A Case Full of Technical Content
This is another case relating to gift aid. Readers may recall the cases of N Green and HMRC, and also J Netley and HMRC, both relating to gifts of shares to charities. These gifts were made shortly after the entry of cash shell companies onto the Channel Islands Stock Exchange or AIM. The cash shell companies had very recently acquired trading subsidiary undertakings.
This case has similar features: a cash shell was created, called Sharp Creation plc. Immediately prior to it acquiring a trading subsidiary, Baa Bar Limited, it had 12,151,409 shares in issue with amounts subscribed in cash of £2,403,999. The average subscription price was therefore 19.78p per share.
It has been taking some considerable time for these cases to wend their way to the Tax Tribunal. This case related to gifts of shares made in 2003.
Student Bars in North West
Baa Bar Limited operated 7 bars in Liverpool and Manchester focussing on the student communities in those two cities. It had been seeking a buyer for some months and offers had been received in the broad range of £9 million to £13 million. Sharp Creation plc offered the most advantageous price to the shareholders of Baa Bar Limited and the acquisition took place in November 2006.
The offer comprised cash of just over £12m together with 5,185,000 shares in Sharp Creation plc. The total consideration therefore varies according to the value that is attributed to the consideration shares:
- Should the value be the average subscription price of 19.78p?
- Should that value be reduced by the costs incurred to date?
- Should the value be 26.04p per share as set out in the purchase agreement? If so, what was the source of the additional value of 6.26p per share?
Whatever the answers to the above questions, we have a relatively close range of values for the entire share capital of Baa Bar Limited of some £13 million to £13.6 million. As Baa Bar Limited had been exposed to the market there is no indication that this was any form of bargain purchase.
The cash consideration was greatly in excess of the funds raised from shareholders. This consideration was very largely funded by bank borrowings of £11.7 million. The group therefore started life with eye-watering borrowings, with a gearing of more than 3:1.
The Channel Islands Stock Exchange (CISX)
Very soon after the acquisition of Baa Bar Limited the buyer changed its name to Baa Bar Group plc and it was listed on the Channel Islands Stock Exchange. It was launched onto the market with a list price of 108p. At that point there were just over 17.3 million shares in issue. The market capitalisation on the basis of the list price was therefore a little short of £19 million.
An obvious question to ask was the source of the additional value: the shareholders had subscribed 19.78p per share before costs; there was no indication that Baa Bar Limited represented a bargain purchase, so that purchase should not have moved that amount. Was there some alchemy at work whereby the very act of listing onto CISX created value?
A theme with some of these gift aid cases is that base metal is purportedly converted into gold as a result of listing on the CISX or being launched onto the AIM market. However, there is very little justification for this belief: without a deep and liquid market for the shares, the companies have the badge of honour of being public companies in the markets and very little else, apart from the additional compliance costs that go with that badge.
The Tax Event
Shareholders gifted shares to charities at various dates: the Tax Tribunal was initially concerned with valuations some three months after the listing on the CISX.
The HMRC valuation expert referenced the values at that date to the components of the company. There had been no trading update since launch and therefore nothing to indicate to shareholders any changes in value.
His valuation can be summarised:
| Net asset value net of costs Group cash ignored |
17.05 (6.05) |
pence |
| Before DLOC and DLOM Less DLOC and DLOM 29.5% |
11.00 (3.00) |
|
| Value under cost approach | 8.00 | pence |
I assume that the cash in the holding company was considered to be operating cash. This adjustment had a materially depressive impact on the values, as can be seen.
There are some other immediate valuation points of considerable interest: firstly, we have to consider at what stage in the pricing of listed securities the costs of launch are deducted. Is it the next day, 3 months’ later or a year later? In this case the valuer had determined that the initial costs should no longer feature in the valuation considerations after a period of 3 months.
The second point to consider is the point at which minority discounts feature in valuations. A prudent purchaser would not buy a minority interest at a share price of £1 if he knew that the next day their value would be discounted. However, we would all accept that a small minority interest in a company with no ready market for its shares may be subject to a discount at some modest distance from the date of the subscription. In this case the valuer determined that such discounts were in point after a period of 3 months.
The calculations relating to the DLOC and DLOM deserve analysis: the DLOC was driven by a control premium of 26%. The source of this control premium was not stated in the written decision. This then meant that the discount for lack of control was 26/126, which equated to 20.6%. It appears that the concept of the control premium is alive and well.
As well as a control premium of 26%, added to the value, there had been a deduction of 24% to reflect that this was, in essence, a private company, regardless of the clothing with which it was adorned.
In the next article, we will consider the calculations relating to the DLOM and some of the other fascinating technical aspects of this fiscal valuation.
*The views expressed are the author's and not ICAEW's.