Tax Court Rules: A Business Claims Value of $12M; The IRS Argues for $36M

Estate of Natale B. Giustina v. Commissioner

What happens when a case lands in the United States Tax Court where Form 706 found the fair market value of a business share at $12.6 million and the IRS estimates it’s worth $36 million? Find out, in Estate of Natale B. Giustina v. Commissioner! At issue was a 41 percent share in a closely held timber company.

Meanwhile, in the Delaware Chancery Court, In re Answers Corp. Shareholders Litigation finds plaintiff shareholders arguing to enjoin the sale of the company because they believed it was of higher worth. The Court finds the plaintiff’s disclosure own disclosure inadequate, and orders reliance on the market approach to business valuation. Here’s why.

Estate of Natale B. Giustina v. Commissioner
T.C. Memo. 2011-141
June 22, 2011
Judge Morrison
United States Tax Court

The primary issue before the United States Tax Court was the fair market value of the decedent’s 41.1 percent interest in a closely-held timber holding company. The Form 706 reported a value of approximately $12.6 million, the IRS valued the interest at $36 million, and the Tax Court ruled the fair market value of the decedent’s interest was approximately $27.5 million.

The court found the estate expert’s DCF analysis to be better overall; however, the expert tax-affected the earnings, and the court reversed the tax-affecting adjustment. The court also ruled that the estate expert’s company specific risk premium of 3.5 percent was too high, citing “standard portfolio investment theory.”

As such, the court lowered the estate expert’s company specific risk premium to 1.75 percent. The court accepted the IRS expert’s 25 percent discount for lack of marketability over the estate expert’s 35 percent DLOM, which was based on pre-IPO studies. The court did not allow for an application of a discount for lack of control under the adjusted net asset, stating that a minority shareholder would receive their pro-rata share of the sales proceeds (ignoring the fact that the minority owner cannot unilaterally compel liquidation).

Finally, the court assigned weightings to only the income and asset approaches, assigning weights of 75 percent and 25 percent, respectively. The weights were based on the fact that the court felt there was a 75 percent chance the entity would continue to operate as a going concern and only a 25 percent chance of liquidation.

In re Answers Corp. Shareholders Litigation
2011 Del. Ch. LEXIS 57
April 11, 2011
Judge Noble
Delaware Court of Chancery

Plaintiff shareholders filed a motion for a preliminary injunction to enjoin the sale of defendant company, arguing the deal was the result of an unfair sales process and characterized by an unfair price, and defendants, the company’s board of directors, had to make additional and corrective disclosures in the proxy materials relating to the sale.

The company operated a website that was highly dependent on search engines. The shareholders argued the self-interests of three board members tainted the negotiating process. However, the shareholders did not challenge the independence or disinterestedness of four directors on the seven-member board. Thus, the process and the proposed transaction were approved by a disinterested and independent board. Further, the market check and strategic alternatives to selling the company were adequate. Ultimately, no other bidders emerged.

The shareholders limited their disclosure claim to six graphs. Five of the graphs were either confusing to shareholders or not material to the shareholders’ vote and did not have to be disclosed. The sixth graph adequately apprised shareholders of the risks arising out of the company’s dependency on a particular search engine.

The shareholders did not show: (1) a reasonable probability of success on the merits of their claims; (2) that the proposed class would suffer irreparable harm in the absence of interim injunctive relief; and (3) that a balance of the equities supported judicial interference with the stockholder franchise. The Delaware Chancery Court approved the sale of the Internet company, despite the lack of any long-term forecasts (preventing the use of a DCF analysis).

As such, the fairness opinion had to rely on the market approach. It should be noted that the court was made aware that the public comparables were not truly comparable to the subject.