Introduction
This case (ABC (Pty) Ltd v Commissioner for SARS ITC12466) considers the reasonability of the valuation method utilised by the appellant, ABC (Pty) Ltd, in valuing its shares in D entity which were sold during the 2002 and 2003 years of assessments. The value of those shares impacted their base cost for Capital Gains Tax (CGT) purposes and resulted in a capital loss of approximately R8 million for ABC.
ABC acquired its shares in D Entity before the date when capital gains tax was introduced in South Africa (1 October 2001), thus making the shares “pre-valuation date assets” as defined in paragraph 1 of the 8th Schedule. For the purpose of determining the base cost of pre-valuation date assets as at 1 October 2001, paragraph 26(1) of the 8th Schedule gives the taxpayer an election to use any one of three valuation options. One option is market value as contemplated in paragraph 29 of the 8th Schedule, which ABC chose to use.
ABC had valued the entire D Entity company using the discount cash flow (DCF) method and then apportioned the company value to the percentage of its D Entity shares sold. This apportionment was for the purpose of determining the base cost of the shares for CGT purposes. The Commissioner of the South African Revenue Services (CSARS) rejected the DCF method in his additional assessments issued to ABC for the 2002 and 2003 years of assessments in which he reduced the base cost of the shares to nil.
On 5 July 2007, ABC objected to the additional assessments. The objection was based on the fact that the Commissioner’s rejection of the valuation of the D Entity shares as at 1 October 2001 was misguided and flawed in material respects. Following the disallowance of the objection, an appeal was made by ABC to the Cape Town Tax Court.
Facts
During the 2002 and 2003 years of assessments, ABC (Pty) Ltd, an investment holding company, sold some of its shares in D Entity (Pty) Ltd, a casino and hotel company. 2.37% of the shares were sold during the 2002 year of assessment and another 2% was sold during the 2003 year of assessment. ABC recognised a capital loss in excess of R8 million for CGT purposes on the disposal of the shares. On 10 April 2007, the Commissioner of the South African Revenue Services (CSARS) issued additional assessments in respect of the years of assessments when the shares were sold.
In the additional assessments, raised in terms of paragraph 29(7) of the 8th Schedule, the Commissioner reduced the base cost of the ABC’s shares in D Entity from R 8,6 million to R nil. The resulting effect for ABC was a capital gain of R2 million in its 2002 year of assessment and another capital gain of R2,2 million in its 2003 year of assessment.
On 5 July 2007, ABC objected to the additional assessments. ABC had valued the entire D Entity company using the discount cash flow (DCF) method; which values the business of an entity on its future forecast free cash flows, discounted back to present value terms through the application of a discount factor which represents the required return sought by an investor. This discount factor is also reflective of the risk inherent in the business. The valuation was obtained from an independent firm of specialists. However, the Commissioner rejected the DCF method, viewing the “net asset value” method as a more appropriate valuation method under the circumstances. In terms of the net asset value method, the Commissioner considered D Entity’s net asset value to be R nil on 1 October 2001. ABC’s shareholding in D Entity as at 1 October 2001 was therefore also R nil, thereby justifying the Commissioner’s reduction of the base cost of the shares to nil.
The specific circumstances viewed by the CSARS as warranting the rejection of the discount cash flow method was the fact that as at 1 October 2001, although D Entity had been granted a casino licence, the pending litigation with the X Group regarding a dispute over the location from which the casino would operate made it difficult to predict future cash flows. As a result of this dispute, D Entity applied for a temporary licence for the operation of a temporary casino at an alternative site, but this licence was only granted on the 4th October 2001, after the “valuation date” of 1 October 2001 for CGT purposes.
The court held that the litigation between the X Group and D Entity was not so significant as to make future cash flow predictions very difficult for the purpose of using the DCF valuation method. Furthermore, upon testimony of witnesses, it was found that although the temporary licence was granted after 1 October 2001, by that date all indications from the Gambling Board were that D Entity would definitely receive the licence. So much so that the company had already made certain capital expenditures regarding site preparation with the confidence it would receive the licence.
Held
Both the future cash flows as well as the discount rate used in the DCF method were found to be reasonable; having been prepared independent by a highly professional firm for substantiating the temporary licence application. They were also audited by the Gambling Board considering the grant of the licence.
Yekiso, J further surmised the following at par 64:
“In addition, the figures were not prepared for a capital gains valuation but rather in support of a temporary licence application. In my view, figures prepared by a third party and subjected to public scrutiny would be more reliable than if prepared by management solely for capital gains valuation purposes.”
The 2002 and 2003 additional assessments were consequently set aside, with the Commissioner being ordered to pay costs.