Valuation of property
The types of property upon which experts are called to express valuation opinions include:
· Real estate
· Business
· Art
· Mining Property
· Life interest in real estate
· Software
There is a necessary measure of inexactitude in valuation. Lord Simon stated in Gold Coast Selection Trust v. Humphrey, [1948] A.C. 459:
“If the asset is difficult to value but is nonetheless of a money value, the best valuation possible must be made. Valuation is an art, not a science. Mathematical certainty is not demanded, nor indeed is it possible.”
It is rare for the court to accept exactly the valuation put forward by one or other valuator. The reason for this is that seldom is the opinion of value expressed by one valuator determinative or even particularly important.
The utility of valuation opinions in tax cases is that the expert valuations for both sides contain hearsay data of comparables or other information as well as principles or methodology that enable the judge to arrive at his or her own valuation.
Expert valuation testimony is important in the valuation of businesses. A business expert’s valuation performs an essential function in assisting the court to choose and apply methods of valuation.
Since there is usually a disparity between methods used and the determination of the appropriate capitalisation rate, it is important that the expert explain to the court how the various methods are applied and why a particular capitalisation rate should be chosen.
To the average judge, the choice and application of the capitalisation rate are not matters that are familiar to him or her.
Other areas where experts are called are in the valuation of art, software or artefacts of some type. In each case, the experts are essential for several reasons:
· They put before the court comparables which are otherwise hearsay;
· They give the court evidence of different methods of appraising property that have varying degrees of acceptability;
· They state conclusions of value that are not, as a rule, treated as conclusive by the court; and
· They give the court, which is generally not an expert, the tools, methodology and evidence which will enable the court to form its own valuation.
It is only if courts recognise the practical utility of those various functions that they can approach the issue with the knowledge and objectivity necessary to perform their function.
Judges must of necessity turn themselves into experts in a narrow field of expertise that is in issue before them. They must do so in order to examine the evidence of the expert critically and objectively. Otherwise they can be misled into accepting an untenable proposition advocated by overly partisan experts for one side or the other.
Software
One of the most elusive, difficult and complex areas of expertise is the valuation of software.
One reason for this is that software forms the basis of many tax shelters in which an integral component is the value of the software which is said to be the price which the investor or a partnership agrees to pay.
Accounting testimony
I start with two fundamentally opposed propositions:
· Evidence on the question of whether the treatment of a particular item is in accordance with generally accepted accounting principles (GAAP) is usually irrelevant and is of no assistance in determining whether the treatment of such items is acceptable for the purposes of computing income for tax purposes.
· It is customary to allow parties (usually taxpayers) to adduce evidence of GAAP or its more recent incarnation international financial reporting standards (IFRS).
Judges acknowledge that GAAP plays a very minor role in the determination of income for tax purposes.
The weight, if any, to be accorded to the accounting treatment was discussed fully in Ikea Limited v Canada.
The issue in that case was whether tenant inducement payments received by a proposed lessee from a lessor were received on capital or revenue account.
The Tax Court held the receipts to be on revenue account in the hands of the recipient and to be included in the income of the recipient in the year of receipt. This judgment was upheld by the Federal Court of Appeal and the Supreme Court of Canada.
The appellant filed with the court a statement by a chartered accountant. She stated that the proper treatment under GAAP was for Ikea not to include the entire lease inducement payment of C$2.65 million ($2.64 million) in determining its earnings for the 1986 year, but rather to apply a portion of it to the cost of fixtures and to amortize the balance over the term of the lease.
The Tax Court, Federal Court of Appeal and the Supreme Court all held that notwithstanding the accounting treatment, the entire lease inducement payment should be included in the taxpayer’s income in the year of receipt.
Transfer pricing
The next area in which expert opinion evidence is frequently called is in cases involving transfer pricing.
There have been several major transfer pricing cases recently:
· GlaxoSmithKline 2012 SCC 52 (SCC)
· General Electric Capital Canada Inc. 2011 DTC 5558 (FCA)
· Alberta Printed Circuits Ltd. 2011 DTC 967 (TCC)
In GlaxoSmithKline and General Electric, ss.69(2) of the Income Tax Act was applied. In Alberta Printed Circuits in the TCC, ss.247(2) was applied by the Canada Revenue Agency (CRA) and its application was substantially modified by the TCC.
The determination of fair market value for the purpose of ss.69(1) is relatively routine and expert evidence on such an issue is regularly called. A more difficult question is what type of expert testimony is required in a case involving ss.247(2).
An issue under ss.247(2) is whether – under paragraph (a) – the terms and conditions made or imposed in respect of its transaction or series “differ from those that would have been made between persons dealing at arm’s length” or under paragraph (b) “where the transaction or series would not have been entered into between persons dealing at arm’s length”.
In Alberta Printed Circuits, Mr. Justice Pizzatelli dealt with this problem in a very thorough analysis. He was required to consider five different methods of valuation:
Traditional transaction methods:
· The comparable uncontrolled price method;
· The resale price method; and
· The cost-plusmethod.
Transactionalprofit methods:
· The profit-split method; and
· The transactional net margin method.
The difference between ss.69(2) (repealed) and ss.247(2) has been very simply resolved by the Federal Court of Appeal in General Electric Canada Ltd.:
“Subsection 69(2) was replaced by subsection 247(2) of the Act for taxation years beginning in 1998, which covers all the taxation years under appeal here. However, as the Federal Court of Appeal confirmed in paragraph 12 of General Electric Capital Canada Inc. v. Canada, ’…there is no meaningful difference between paragraphs 247(2)(a) and (c) and subsection 69(2) of the Act.’”
In other words, ss.69(2) and ss.247(2) have conveniently been reduced to a relatively simple free market value test.
The determination of free market value can be a complex and difficult procedure and in the case of valuation necessary to determine transfer pricing issues, the court must, as was done in Alberta Printed Circuits, exercise an informed discretion in determining which method of valuation is most appropriate.
In making such a choice, expert valuators knowledgeable in all methods are indispensable. What the court must constantly recognise is that the court is the ultimate adjudicator of the most appropriate method, not the valuator, no matter how expert.
