Market value of shares on valuation date
An interesting judgment was handed down in the Supreme Court of Appeal (SCA) on 30 September 2015 in the case of Commissioner for the South Africa Revenue Service v Stepney Investments (Pty) Ltd. The matter concerned the determination of the valuation date value of certain shares for purposes of calculating the capital gain or loss that arose upon their disposal
Stepney Investments (Pty) Ltd (Taxpayer) owned certain shares in Emanzini Leisure Resorts (Pty) Ltd (Company). The Company was mainly involved in the casino, hotel and leisure sector. At the relevant time the Company was awarded a casino licence for a period of 15 years in respect of a particular area and intended to establish a casino at a particular site. Unfortunately the Company became involved in a litigious dispute with a third party in respect of the development of the casino on the preferred premises, causing a delay in the establishment of the casino. In fact, it had to apply for a temporary licence to establish a casino at an alternative site.
The Taxpayer disposed of its shares in the Company during the 2002 and 2003 years of assessment. For purposes of calculating its base cost in determining its capital gain or loss the Taxpayer decided to use the market value of the shares on the valuation date (1 October 2001) in accordance with paragraph 26(1)(a) and paragraph 29(1)(c) of the Eighth Schedule to the Income Tax Act No 58 of 1962 (Act).
In addition, paragraph 31(1)(g) of the Eighth Schedule to the Act provides that the market value of an asset on a specified date is the price which could have been obtained upon a sale of the asset between a willing buyer and willing seller dealing at arm’s length in an open market.
For this purpose the Taxpayer relied on a valuation that was performed by a third party in respect of the value of the shares in the Company. Based on the valuation, the Taxpayer declared a capital loss in respect of the disposal of the shares in the Company in that the base cost of the shares exceeded the proceeds that was received by or accrued to the Taxpayer upon disposal.
However, the South African Revenue Service (SARS) was not satisfied with the valuation on which the Taxpayer based its calculations and issued additional assessments adjusting the valuation-date value to zero. The Taxpayer objected to the additional assessments but SARS disallowed it. The Taxpayer then appealed to the Tax Court. The Tax Court found in favour of the Taxpayer, but SARS then appealed to the SCA.
At the centre of the dispute was the valuation and in the Tax Court a multitude of evidence was led by the parties, either criticising or defending the valuation. One of the first points of contention was the methodology used in valuing the shares. The valuation was based on the discounted cash flow method, but SARS insisted that the net asset value method should have been used. SARS later conceded this point but still had several other criticisms against the valuation and specifically the projections used and assumptions made therein. It was for the taxpayer to prove the market value of the shares, and that the valuation was reasonable.
SARS argued that the forecast amounts from 2001 were used, and not management accounts from 2004 which were available at the time of the valuation. The available figures showed that the forecast amounts from 2001 were out by a substantial number. The Taxpayer argued that this would amount to applying hindsight. However, the SCA held that in the circumstances it was reasonable because the actual figures indicated that the forecasts were unreasonably optimistic. The forecasts couldn’t simply be accepted by a valuer, but had to be tested for reasonableness, and for this purpose later information could be taken into account.
In addition, after analysing the evidence and considering SARS’s further criticisms, the SCA found that:
- there were problems in the projected tax calculations in that the incorrect statutory rates were used, and that the calculations differed from what was previously submitted to the Gambling Board;
- the capital expenditure forecasts were inaccurate because it did not take into account any construction to be undertaken at the temporary site, and this impacted materially on the valuation;
- the valuation was based on the assumption that the licence would be renewed after the 15 year period and it did not take into account the risk that the licence could potentially not be extended;
- the Company had a licence which it could not put to economic use given the unresolved litigation, and this risk factor was disregarded; and
- in applying the discounted cash flow method, a discount factor was applied across the board for all companies in the group of the Company, and that such “one size fits all” approach was inappropriate in the circumstances.
Accordingly, the SCA rejected the valuation as unreliable.
The Taxpayer raised that SARS only ever attacked the valuation on the basis that the incorrect valuation methodology was used, and couldn’t raise further criticisms because that would amount to changing the grounds of assessment. The SCA found that it was clear from the documents that SARS contested the valuation as a whole on the basis that the value of the shares were overstated, and it proffered various reasons for that contention. Interestingly, the SCA noted that, even if that was not the case, the Taxpayer never raised the issue in the Tax Court, and therefore could not subsequently raise it in the SCA.
Despite the lack of success by the Taxpayer in respect of defending the valuation and proving its base cost in the shares, the Taxpayer did have some success.
Essentially, SARS assessed the Taxpayer on the basis that the base cost of the shares was zero, and that is the assessment against which the Taxpayer objected.
SARS conceded, and the SCA confirmed, that the value of the shares as at the valuation date could not have been zero. The 15 year licence was a valuable asset.
Also, as mentioned, SARS conceded that its initial contention that the net asset value methodology should have been used, was not correct.
Accordingly, the SCA upheld SARS’s appeal to the SCA with costs, but still allowed the Taxpayer’s appeal in the Tax Court on the basis that the matter be remitted to SARS for further investigation and assessment. The Taxpayer was awarded costs in the Tax Court in terms of s130(1)(a) of the Tax Administration Act, No 28 of 2011 in that SARS’s grounds of assessment were unreasonable.
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