Private ruling: Valuation of a private company
Date of advice: 30 November 2022
Published: 30 January 2023
Ruling period: Year ending 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Does the Commissioner consider the method described in valuing a company appropriate in determining whether the maximum net asset value (MNAV) test in section 152-15 of the Income Tax Assessment Act 1997 (ITAA 1997) is satisfied? | A1: No.

Relevant facts and circumstances: 1. The taxpayer is the 50% shareholder of a private company (the Company). 2. The Company is a wholesaler. 3. The taxpayer is considering restructuring asset holdings for asset protection and estate planning purposes. The intention is to transfer the shares owned in the Company into a family trust (the Trust). 4. The taxpayer engaged a firm to prepare a valuation report (the Report) for the Company. The Report deemed the equity value of the Company to be below $X million. This figure consisted of the business value (enterprise value) plus net surplus assets. 5. The net value of the taxpayer's CGT assets, along with the CGT assets of connected entities connected and affiliates or entities connected with affiliates, was less than $6 million. These values included the equity value of the Company as per the Report. 6. The Report adopted Capitalisation of Future Maintainable Earnings (CFME) as a valuation methodology for the business of the Company. 7. The capitalisation rate used in the Report was 100%. 8. The adopted business value in the Report was below the normal range of EBITDA of the Company over the previous 4 income years. 9. It was explained in the Report that the Capital Asset Pricing Model (CAPM) was not used to determine the capitalisation rate due to the difficulty in accurately assessing the beta of private companies. 10. The Report was referred to the Australian Taxation Office's (ATO's) Valuation Services for assessment. Valuation Services provided their position to the case team.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 102-20 | Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1997 Section 108-5 | Income Tax Assessment Act 1997 Division 152 | Income Tax Assessment Act 1997 Subsection 152-10(1) | Income Tax Assessment Act 1997 Paragraph 152-10(1)(c) | Income Tax Assessment Act 1997 Section 152-15

Reasons for decision: Summary: As the Commissioner does not accept the enterprise value and equity value in the Report, the method used in valuing the Company is not considered appropriate in determining if the MNAV test in section 152-15 is satisfied. | Detailed Reasoning - Detailed reasoning: 1. You make a capital gain or capital loss if a CGT event happens to a CGT asset. [1] Shares in a company are considered to be CGT assets. [2] 2. CGT event A1 happens if you dispose of your ownership interest in a CGT asset. [3] 3. The taxpayer is proposing to transfer shares that he owns in the Company into the Trust. This would result in CGT event A1 to happen and a capital gain to be made. | Detailed Reasoning - Basic conditions for relief: 4. Division 152 provides capital gains tax (CGT) concessions that allow eligible taxpayers to disregard or defer some or all of a capital gain arising from the disposal of an active asset used in a small business, provided certain conditions (the basic conditions) are met. Subsection 152-10(1) sets out the basic conditions to be satisfied before a taxpayer can access the CGT concessions. 5. Subsection 152-10(1) states: A *capital gain (except a capital gain from *CGT event K7) you make may be reduced or disregarded under this Division if the following basic conditions are satisfied for the gain: (a) a *CGT event happens in relation to a *CGT asset of yours in an income year; (b) the event would (apart from this Division) have resulted in the gain; (c)at least one of the following applies: (i) you are a *CGT small business entity for the income year; (ii) you satisfy the maximum net asset value test; (iii) you are a partner in a partnership that is a CGT small business entity for the income year and the CGT asset is an interest in an asset of the partnership; (iv) the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year; 6. This ruling seeks to determine if the taxpayer satisfies the MNAV test in paragraph 152-10(1)(c). 7. The MNAV test is contained at section 152-15. It states that the MNAV test is satisfied if, just before the CGT event, the sum of the net value of the CGT assets of yours, any entities connected with you and any affiliates of yours or entities connected with your affiliates, does not exceed $6,000,000. 8. You have stated that the total net value of CGT assets owned by the taxpayer, connected entities and any affiliates or entities connected with affiliates, amounts to less than $6 million. A significant proportion of this amount is in relation to the equity value of the Company, as determined by the firm that wrote the Report. This valuation will now be examined. | Detailed Reasoning - Review of the Report: 9. The ATO's Valuation Services reviewed the Report and found the valuation to be materially understated. 10. The review deemed the methodology selection, being CFME, as suitable. However, the major finding - based on revenue size of the wholesale business, consistent profitability and risk and growth factors identified in the Report - was that the capitalisation rate of 100% was materially overstated. In spite of the potential to lose existing customers in the event of the taxpayer leaving the business, the review considered that most customers are likely to remain, as the business has been operated with good reputation. The 100% capitalisation rate is indicative of an extremely risky business, which the Company is not considered to be. 11. Moreover, the review did not accept the assumption of no goodwill in the business. 12. The review also found that the failure to apply CAPM when calculating the capitalisation rate resulted in an understatement of the enterprise value. Although accepting of the difficulties in sourcing an appropriate equity beta for private companies, methods are still available, such as estimates based on industry averages, using the debt to equity ratio of comparable companies, or using the beta of company's earnings. Moreover, using Future Maintainable Earnings (FME) as a primary valuation methodology is considered reasonable, but using a 12 month period for FME is not common and the reason provided for using 12 months is not considered sufficient. Based on the calculated FME and suggested capitalisation rate the enterprise value calculated is understated. 13. A multiple in the XX range (controlling basis) was found to be more reasonable than a capitalisation rate of 100%. 14. In short, the review concluded that a significantly higher enterprise value is more reflective of the business. 15. When factoring in net surplus assets to the enterprise value, the review adopted an equity value of the Company above $6 million. 16. There is a material difference between the equity value in the Report as compared with the equity value adopted by the ATO's Valuation Services. Consequently, the Commissioner does not consider the valuation contained in the Report as appropriate. This will result in the MNAV test in section 152-15 exceeding $6 million resulting in this test not being satisfied. [1] Section 102-20 [2] Section 108-5, Note 1 [3] Section 104-10

Reasons for decision: All legislative references are to the ITAA 1997 unless otherwise stated. | Question: Does the Commissioner consider the method described in valuing the Company appropriate in determining whether the maximum net asset value (MNAV) test in section 152-15 is satisfied?