VALUING A BUSINESS WITHOUT ACCURATE FINANCIAL STATEMENTS
by Gerald S. Blackman,CA, ALA, CBA, CFE
(Reprinted from the Canadian Journal of Litigation Accounting, December 1993)
All too often, clients
do not fully comprehend the need to have a detailed real estate appraisal
or business valuation report prepared in support of the numbers being
used in documents filed with revenue authorities. A 1987 U.S. Tax Court
case, Estate of Spruill v. Commissioner, illustrates the weight
courts place on a well-documented appraisal report attached to documents
filed with the taxation authorities. The case, although involving U.S.
estate tax, deals primarily with the valuation of real estate.
The decedent left
property comprised of 38 acres of farmland. This land was zoned as residential,
but was bordered by a suburban office park and a major regional shopping
centre. The executors engaged an attorney and an accountant with extensive
experience in estate administration and the preparation and filing of
estate tax returns. The accountant hired an appraiser to value the real
estate at the date of death. The lawyer and accountant reviewed the
appraisal, determined it was reasonable, and filed it along with the
estate tax return.
A series of events, including a sale of the farmland over a year after
the decedent's death at a price substantially higher than the appraised
value, resulted in an examination of the estate tax return and a criminal
investigation by the Internal Revenue Service ("IRS"). The advisors
to the estate had intended to notify the IRS of the sale, however, the
investigation had begun before this could be done.
This divorce case
involved an array of financial, valuation and even forensic accounting
expert evidence. Some of the comments of the trial judge are included
below to show just how difficult and challenging a task the wifes
valuation expert had to confront.
The court, in reviewing
the facts of the case and evaluating the circumstances and actions of
the executors, concluded, among other things, that:
" ... The
returned value reflected the written, well-documented opinion of a widely
experienced appraiser recommended to the executors by their attorney.
A copy of the report was attached to the estate tax return and it spelled
out in detail the basis of the appraisal. It is difficult to believe
that one committing fraud would attach to his return a full and complete
explanation of what he was doing, especially where, as here, the value
of a highly publicized piece of property was the issue ... ."
" ... By
attaching the appraisal report to the estate tax return, the executors
explicitly and openly informed the IRS of the facts relied upon and
the reasoning employed in arriving at the value of the property. Nothing
was concealed and no one could have been misled in this respect ... ."
While the appraisal
was not the only factor which influenced the court, it clearly played
a significant role in arriving at its opinion.
Opinions of value
used in documents filed with the revenue authorities should be supported
by a detailed report as to how the appraiser/valuator arrived at his/her
conclusions, including the methodology adopted, the assumptions used
and the supporting calculations. Such a report will certainly demonstrate
to the authorities that the numbers used were well founded and not just
pulled out of the air.
© copyright Wise, Blackman 1999-2003