Determining the Market Values for Small Business CGT Concessions - Moloney's Case

Relevance of 'Market Value' in Accessing the SBC

A private business may undergo a restructure for a number of reasons (for example - estate planning, future exit, structuring or asset protection reasons). However, without tax relief, an internal restructure may result in a significant CGT impost.

The small business CGT concessions (SBC) can be a handy tool for internal restructures, potentially allowing any capital gain arising on an internal business restructure to be significantly reduced or eliminated.

When applying the SBC, the concept of 'market value' plays a crucial role, Relevantly, this includes:

• the maximum net asset value test (MNAV Test), which requires the net value of the CGT assets (being their 'market value' less certain liabilities) to be below $6 million;
• determining the 'capital proceeds', where the market value substitution rule can apply if parties are not dealing at arm's length.

Moloney & Ors v FC of T [2024] AATA 1483 shows the difficulty in valuing intangible assets such as goodwill or an equity interest in a private business, which are generally unique and illiquid. Just as a master chef's recipe of unique ingredients can be closely examined by judges, the Moloney's decision highlights how a valuer's report and assumptions used can be closely scrutinised by the Commissioner - and possibly by a Tribunal or Court.

Background Facts - Moloney & Ors v FC of T [2024] AATA 1483

In summary:

1. the JG Moloney Family Trust (Moloney Trust) owned shares in a company that carried on a business specialising in agricultural products in Western Australia.
2. under an internal restructure, the Moloney Trust sold the shares to a company (which happened to be the existing trustee of the Moloney Trust).
3. the Moloney Trust obtained advice from Crowe Horwath providing that the SBC applied and the MNAV Test was met (based on the valuation of the business). A valuation was also obtained from a valuer at Crowe Horwath, which stated the market value of the business was $3.5 million. In calculating the capital gain arising from the share sale, the Moloney Trust applied the 50% CGT discount and a combination of various small business CGT concessions, resulting in a net capital gain of $nil.
4. under an audit, the Commissioner sought its own valuations from KordaMentha. The audit decision concluded that the market values substitution rule applied to substitute the KordaMentha value of the shares (around $10 million) in place of the share sale price under the restructure. Further, it was concluded that the MNAV Test was failed (relying on the KordaMentha valuation), thus the Moloney Trust was not entitled to claim the SBC. The audit decision resulted in a net capital gain of $3,488,740.50 and notice of amended assessments were issued.
5. the Commissioner determined that all relevant information was provided to the tax agent, thus no shortfall penalties were imposed. This was based on the ‘safe harbour rule’ in subsection 284-75(6) of the Taxation Administration Act 1953 (Cth), which applies where the taxpayer provides the registered tax agent with all relevant taxation information (and there was no intentional disregard or recklessness by the agent).

After lodging an Objection (which was disallowed), the taxpayers applied to the AAT for a review of the objection decision. In the Objection, they primarily relied on another valuation (from PKF, which valued the shares at around $3 million).

AAT’s Decision

There were two key issues before the AAT, which is summarised as follows (along with the AAT’s conclusion regarding each issue):

1. were the parties dealing at an arm’s length: If it is found that the parties were not dealing at arm’s length, the market value substitution rule would apply. The AAT found no real bargaining between the related parties. In particular, the AAT noted that the same individuals controlled both sides of the transaction and the valuations were simply accepted without challenge. Thus, they were not dealing at arm’s length and the capital proceeds is deemed to be the ‘market value’ of the shares;
2. application of the MNAV Test: the determination of the market value also affects the availability of the SBC by virtue of the MNAV Test (i.e. if the Commissioner’s higher valuation was accepted, this meant that the $6 million threshold was exceeded and the SBC was not available. The AAT thoroughly examined the rationales and assumptions behind each valuation and ultimately, the AAT preferred PKF’s more conservative valuation over KordaMentha’s higher figure. Deputy President Molloy was persuaded by  a lower capitalisation multiple (3.75 to 4.25) compared to that adopted by KordaMentha (5.5 to 6.0), as it considered PKF’s was more realistic given the challenges of selling an interest in an unlisted entity, as well as the nature of the business (limited geographical operation of the agricultural business and poor profitability forecasts for the sector).

Outcome

The AAT’s preference of the taxpayers' valuation meant that:

1. the capital proceeds determined by the Commissioner under the amended assessment ($10 million) was incorrect. The market value substitution rule applied to deem the capital proceeds to be based on the taxpayer’s PKF valuation and not the Commissioner’s significantly higher valuation; and
2. the MNAV remained under $6 million, allowing access to SBC and resulting in a net capital gain of $nil for the income year that the internal restructure occurred.

Key Takeaways

• Transactions between related parties will often be non-arm’s length, meaning that obtaining a market value would be necessary to substantiate the market value of the CGT asset in question
• Be prepared for the Commissioner to challenge valuations, as the Commissioner may obtain their own valuations of the market value.
• Seeking specialist tax advice on internal restructure and obtaining a robust valuation is crucial, as in Moloney it meant that the Commissioner did not seek to impose an administrative penalty (even if they believed that the Concessions did not apply).

‍This article in no way constitutes legal advice. It is general in nature and is the opinion of the author only. You should seek legal advice tailored to your individual circumstances before acting on anything related to this article.