Opinion ID: 28167
Heading Depth: 3
Heading Rank: 2

Heading: Assignment of Weight to Values

Text: 51
52 Prior to determining the appropriate method of valuing Dunn Equipment, the Tax Court reviewed the factors that bear on the fair market value of a block of stock in a closely-held, non-traded, operating corporation and concluded that 53 the value of Dunn Equipment is best represented by a combination of an earnings-based value using capitalization of net cash-flow and an asset-based value using fair market value of assets, with an appropriate discount for a lack of marketability and lack of super-majority control. 29 54 In so doing, the Tax Court rejected the approach of the Estate's expert, who used capitalized net earnings to determine the income-based value of the Corporation, and went instead with a capitalized net cash-flow method. As the Estate is not contesting the Tax Court's choice of the cash-flow approach over the earnings approach, we too accept the court's choice. 55
56 To its credit, the Tax Court flatly rejected the Commissioner's legally and factually absurd contention at trial that no weight should be given to the Corporation's earnings-based value and that its value should be based entirely in an asset-based approach, with no consideration of built-in tax liability. In so doing, the Tax Court concluded that the Commissioner puts too much emphasis on the fair market value of assets 30 — to us, a classic understatement — and stated correctly that because Dunn Equipment was an operating company, the better question is not whether we should disregard the earnings-based value, but whether we should disregard the asset-based value. 31 The Tax Court went on to voice agreement with the basic position urged by the Estate's valuation expert that substantial weight should be given to both the asset-based value and the earnings-based value of the Corporation. Although we wholeheartedly endorse the point made by the Tax Court's rhetorical question whether any weight at all should be given to the asset-based value — and see little hyperbole in it — we are constrained to proceed, as proposed by the Estate and as done by the Tax Court, with a methodology that assigns some weight to each of the values generated by those two disparate approaches. 57 The final determination required to complete the pre-discount valuation methodology in this case, then, is the selection of the respective weights (percentages) to be assigned to each of the Corporation's theoretical values, asset-based and earnings-based. As observed in our discussion of the potential effects (or lack thereof) of the likelihood of liquidation and latent gains tax liability on the value of the Corporation's assets, it is in the exercise conducted to determine the relative weights to be accorded to each of the two differently calculated values of the Corporation — and only in that exercise — that the likelihood of liquidation vis-à-vis the likelihood of indefinitely retaining and using the assets, comes into play. 58 The Tax Court was of the opinion — and we agree — that the hypothetical willing buyer of the Decedent's block of stock would be unlikely to provoke liquidation of the company, even if he could. The Tax Court bolstered that conclusion with the recognition that even though the Estate's block of stock represents day-to-day control, the buyer of that block would lack the power to compel liquidation, merger, or consolidation. 32 In this regard, the court cogently emphasized that Dunn Equipment's history, community ties, and relationship with its employees would make it difficult if not virtually impossible for the holder of the Estate's block of stock to secure the votes of additional shares sufficient to institute liquidation. After concluding that the likelihood of liquidation was slight, the Tax Court added: 59 A rapid liquidation would have flooded the market with equipment, reducing the value obtained for each piece. A lengthy, drawn-out liquidation (also called a creeping liquidation) would have risked the loss of customers who, at some point, would have realized that Dunn Equipment no longer meant to stay in business and who would therefore have sought other suppliers of equipment. 33 60 Despite having asked rhetorically — but, in our opinion, insightfully — whether the asset-based value of the Corporation should not be disregarded altogether, the Tax Court simply reiterated the factors that should be considered (largely paraphrasing Rev. Rul. 59-60, 1959 WL 12594), then conclusionally completed its pre-discount valuation methodology by assigning unequal percentages of weight to the results of its two approaches to valuation. 61 Given the stipulated or agreed facts, the additional facts found by the Tax Court, and the correct determination by that court that the likelihood of liquidation was minimal, our expectation would be that if the court elected to assign unequal weight to the two approaches, it would accord a minority (or even a nominal) weight to the asset-based value of the Corporation, and a majority (or even a super-majority) weight to the net cash flow or earnings-based value. Without explanation, however, the Tax Court baldly — and, to us, astonishingly — did just the opposite, assigning a substantial majority of the weight to the asset -based value. The court allocated almost two-thirds of the weight (65%) to the results of the asset-based approach and only slightly more than one-third (35%) to the results of the earnings-based approach. We view this as a legal, logical, and economic non sequitur, inconsistent with all findings and expressions of the court leading up to its announcement of this step in its methodology. We also note that the Tax Court's ratio roughly splits the difference between the 50:50 ratio advanced by the Estate and the 100:0 ratio advocated by the Commissioner. 62 Irrespective of whether the crucial step in the Tax Court's methodology, the assignment of relative weights to the results of the different valuation approaches, is deemed to be an issue of law or a mixed question of fact and law, we review it de novo. Our plenary review leads us inescapably to the conclusion that the Tax Court's 65:35 ratio in favor of its asset-based value constitutes reversible error. How, we must ask, can the value of a corporation that possesses all the attributes verbalized by the Tax Court conceivably be governed essentially twice as much by its asset-based value as by its earnings or cash flow-based value, when its assets (1) are not susceptible of appreciation (except, possibly, de minimis by the condo and the plant sites), (2) are physically depreciated and depreciating as a result of their being used as intended, (3) are being replaced constantly with newer models at great cost, and (4) are virtually certain not to be put up for sale because indefinite operation — not liquidation — is all that can be predicted as the Corporation's future, both long-term and short? 63 At this point we must emphasize the fact that the lion's share of the Corporation's assets comprised heavy equipment which, to such an operating company, is virtually indistinguishable from consumable supplies — and likely would be so regarded were it not for the administratively necessary but economically unrealistic artificiality of 12-month tax years. Those assets are constantly depreciating from heavy use and obsolescence; they are being replaced to the tune of $2 million annually; their highest and best use is short-term rental, frequently impossible to accomplish without the furnishing of operators by the Corporation; and the tax effects of their unlikely sale to third parties would greatly diminish their value to the Corporation. Indeed, it takes eight salesmen and 123 common-law employees, working full time in this highly competitive industry, to make these heavy-equipment assets produce even moderately acceptable levels of profitability. 64 Throughout its comprehensive and logical background analysis, the Tax Court recognized that Dunn Equipment is an operating company, a going business concern, the Decedent's shares in which would almost certainly be purchased by a willing buyer for continued operation and not for liquidation or other asset disposition. For purposes of valuation, Dunn Equipment is easily distinguishable from true asset-holding investment companies, which own properties for their own intrinsic, passive yield and appreciation — securities, timberland, mineral royalties, collectibles, and the like. For the Tax Court here to employ a valuation method that, in its penultimate step of crafting a weighting ratio assigns only one-third weight to this operating company's income-based value, defies reason and makes no economic sense. 34 Our conclusion is all the more unavoidable when viewed in the light of the Tax Court's disregard of the ubiquitous factor of dividend paying capacity — in this case, zero — which, if applied under customarily employed weighting methods, would further dilute the weight of the asset-value factor and reduce the overall value of the Corporation as well. The same can be said for the effect on cash flow of the underpayment of officers' compensation. 65 When we review the objective, factual record in this case — which is all that remained for the Tax Court to rely on after it disregarded most expert testimony — we are left with the definite impression that an error was committed at the weighting step of the method employed here. This review also mandates that something between zero and a small percentage of weight be assigned to the Corporation's asset-based value, and that the remainder of the weight be assigned to its earnings-based value. Under different circumstances, we might be inclined to remand for the Tax Court to make another try at assigning relative weights and constructing a reasonable ratio. Given the state of the record and the seven-plus years that this case has languished in the courts (over a year now in ours), such a remand, coupled with its potential for yet another appeal, militates against sending this particular issue back to the Tax Court. After all, the record of this case, free as it is of credibility calls and genuine disputes of material fact between the parties (other than as to their experts) places us in exactly the same methodological vantage point as the Tax Court when it comes to assigning relative weights to the results of the valuation approaches employed. This is true regardless of whether that assignment be labeled a question of law or a mixed question of fact and law. 66 Tempting as it is to follow the implication of the Tax Court's rhetorical question and disregard the asset-based value altogether, we remain cognizant of the venerable Cohan 35 rule, which counsels against assigning a zero value or probability to anything under any circumstances, and therefore resist that temptation. Recognizing the impossibility of ever making an absolutely precise and universally accepted determination of weighting percentages, 36 we nevertheless hold that the proper method of valuing the stock of Dunn Equipment, under all the relevant circumstances and discrete facts of this case (not the least of which is the unlikelihood of liquidation of its assets), requires assigning a weight to its earnings-based value somewhere between 75% and 90%, and to its asset-based value somewhere between 10% and 25%. Within these ranges we select 85% for the earnings-based weight and 15% for the asset-based weight, producing a 85:15 weighting ratio.