A Homage to Reverend Charles Dodgson

This 2017 Tribunal decision related to the value of shares for gift aid purposes. Readers may recall the case of N Green v HMRC relating to a company, Chartersea, which had been listed on the Channels Islands stock exchange.

Both cases related to claims that shares had marvellously increased in value by a factor of 4 or more as a result of being placed on a public exchange. 

Interest in this case may be quickened as the target company was an accountancy firm, Frenkel Topping Limited, (“FTL”) a firm which specialised in personal injury claims work. It was acquired by a company renamed as Frenkel Topping Group Limited (“FTG”) which was admitted to the Alternative Investment Market (“AIM”) on 28 July 2004. Gifts of shares to unsuspecting charities were made by various shareholders, including Mr Netley, on that same date. 

The task at hand for the Tribunal was to determine:

“What was the market value of the shares in Frenkel Topping Group Plc which the Lead Appellant disposed of by way of gift to charity on 28 July 2004 as at that date for the purposes of section 587B ICTA 1988 (and on what basis and principles should the market value of such shares be determined)?”

“Why, sometimes I believe as many as six impossible things before breakfast.”

The range of values was wide: the taxpayer maintained a value of 48p per share, whereas HMRC considered the value to be 6.6p. 

Mr Netley held 82,000 shares which had a subscription price of £10,000 or 12.2p per share. These shares were gifted to charity. On the same date as the gift, Mr Netley had subscribed for a further 4,792 shares for £2,300, or 48p per share under a placing memorandum.

In order to track the complex tangle of share issues and consolidations, the data is collected below:

If the fact that JBS had a close business relationship with FTL is set to one side, the indicative value for the entire share capital immediately prior to the acquisition of FTL is therefore 10.52p per share. What factors led to that value increasing by a factor of just over 4.5 times to a value of 48p per share?

“It would be so nice if something made sense for a change.”

On the day of the admission of the shares to AIM, there were four trades, two of 1,000 shares and two of 4,972 shares at prices of 49.63p and 47.25p respectively. One of those trades related to the mother of one of the original subscribers who was buying the shares due to their investment potential. This was therefore a similar pattern of events as occurred in other cases. 

There was then a considerable gap before the next transaction on the AIM market, with 7,187 shares being bought at 45.5p on 26 October 2004. This was indeed very thin trading in the shares of FTG. It was recognised that only 0.8% of the shares were freely transferable in any event, with the rest being bound by various transfer restrictions. The Tribunal did not consider that these trades were a reliable indicator of the market value of the shares. 

“Curiouser and Curiouser”

Perhaps it was a bargain purchase of 66.2% of FTL which turned base metal into gold. There was an agreement that a further 16.6% of FTL was to be acquired for £600,000, so the indicative value of 66.2% of FTL was some £2,393,000. In the acquisition agreement the figure cited was close to this at £2,248,250. If this figure is plugged into the table above, it moves the value down to 9.35p per share. 

If this was not the source of the alchemy, then where was it to be found? It was argued that the shares increased in value very materially as a result of being admitted to the AIM market. This is an odd conclusion: the logical first step must be that an admission to the AIM market is worth just the cost of acquiring it. 

The Valuation Experts  

The two experts were both Chartered Accountants and experienced valuers. The values argued were 42p and 6.6p for taxpayer and HMRC respectively.

The expert for the taxpayer considered that another company which was admitted to AIM some months after FTG, Brookes Macdonald plc, was the best source of evidence as to value. This derived a value for the shares of FTG of 42.17p. 

The expert for HMRC used a price earnings ratio approach, seeking guidance from the FTSE Actuaries index, the BDO PCPI and the acquisition of FTL. The latter provided PE ratios of 11.2 to 11.9, whilst the FTSE Actuaries Index was 13.0 and the BDO PCPI was 14.0. He reduced the PE ratio to 10, being swayed by losses made by FTL in its latest period. Based on 2003 earnings for FTL of £302,496, and with no adjustment for the costs of being on AIM, he derived earnings per share of 0.66p and a valuation of 6.6p per share. 

“Everything’s got a moral, if only you can find it.”

The valuation decision was very materially affected by the view that shares in a public company were worth twice those of a private company. The PE ratio of 11.9 was rounded to 12 and doubled to 24 as this was a public company. This delivered values per share on the basis of maintainable profits of 15.9p. This figure was then increased to 17.5p, equivalent to the consideration paid by JBS for its shares in FTG.

“When I use a word it means just what I choose it to mean.”

There are various technical considerations which ooze out of this case: 

• This was another case in which DCF was employed by one of the experts – it did not gain traction in valuing a small minority holding as the Tribunal held that the relevant information would not have been available; 
• The BDO PCPI was not a favoured source, as there was no information as to what transactions were included within it;
• It was also noted that the BDO PCPI related to 100% interests which commanded a premium compared to minority holdings;
• As with the case of N Green v HMRC there was little included in the published Decision regarding the fundamental challenge of applying minority discounts. If subscribers invest in a company they would not expect to find that their shares would immediately be savagely discounted; they would not anticipate a valuation on the following day of 20% to 25% of the amount subscribed. However, some 12 months later a high discount would be applied to the valuation of small holdings in many companies with scarcely a second thought, unless there was strong governance or a liquid market in the shares;
• A related theme which was not explored in depth related to the differences between minority holdings in private companies and public companies. In this case, although FTG had the title of plc and the badge of honour of admission to AIM, the shares cannot be considered liquid in any real sense. In this context, the very notion that the PE ratio should be doubled as the company was a public company can be readily questioned. If admission to AIM is worth more than the cost of acquiring it, we must ask from where does that increased value come;
• The FTSE Actuaries Index was also not a favoured source as the companies in the index were far larger and there was no information on relative growth prospects. Clearly the use of a PE multiple which was far higher than that index could only be justified if there were strong grounds to believe that the growth prospects of FTG were stratospheric in nature. However the Tribunal made it very clear that this was not their finding;
• The evidence of the pricing of Brookes Macdonald plc was swept aside, as it entered AIM after 28 July 2004. It could therefore not be known about by market participants at that date. However if it was a fair reflection of market sentiment, we might have expected it to be valid evidence of market pricing. We might then expect it to stand, unless there was evidence that the market sentiment had moved between the two dates. Subsequent events are generally valid in valuations if such events cast a penetrating light back into the fog of the past, moving from the shadows the circumstances which applied at an earlier date.

Andrew Strickland