Miley v FC of T

Members:
BJ McCabe DP

Tribunal:
Administrative Appeals Tribunal, Sydney

MEDIA NEUTRAL CITATION: [2019] AATA 5540

Decision date: 23 December 2019

---

BJ McCabe (Deputy President)

1. Division 152 in Part 3-3 of the Income Tax Assessment Act 1997 (ITAA97) includes several measures which allow small businesses to reduce the amount of their capital gains upon disposal of an asset. Section 152-10 sets out the basic conditions which must be met before a taxpayer can access the relief available under the Division. One of those basic conditions, mentioned in s 152-10(1)(c)(ii), is that the taxpayer must satisfy the maximum net asset value test referred to in s 152-15. A taxpayer will satisfy the maximum net asset value test if, just before the CGT event, the sum of the net value of the taxpayer's CGT assets (and the net value of any CGT assets of other entities or affiliates attributed to the taxpayer) does not exceed $6 million.

2. The applicant in this case owned 100 shares in a company. He and his two fellow shareholders - each of whom owned a third of the shares in the company - sold the entirety of their holdings to a common buyer for $17.7 million in March 2008. The sale price was split three ways but the applicant said his parcel of shares should not be valued at $5.9 million, which is the amount he was actually paid. As the applicant explained in his notice of contention in related Federal Court proceedings, his shares should be valued at a lower figure because:

…the consideration received by the vendors under the share sale agreement that gave rise to the CGT event was additionally for the grant of valuable restrictive covenants, being assets that did not exist at the valuation time…

3. Mr Miley pointed out his parcel of shares was almost certainly worth a lower amount if the shares were valued in the absence of those restrictive covenants in the contract - and certainly low enough for the applicant's net asset value to remain below $6 million. If he is right, the value did not exceed the maximum net asset value test at the valuation date which occurred just before the CGT event when the contract was concluded. In those circumstances, he was (subject to satisfying the other basic conditions) entitled to access the relief available under Div 152.

4. The Commissioner disagrees. The Commissioner says the best guide to the value of the shares in the applicant's hands just before the sale was the amount he and his co-equal shareholders received in the course of the arms' length sale that occurred immediately after the time at which value was assessed. When that amount was combined with the value of other CGT assets at the relevant time, Mr Miley 's net assets exceeded $6 million and he was unable to satisfy the maximum net asset value test.

5. These proceedings were commenced some time ago. At the first hearing, a differently constituted Tribunal decided the case in favour of the applicant after applying a discount to the amount actually received by Mr Miley . The discount was applied because the Tribunal found an additional amount was paid by the purchaser to secure control even though none of the individual shareholders could deliver control on their own prior to the contractual agreement: see
Miley and Commissioner of Taxation [2016] AATA 73 at [37]. The matter was remitted by the Federal Court on appeal: see
Commissioner of Taxation v Miley [2017] FCA 1396. In the course of his reasons, Wigney J expounded on the correct approach to valuing assets in this context. With the benefit of those reasons, the parties returned to the Tribunal to reargue the case without calling fresh evidence.

THE SALE OF THE SHARES

6. The basic facts are not in dispute. They are set out in Commissioner of Taxation v Miley at [1]-[10]. I will summarise them below:

• • The applicant owned 100 shares in a company, AJM Environmental Services Pty Limited (AJM). The company had two other shareholders, Mr Perry and Mr Minshull. Each of them owned 100 shares.
• • The three shareholders entered into a single Contract of Sale and Purchase (the sale contract) dated 7 March 2008 under which they each agreed to sell their shares in AJM to EIMCO Water Technologies Pty Ltd. They also agreed to sell their shares in another company they jointly controlled called AJM Properties Pty Ltd.
• • The purchase price was $17.7 million. Each of the sellers received $4.9 million at or soon after the time of the sale; they also received an additional $1 million each in the same year of income that the purchaser had paid into an escrow account, which meant each of the sellers received a total of $5.9 million from the purchaser in connection with the sale.
• • The purchaser, EIMCO, was at arms' length from the vendors.

7. The contract is reproduced in exhibit R3. It includes a term requiring each of the sellers to enter into an employment agreement with the company for a term of five years (clause [16.1.2(d)]) and terms requiring the individual applicants to promise AJM and the purchaser not to compete with the company or any member of the purchaser's group for five years after the sale: clauses [13] and [23].

8. The Commissioner pointed out in written submissions that the contract did not attribute or assign any value to the applicant's agreement to enter into the employment agreements or to their agreement to the non-competition clauses.

THE EXPERT EVIDENCE

Mr Halligan, who gave evidence on behalf of the applicant

9. The applicant relied on the expert evidence provided by Mr Brendan Halligan, a valuer. His evidence was contained in two reports: exhibit A1, which is dated 14 April 2015, and exhibit A2, which is dated 17 June 2015. Mr Halligan is a chartered accountant and the principal of a specialist forensic accounting and valuation practice. I have no reason to doubt his qualifications to give expert evidence.

10. In exhibit A1, Mr Halligan opined (at [9]; see also [109]-[110]):

…the buyer acquired more in this transaction than the equity in AJM Environmental. In addition, it acquired certain valuable contractual rights that were part of the Sale and Purchase Agreement itself. These rights included….the non-competition agreements… The Purchase Price, therefore, reflected not only the market value of AJM Environmental but also the combined market value of these rights. Accordingly, it is necessary to deduct the combined market value of the rights from the Purchase Price in order to determine the amount referable to AJM Environmental.

11. Mr Halligan went on (in [10], [111]ff) to assign values to the various rights in the sale contract. He determined the non-competition clauses on their own had a market value of $1,671,000: at [117]-[119]. If that amount was quarantined from the purchase price payable under the contract, it followed that only "$16,016,000 of the Purchase Price [out of a total purchase price of $17.7 m] was referable to the relevant equity at the valuation date". Mr Halligan concluded (at [15]; see also [120]) that, after adjustments:

…the market value of Mr Miley ' s shareholding in AJM Environmental at the valuation date is $3.101 million and the market value of his shareholding in AJM Property at the valuation date is $14,000.

12. Mr Halligan's opinion as the value of the equity in AJM was informed by his analysis of the financial circumstances and assets of that entity. He also carefully evaluated the terms of the sale contract, including the non-competition obligations (at [82]ff) and the employment agreements (at [86]ff). And then there was the evidence of the sale price actually achieved. He explained (at [94]ff):

…the exchange that was effected by the Sale and Purchase Agreement provides strong evidence of the combined market value of all of the equity in AJM Environmental and AJM Property at the valuation date.

13. He went on to point out evidence of the sale price, while important and useful, was not definitive. He said:

…determining the market values of all of the equity in these companies is only a first step in determining the market values of Mr Miley ' s shareholdings. Further matters need to be taken into account before the market values of those shareholders can be determined.

14. Mr Halligan noted (at [95]) he assumed the valuation date to be 6 March 2008, the day before the parties entered into the contract. He explained it was appropriate to take account of the outcome achieved through the contract though the agreement had not formally come into existence on 6 March because the assets disposed of in the contract were comparable to those in existence at the valuation date: at [95], [97]-[99].

15. After pointing out (at [100]) the term 'market value' is not defined in the legislation, he acknowledged the widely accepted proposition that:

'market value is normally understood to mean the price that would be negotiated in an open and unrestricted market between a knowledgeable, willing but not anxious buyer and a knowledgeable, willing but not anxious seller acting at arm's length.

16. With that observation in mind, Mr Halligan opined (at [103]-[107]):

• • The sellers and the buyer were acting at arm's length;
• • The sellers and the buyer were knowledgeable;
• • The sellers and the buyer were willing and not anxious;
• • The purchase price did not, on its face, understate or overstate the value of the equity that would be objectively determined by hypothetical parties; and
• • The sale was negotiated in a market that was not entirely open because other potential buyers were not alerted to the possibility of the sale.

17. Mr Halligan was untroubled by the last consideration because he said the value achieved in the circumstances did not depart from what one would expect on an objective analysis: at [107].

18. While he did not quibble with 'market value' being used as the starting measure, Mr Halligan's point of departure was on the question of what was being sold in the sale transaction. After noting (at [109]) the sale contract stated the purchase price of $17.7 million was consideration for the sale of AJM (which also delivered the equity in AJM Properties), he went on to make the point that the buyer was acquiring more than just the equity. It was also acquiring the valuable contractual rights that were part of the sale contract: at [109]. He assessed the value of the non-competition rights negotiated in the sale contract at $1.671 m: at [119]. He explained the way in which he reached that amount at [121]-[126].

19. Having ascertained the purchase price of the equity less the value of the non-competition rights included in the sale contract, Mr Halligan then set about explaining how the purchase price for the equity should translate into a valuation of the applicant's shares. At this point of the analysis, he applied a 16.7% discount because the applicant's parcel of shares did not on their own confer control: at [134]. He reasoned:

135. All other things being equal, the average price per share of a controlling shareholding will be higher than the average price per share of a non-controlling shareholding because of the value of control.

136. The value of control relates to the value in having the power to make decisions that affect the amount, timing, and risk of the cash flows from an investment in the equity of a company, whether listed or unlisted. Those decisions might, for example, affect the company's strategic, operating, taxation, investment, and dividend policies.

20. Mr Halligan then went on to discuss research on corporate control transactions: at [139]. He concluded the size of the applicant's shareholding did not confer control in and of itself but it was capable of providing the applicant leverage over anyone seeking control - by giving the applicant the ability to block a special resolution, for example. He concluded:

I believe premium for control of 20% would be appropriate for both companies. A premium for control of 20% converts mathematically into a discount for the relative lack of control of 16.7%.

21. Mr Halligan suggested a further discount of 30% was appropriate to reflect the relative lack of marketability for each company. He pointed out "an investment is marketable if it can be sold and converted to cash in a relatively short period of time": at [143]. Given the sale of minority shareholdings in an unlisted privately held company is often more difficult - because there is no active market where transfers can readily be effected, and because many corporate constitutions in private companies include restrictions on the transfer of shares - Mr Halligan opined (at [142]) it was appropriate to apply a discount. He added that was a common practice in Australian valuations: at [148].

Mr Tony Samuel, who gave evidence on behalf of the Commissioner

22. Mr Tony Samuel is a chartered accountant. He leads the forensic accounting and valuation team at Sapere Research Group. His curriculum vitae is included in his report, which was tendered in the original proceedings: exhibit R6. I have no reason to doubt his expertise.

23. Mr Samuel's evidence in his report comes down to this: it was appropriate to value the shares using the 'market approach' in the absence of sufficient data suggesting a different methodology was appropriate: at [51]. He noted the sale documented in the agreement reached the day after the valuation date was a sale of the going concern by sellers acting willingly at arm's length from a willing and informed buyer, in circumstances where neither buyer nor sellers were especially anxious. He added there was a minor possibility the market value approach would understate the value of the company given the absence of proper marketing activity in this case: at [42]. The price paid for the going concern was the starting point for attempting a valuation of the shares sold by the applicant. He reasoned it was appropriate to simply divide the price received by three in circumstances where the applicant held one third of the shares. He then attributed one third of the sale price to each of the three (equal sized) parcels of shares after allowing for some minor adjustments: at [45].

24. Mr Samuel said it was not appropriate to discount the value attributed to each parcel to take account of the fact none of them individually delivered more than a minority shareholding. He argued the hypothetical willing seller of a minority shareholding would have been aware in the circumstances that the three parcels of shares could be sold together at the same time to deliver control. A control premium should therefore form part of the purchase price, and a discount was not appropriate: at [25], [125]-[129].

25. Mr Samuel also insisted it was inappropriate to apply a discount that reflected a lack of marketability. While he acknowledged AJM was an unlisted company and that sales of shareholdings in unlisted companies were generally more difficult than the sales of shareholdings in a listed company, he insisted it was wrong to apply a discount in the circumstances of this case. He explained that any marketability discount would have already been reflected in the purchase price paid by the buyer, so it was inappropriate to apply a further discount as Mr Halligan had done: at [124]-[125].

26. The evidence of Mr Samuel in relation to the treatment of the non-competition clauses is of particular relevance for present purposes. He said (at [118]) it was common practice for non-competition clauses to be included in a sale agreement because in a case like this:

From the point of view of the Buyer, a key attribute of the business being purchased was the continuing involvement of the three shareholders, and the absence of those individuals competing in the market against them.

27. Mr Samuel went on to note (at [120]) Mr Halligan had observed (in [83] and [84] of his report):

…the Sellers acknowledged, among other things, that:

…default under this clause would lessen the value of the Shares and the Business…

And:

…the restrictive undertakings in this clause are reasonable and necessary to protect the value of the Shares and the Business.

28. That concession, Mr Samuel argued, demonstrated "the value from non-competition is embedded in the value of the shares": at [121].

29. In the course of his report, Mr Samuel addressed (at [119]) the timing issue which appears to lie at the heart of the applicant's argument at the rehearing:

119. Whilst I agree with Mr Halligan that the non-competition agreements did not exist immediately prior to the sale of the shares in the AJM companies, in my opinion the non-competition agreements are no more than reasonable terms arising from that sale. Any value arising from non-competition is embedded in the value of the shares immediately prior to their sale. Indeed, as noted by Mr Halligan, the non-competition agreements arise from a clause within the Sale and Purchase Agreement.

120. Put another way, the value of the key stakeholders to the business (whether through the continued involvement in the business or their absence from the market by way of competition) is part of the goodwill of the business being acquired. The non-competition agreements are simply a mechanism for protecting the goodwill of the business.

30. Mr Halligan commented on these conclusions in his supplementary report dated 17 June 2017. In that report, he said (at [19]-[24]) he disagreed with Mr Halligan's analysis for four reasons:

• • The shareholders, acting individually or collectively, could have sold the equity in the company without agreeing to the non-competition clauses and the sale price they would have realised would almost certainly have been much lower;
• • The non-competition agreements and the equity in AJM Environmental are different items of property. We know that because (a) the rights created by the non-competition clauses only came into existence on the date of the agreement which came after the valuation date; (b) the property in the non-competition agreements came from the Sale and Purchase Agreement to which AJM Environmental was not a party whereas the property in the equity comes from the shares in the company; and - with respect, redundantly - (c) the equity was transferable without the negotiation of the non-competition clauses;
• • The Buyer treated the non-competition agreements as separate assets in its audited financial statements where it estimated them to be valued at approximately $1.671 million; and
• • The hypothetical seller would not have been able to enter into the non-competition agreement the applicant entered into because there is no basis for assuming the hypothetical seller was also capable of agreeing to enter into a non-competition agreement.

31. Mr Samuel concluded the applicant's shares were valued at $5.9 million as at the date of the valuation if one did not apply a discount reflecting the control issue.

32. I was provided with a copy of the transcript of the hearing that occurred before the Tribunal on the earlier occasion. Mr Halligan and Mr Samuels gave concurrent evidence in those proceedings. Mr Jones, who appeared for the applicant, pointed out in his oral submissions before me that he had asked Mr Samuel whether he agreed:

• • If the purchaser of the shares in the companies did not have the benefit of the non-competition clause, they would have paid less for the shares; and
• • The value of the company without the non-compete agreement is less than the value of the company with it.

33. Mr Jones noted Mr Samuels agreed with both propositions, and he never disputed the $1.6 million figure Mr Halligan had used as an estimate of the value of the clause.

THE CORRECT APPROACH TO THE VALUATION

34. I need not concern myself with the expert evidence concerning the appropriateness of discounts for marketability and control in the wake of the decision in Miley . The applicant focuses instead on whether the value attributed to his shares should be reduced to reflect a finding that part of the price he received under the sale contract was attributable to the non-competition clauses in the contract rather than the value of the shares.

35. The applicant's argument at the hearing before me was, at least up to a point, straight-forward. While Mr Jones, counsel for the applicant, did not articulate the case in precisely these terms, I was invited to infer the reasoning in Miley was not an obstacle to the applicant's success upon remittal because Wigney J expressly left open the question of how the Tribunal should deal with the arguments over the non-competition clauses that were not considered on the earlier occasion.

36. In his oral submissions, Mr Jones said the correct approach was to deduct the value of the restrictive covenants - which he said was not in doubt in light of the expert evidence - from the consideration nominated in the sale contract, and then divide the remaining figure by three. Mr Jones suggested that exercise involved a relatively conventional application of the apportionment rule contemplated in s 116-40 of the ITAA97 because there was more than one CGT event provided for in the sale contract. He explained the sale of the shares to the buyer was CGT event A1, which is addressed in s 104-10, while the creation of the contractual rights in the form of a restrictive covenant was CGT event D1, which is dealt with in s 104-35. He argued that distinction was important because the contractual rights "could only exist under contract, they didn't exist prior to the execution of this contract". Mr Jones pointed out both Mr Halligan and Mr Samuel agreed with that proposition - i.e., the non-competition agreements did not exist immediately prior to the sale of the shares - but only Mr Samuel said the value of the restrictive covenants became embedded in the purchase price of the shares.

37. Mr Jones said the High Court's decision in
Hepples v Federal Commissioner of Taxation (1992) 173 CLR 492 was authority for the proposition that the rights which were created only came into existence upon execution of the agreement.

38. Reduced to its essence, the applicant's case is that the rights created by the restrictive covenants did not even exist "just before the CGT event" when the valuation of the applicant's net assets was to occur. Prior to that point, Mr Miley was not under any obligation not to compete with the company or to remain in the company's employ. It follows that any value attributable to his agreement to accept those obligations does not become available until after the contract is concluded, and does not form part of his assets for the purpose of the maximum net asset value test.

39. While the applicant did not regard the reasoning in Miley as an obstacle to his success in these proceedings, I am not so sure. Wigney J pointed out (at [77]) the Tribunal was required:

…to determine the net value of Mr Miley ' s CGT assets "just before" the relevant CGT event. That in turn required the Tribunal to determine, amongst other things, the market value of those assets.

40. His Honour acknowledged (at [78]) the term 'market value' is not defined in the statute for present purposes but said it was widely accepted the expression refers to "what a willing and knowledgeable, but not anxious purchaser would pay a willing and knowledgeable, but not anxious vendor for the assets in question": citing
International Petroleum Investment Company v Independent Public Business Corporation of Papua New Guinea [2015] NSWCA 363 at [2] (per Bathurst CJ), citing Spencer and
Marks v GIO Australia Holdings Ltd [1998] HCA 69; (1998) 196 CLR 494. Wigney J went on to explain the market price of an asset was much easier to identify when the product in question was routinely traded on the open market; in such a case the current price on that market is a good guide (assuming, of course, the market is comprised of willing and not anxious participants trading at arms' length): at [79]. The task was more difficult where there was no ready market for the asset in question, or no buyers currently in the market. In such a case, his Honour explained at [80], it may be necessary to hypothesise:

…that there is a willing and knowledgeable, but not anxious purchaser. The question then becomes what a willing but not anxious vendor could reasonably expect to obtain, and what amount the hypothetical purchaser could reasonably expect to have to pay, if they got together and agreed on a price…

41. But His Honour warned one should not be too quick to rely on a hypothesis if there is other reliable evidence of market value at hand. His Honour explained (at [81])

Where the asset in question has been the subject of a recent arm's length sale, it is generally unnecessary to hypothesise. If the recent sale transaction can be said to be one between a willing but not anxious seller, and willing but not anxious buyer, the price that the buyer and seller actually agreed on may generally be taken to be the market price, or at least a reliable indictor [sic], if not the best evidence, of the market price…

42. In written submissions, the Commissioner pointed out there was no evidence to suggest the applicant and the others sellers and the buyers were not "freely contracting parties" in the sense that term was used by Gleeson CJ in
Boland v Yates [1999] HCA 64; (1999) 167 ALR 575 at [83]. In those circumstances, I was told there was no warrant for going beyond the evidence of what transpired in the sale - namely, that the applicant received $5.9 million for the sale of his 100 shares shortly just after the CGT event.

43. That analysis has the attraction of simplicity, but - the applicant would say - it does not really address the core of his argument: he did not just sell the shares in that sale. He also 'sold' a valuable right which did not come into existence until after the time of the valuation, and which accounts for part of the consideration he received under the contract of sale.

44. The Commissioner says that submission misses the point of the enquiry, which is to determine the market value of the shares just before their sale to the purchaser. Whatever their value as discreet assets, the restrictive covenants also had a positive impact on the value of the shares. Indeed, that was their point. A willing but not anxious buyer of a business like that owned by AJM- a business depending on the contribution of individuals associated with the business, or which required protection from subsequent competition provided by those individuals - would naturally press to include restrictive covenants in the contract for sale. The existence of those covenants justified paying a higher price for the shares. That is fair enough because the shares themselves are more valuable because of the covenants which enable the purchaser to capture and sustain more of the goodwill, as Dawson J explained in Hepples (at 519-520).

45. A buyer and seller bargaining at arms' length in these circumstances do not bargain in a vacuum. The individual sellers in this case were bargaining as one to achieve a comprehensive deal that delivered control of the company - something the applicant could not deliver on his own. The applicant, like so many sellers in his position, knew he could enhance the value of his shares in that transaction by agreeing to the restrictive covenants. The shares would have been valued in the shadow of the impending deal when all parties know of its terms and understood their likely impact on the consideration that would be delivered once the formal contract was executed.

46. The restrictive covenants were integral to the applicant maximising the value of his share sale. Without the covenants, he would have sold the shares for less. But without the sale, the covenants probably had no value: they were only valuable to a buyer in connection with the sale because they protected and preserved the goodwill which was embedded in the price paid for the shares. That commercial reality was explicitly acknowledged in the terms of the sale contract at clauses [13] and [23]. Clause [13], for example, included a requirement that the applicant enter into an employment agreement that would bind him to the company for a time. The terms of the employment agreement also acknowledge the intention to preserve the goodwill of the business, providing at clause [13.9.2]:

The restrictive undertakings in this paragraph:

• (a) are reasonable and necessary to protect the value of the Business; and
• (b) are separate from and in addition to the restrictive undertakings set out in the S&P agreement…

47. It follows the value of the shares just before their sale - the relevant point for assessing their value for the purposes of the asset test in Div 152 - was impacted by the terms of the deal that was formally struck immediately thereafter. There is no justification for looking beyond the evidence of value suggested by that transaction, nor is there any justification for splitting hairs over the nature of the assets that were sold. The parties to the sale were quite clear on what they wanted to achieve in the contract: they wanted to achieve a sale of the shares, and they negotiated a price which delivered an agreed value to the applicants as consideration for that outcome.

48. The correct approach is to take the total purchase price and divide it by three. That meant the shares were valued at $5.9 million. When that amount is added to the value of other assets held by the applicant, the net value of his assets for the purposes of the test in Div 152 exceeds $6 million. That means he is not entitled to the concessions conferred under that division. The objection decision as to primary tax liability must therefore be affirmed.

PENALTIES

49. The Commissioner imposed administrative penalties on the applicant. The applicant says he should not have done so because the applicant's position, even if ultimately proven to be wrong, was reasonably arguable. I agree with the applicant.

50. This case has raised thorny questions over valuations. The decision of Wigney J in Miley provided welcome clarification of the correct approach to valuing assets under Div 152. But the clarity of that reasoning was not available to the applicant when he set about trying to prove his case. Even after the decision in Miley was handed down, the portion of the dispute litigated in these proceedings continued to present a difficult question that required careful analysis with the assistance of experienced tax lawyers who took different views. I am satisfied Mr Miley presented cogent and rational arguments through highly competent counsel that were reasonably open in the circumstances.

51. The Commissioner does not have to impose an administrative penalty every time there is a shortfall. The law in this area is advanced when taxpayers make reasoned arguments in good faith about their liability.

52. While the Court and the Tribunal did not ultimately accept the applicant's arguments, it was a close run thing. I am satisfied the objection decision with respect to the penalties should be set aside and decide in substitution that an administrative penalty should not be imposed.