Summary

The approach in determining the market value of a taxpayer's shareholding in a company was to determine the price a hypothetical purchaser would pay. A fair figure for the net sustainable pre tax profit of the company was a figure that took into account various factors including the history of growth of the company, and a fair multiplier was to be taken from a directly comparable company.

Facts

Determination of the market value of the taxpayer's (M) shares, as at March 31, 1982 which value was relevant to M's liability to capital gains tax on the disposal of the shares. M was the managing director of R and owned 66 per cent of the shares. In the year to March 1981, R's net profit was 10.7 per cent of turnover. In the preceding years there had been a steady growth in the net profit. In the year to March 1982 R's net profit after directors' emoluments but before tax was diminished to 2.9 per cent by a significant increase in overheads. At that time R underwent difficulties as a result of the depreciation of sterling. R had obtained some protection against currency movements by buying US dollars forward, but subsequently discontinued that practice, which had an adverse effect on its profitability. R did not have management accounts or any equivalent, nor did it undertake budgeting or forecasting. The experts appointed by the parties agreed that the appropriate method of valuing the company was the capitalised earnings approach, that required the maintainable earnings of the business to be identified and then multiplied by an appropriate factor. The disagreement between them about the multiplier was relatively modest, but the experts did not agree as to the level of R's maintainable earnings.

Held

The court was required to determine the price that a willing purchaser would pay M for his shareholding in R. A purchaser would not regard a recalculation of the actual results in the year to March 31, 1982 by the use of historical exchange rates as a sensible basis for the determination of a fair price. Adjustments of the profits to take account of excessive expenditure were appropriate. A hypothetical purchaser would consider whether R had a sound business to whose true profitability the pre-1982 figures were a realistic and reliable guide, and would ask himself whether the year to 1982 was an isolated poor year whose outcome might not be repeated. Accordingly a fair figure for the net sustainable pre tax annual profit of R as at March 31, 1982 was a figure that took into account the better results of R, and the history of growth to March 1981, the poor results in the year to March 1982, the cost of taking protective measures (against adverse currency movements), adjustment of overheads and the comparatively high level of stock held by R in March 1982. A calculation of the effective rate of corporation tax that the company actually suffered was no longer possible. The average rate of tax, 16.6 per cent, in the three years to March 31, 1982 should be adopted. Net after tax earnings were therefore £95,910 per year. The appropriate multiplier was 10. The most directly comparable company was one whose price-earning ratio was at the time 11.6. However, an investor in that company, buying less readily marketable shares, would expect to fix his price by reference to a smaller multiplier. Accordingly the value of the entire company as at March 31, 1982 was £959,100 and the value of the taxpayer's shareholding was £633,006.

Judgment accordingly.