Private ruling: maximum net asset value test
Published: April 2012

Ruling: On the basis that the only assets of the taxpayers are their respective shareholdings in the company and their respective holdings in the trust, do each of the taxpayers satisfy the maximum net asset value test in section 152-15 of the Income Tax Assessment Act 1997 (ITAA 1997) just before the CGT event relating to the disposal of shares in the company by the taxpayers? | No | 1 July 2010 to 30 June 2011 | 1 July 2010 | The company operates a business. | The taxpayers are shareholders in the company. | The shareholders received an offer from purchasing entity 1, who made an indicative offer to purchase the company. | One of the other shareholders proposed to sell their shares in the company to the other shareholders in the company pursuant to the Constitution of the company. | The other shareholder obtained a valuation of the business of the company from an accounting firm. The shares in the company were valued per share, a total value of $A for the shares in the company. | Included in the valuation was a reference to the value of land on which the company business is conducted. The land is owned by a related trust of the shareholders. The valuer relied on a valuation of the land from an earlier date. | The sale of the other shareholders shares did not proceed. | Over a period of time the company negotiated with two third party purchasers, purchasing entity 2 and purchasing entity 3, for the sale of the shares in the company and also for the sale of the company business. The third parties were looking into both expanding and diversifying their product range and blocking the other party from expansion. | Purchasing entity 2 signed a licence agreement with purchasing entity 3 many years earlier. Purchasing entity 3 cancelled the licence agreement due to disagreements between both companies. The split was not amicable. | The company was a target for both purchasing entities 2 and 3 as they both saw value in an acquisition. | You advise that the presence of these underlying motivations for purchasing entities 2 and 3 resulted in them making offers to purchase the company business and/or shares at levels well above the price that a purchaser would pay that did not have these related strategic interests. | Purchasing entity 2 made a non-binding offer for the purchase of some of the shares in the business and some of the units in the trust with an option to acquire the balance. This offer equated to a 100% purchase price of $B (more than $A) for the shares in the company and units in the trust. | This offer did not include an apportionment of the value between the shares in the company and the interests in the trust. | You state that the 100% interest in the trust related to its underlying assets, which includes the land and buildings upon which the company business is conducted plus some intellectual property. To value the company shares alone using the purchasing entity 2 offer, the value of the units in the trust would be deducted from the implicit offer value of $B. | The land value in the valuation was based on a valuation of the property from an earlier period. The other asset in the trust was some intellectual property. Unfortunately the purchasing entity 2 offer did not separately value either the real property or the intellectual property owned by the trust. | A valuation of the land in the trust was obtained, which values the land and buildings at $C. | You explain that using a value of the trusts assets of intellectual property and the land and buildings at $C, you arrived at a value for the company shares under the purchasing entity 2 offer of $D (less than $B). However, considering the special strategic value of the company to purchasing entity 2, you believe this value is a special value above what another purchaser would pay at market value. You believe that purchasing entity 2 had strategic motivations that resulted in it making a special value offer. | The purchasing entity 2 offer was based on the development of certain products and a higher risk as the development of those products was not certain. Due to the high risk and uncertainty, it was not realistic for the shareholders in the company to have expected to have received the full amount of the offered purchase. Therefore, in your opinion, the fact that the offer was subject to a number of contingencies and conditions does not make it the market value of the shares in the company. | The ultimate purchaser of the shares in the company was purchasing entity 3 who submitted a non-binding indicative proposal to purchase the business of the company with an earn out. The proposal states that purchasing entity 3 believed the offer to be 'a premium valuation when you consider the unpredictable nature of past earnings, the changing competitive environment in Australia, the limited ability to expand operations and the relative cost of building a new equivalent facility'. When the offer was made, purchasing entity 3 did not have the market presence of the company and purchasing entity 3's choices were to develop a business or acquire an existing market share. | The conditions offered by purchasing entity 3 were more realistic that those proposed by purchasing entity 2. This differentiates the purchasing entity 2 and 3 offers. | The shareholders in the company entered into a Share Sale Deed with purchasing entity 3 for the sale of their shares in the company for a purchase price of $E (slightly less than $B) | You state that the purchase price paid by purchasing entity 3 was substantially higher than the market value determined by the valuer. This was due to the special value applied to the shares by purchasing entity 3. The special value was applied as purchasing entity 3 was a special purchaser that was willing to pay over and above the market value of the shares (as determined by the valuer) to secure the acquisition. | For the period between the valuation and the sale of the shares to purchasing entity 3, the actual turnover and EBIT for the company's business was lower than anticipated applying the valuer's capitalisation for future maintainable earnings calculation. | Therefore, you seek to rely on the valuation of $A and not the purchasing entity 2 value nor the actual purchasing entity 3 purchase price, given the valuation's contemporaneity with CGT event date to establish the market value of the shares in the company. | None | Section 152-15 of the Income Tax Assessment Act 1997 | Section 152-20 of the Income Tax Assessment Act 1997 | Summary | The taxpayers do not satisfy the requirements to meet the maximum net asset value test in section 152-15 of the ITAA 1997. | Detailed reasoning | Section 152-15 of the ITAA 1997 explains the maximum net asset value test. You satisfy the maximum net asset value test if, just before the CGT event, the sum of the following amounts does not exceed $6,000,000: | · The net value of the CGT assets of yours | · The net value of the CGT assets of any entity connected with you | · The net value of the CGT assets of any affiliates of yours or entities connected with your affiliates. | The meaning of net value of the CGT assets is discussed in section 152-20 of the ITAA 1997 and is taken to be the market values of those assets less amounts listed in subsection 152-20(1) of the ITAA 1997. | In Brisbane Water County Council v Commr of SD (NSW) 80 ATC 4051, Waddell J indicated that the 'market value' is the best price which may reasonably be obtained for the property if it was sold in the general market. He went further to say that the 'value' of an item of property is its value in the general market with three qualifications, namely: | 1. If there is no general market, as in the case of shares in a private company, such a market is to be assumed; | 2. All possible purchasers are to be taken into account, even a purchaser prepared for his own reasons to pay a fancy price; | 3. The value to be ascertained is the value to the seller. | Further, market value of an asset should be assessed with regard to the 'highest and best use' of the asset as recognised in the market. The concept of 'highest and best use' takes into account any potential for a use that is higher than the current one. | The current use of an asset may not reflect its optimal value. Optimal value is defined by the International Valuations Standards Committee as: | …the most probable use of a property which is physically possible, appropriately justified, legally permissible, financially feasible, and which results in the highest value of the property being valued. | It is sometimes argued that an asset has special value to a particular buyer. Usually this is not relevant in deriving a market value. Where there is clear evidence that the special value is known or available to the wider market, this would be reflected in an objective valuation of the asset. If a special value is known and available to one potential buyer and not known or available to the wider market, it will not be reflected in market value. | The ATO guide Market valuation for tax purposes provides general guidance on valuations for tax purposes and the ordinary meaning of market value. It states: | To determine the market value, you should use the most appropriate valuation method. Where comparable arm's length sales data is available (for example, in a market for a commodity product), this is generally considered the most appropriate method. | Where a market exists for an asset, that market is widely considered to be the best evidence of market value of the asset. | The Market Valuation for Tax Purposes also discusses special value: | It is sometimes argued that an asset has special value to a particular buyer. Usually this is not relevant in deriving a market value. Where there is clear evidence that the special value is known or available to the wider market, this would be reflected in an objective valuation of the asset. | In regards to prospective market value, the Market Valuation for Tax Purposes states: | A market value determined in advance may not be reliable because subsequent events may change the appropriate valuation. For example, key personnel in smaller businesses may leave or die, or there may be major fluctuations in equity markets or the economy. | In your case, although the purchaser may have applied a special value to the shares, that special value was also known to, and applied equally by, other interested parties. Both potential purchasers made similar offers. | It is also noted that the valuation you are relying on was requested by a third party (who is not a rulee) for a different purpose. The disclaimer at point 2 of the valuation states: | This report has been prepared for and at the request of a third party. It is not intended for broader publication or circulation and is not to be reproduced or used for any other purpose without my prior written consent in each specific instance. No other party should use or rely on this report and the valuer, its partners and employees specifically disclaim any liability to any other party who acts or relies on this report. | In preparing this report, we have relied on …. as well as information supplied by a third party….In preparing this report we have relied on this information being accurate and complete….Nonetheless, we have not sought to verify this or conducted such fuller examination of all the information to satisfy this position….do not warrant that our enquiries have revealed all matters relevant to the valuation. | The valuation also relies on a land valuation from an earlier period. | As the valuation you have provided was prepared for a different purpose, it cannot be considered for the purposes of the maximum net asset value test. | It is determined that the market value of the shares is equivalent to the price offered by purchasing entity 3. As each of your interests in the company is equal to X%, the value you will attribute to your ownership interest exceeds $6,000,000. Therefore you do not satisfy the maximum net asset value test.




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