Tax affecting is only one issue that makes the federal district court’s opinion in Kress a must-know for valuators, notwithstanding a recent reader comment that it’s doubtful the case would have received much attention had it not been for the tax-affecting angle.
Use ‘prudential judgment’: One thing that stands out is the court’s reminder to appraisers that valuation is more than mathematics. The issue came up when the court critiqued the government expert’s market multiples analysis, finding it was skewed because it was based on only two companies, one of which the court found to be an outlier as to the relevant tax year, 2009. The parties’ experts agreed that this company (Rock-Tenn) was comparable to the subject company for the analyses of years 2007 and 2008. But Rock-Tenn was on its own trajectory as concerns year 2009. Specifically, Rock-Tenn had acquired another company, which had the consequence of increasing Rock-Tenn’s stock price while the stock prices of other guideline companies decreased during that year, the court noted. The subject company’s earnings in the first half of 2008 also were strong, but not for the reasons that drove Rock-Penn’s earnings increase, the court found.
Different rolls: The court noted that the government’s expert said he simply followed the numbers where they led him. But doing so, the court found, did not guarantee a reliable value indicator. Valuation, the court said, required using professional judgment. “Mathematical calculations may give an appearance of precision even when the mechanical formulae on which they rest depends on assigning arbitrary weights to factors that in truth are matters of prudential judgment.” Although the government’s expert tried to be consistent by applying multiples derived from Rock-Tenn’s financial performance, the analysis did not hold up because Rock-Tenn was not a true comparable for each of the relevant tax years. Based on its unique circumstances, it did not feel the effects of the recession, the court said. Therefore, the expert’s analysis failed to properly consider the economic recession, the court decided.
In contrast, the court found the taxpayer’s prevailing expert compared the company on a “holistic” basis to the guideline companies he chose (five to six for each year) and in doing so achieved a much sounder valuation. The court said this expert’s analysis “recognizes the variability and non-quantifiable judgments by which various factors are taken into consideration and impact the price of a share of minority stock.”
A close reading of the Kress opinion reveals the multiple considerations that went into the court’s decision to give “less weight” to the value conclusions of the government’s expert—all of them worthy of attention.
A digest of Kress v. United States, 2019 U.S. Dist. LEXIS 49850, 2019 WL 1352944, and the district court’s opinion are available at BVLaw.
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