shares here being valued are exceptional in character and their value is necessarily very much a matter of speculation. That this is so is apparent from the fact that even two of the appellants' valuers, proceeding upon a very similar assessment of the merits and demerits of these shares and employing the same method of valuation, can nevertheless produce widely differing results. It was also emphasized by the fact that one valuation expert, of great experience, was able to enter the witness box, have his very lengthy report and valuation tendered and support by his oral evidence its conclusions and the value per share which it disclosed, only for it to be later discovered, still in the course of his evidence-in-chief, that that value, which he was intent upon supporting, was the direct product of a simple error in calculation. This error, when corrected, altered his share value by some 20%. The fact that it was not detected earlier demonstrated, I think, how wide is the range of acceptable values for these shares even when one particular set of postulates is adopted by the valuer; when there is disagreement as to one or more postulates the range is very much wider still.
In these circumstances, my task being no more than to ascertain ``a proper measure of liability to tax'' in respect of these shares -
Commissioner of Succession Duties (S.A.) v. Executor Trustee and Agency Co. of South Australia Ltd. (1947) 74 C.L.R. 358 per Dixon J. at p. 373 - I approach that task bearing in mind certain market comparisons. Thus, Winsley shares offered less security than do sound company debentures (yielding 8%) and
ATC 4007
lacked their ready transferability and certain redemption date while possessing a possibility, although not a probability, of some measure of protection against future erosion of real value by inflation. Again Winsley shares lacked the safety of a widely spread underlying portfolio such as is enjoyed by most listed investment companies (which yielded, on the average, something over 5%) and lacked, too, their ready transferability and their degree of protection against the effects of inflation. On the other hand they did provide an opportunity to participate, at one remove, in the earnings of Crane Holdings, a long-established public company of good repute whose own shares were regarded by the market as calling for as low a yield as 3.2%.I give effect, in my valuation of these shares, to the depreciatory effect of the restrictive provisions of Winsley's articles of association and this for the like reasons as were stated by Gibbs J. in
Gregory's case at 71 ATC 4034-6; again, I pay some regard to the size of the parcel of shares here in question. I am also considerably influenced by the absence of likely opportunity to realize any capital appreciation that might otherwise accrue, which is, in a sense, a consequence both of control by Crane family interests and of the restrictions upon transfer of Winsley shares. The related absence of growth potential of these shares, adverted to by the appellants' witnesses, also must be of weight.
A purchaser would, I think, require, in all the circumstances, a yield considerably in excess of 8% and a vendor would be obliged to concede the need for such a relatively high yield. I take some comfort from the manner in which Danckwerts J. approached his difficult task of valuation in In
re Holt (1953) 1 W.L.R. 1488 and ``making the most intelligent guess that I can'' - p. 1502 - I conclude that an additional 2% yield is best calculated to afford a proper measure of liability to estate duty in respect of these shares. It follows that I would apply a rate of capitalization of 10% to the maintainable annual dividend figure of $6,500 and thereby produce a value of $65,000 or $10.40 per share.
I allow this appeal and refer the matter back to the Commissioner with a direction to amend his assessment by substituting for the value placed by him upon the shares in Winsley held by the deceased a value of $65,000 and by otherwise amending his assessment accordingly. I order that the respondent pay to the appellants their costs to be taxed.
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