King & Wood Mallesons welcomes the decision of the Supreme Court of Victoria in Regis Aged Care Pty Ltd v Commissioner of State Revenue [2015] VSC 279 (Regis case). The case has wide-reaching implications for valuations of land and businesses, both in the context of landholder (and land rich) duty and valuations more generally.

Background

The case involved an acquisition of shares by Regis Aged Care Pty Ltd (“Regis”) in Paragon Group Investments Pty Ltd (“PGI”) as part of a merger of two aged care providers. At the time of the acquisition, PGI owned residential aged care facilities in Victoria and Queensland.

The Victorian Commissioner of State Revenue (“Commissioner”) assessed duty under the former land rich provisions in the Duties Act 2000 (Vic) (“Duties Act”) in relation to the acquisition. Duty was assessed on the basis of the Commissioner’s contention that PGI was “land rich” at the time of the transaction by virtue of its land holdings in all places comprising 60% or more of the unencumbered value of all its property.

The dispute concerned the appropriate methodology to be applied in calculating PGI’s property. In particular, the dispute concerned the appropriate methodology by which to assess:

  1. the value of land held by PGI through its linked entities (the “numerator” in the land rich ratio); and
  2. the unencumbered value of all PGI’s property (the “denominator” in the ratio).

Regis retained three expert witnesses in the case: a chartered accountant, a forensic accountant and a land valuer. The Commissioner retained a financial analyst only.

A number of key arguments were put forward by the parties in support of their valuation positions. The key issues which needed to be determined by the Court were as follows.

Portfolio or standalone valuation of land holdings

The Commissioner argued that the appropriate basis for valuing the land held by PGI was on a portfolio rather than a standalone basis. The Commissioner contended that the Duties Act and settled case law established such a valuation. The evidence of the Commissioner’s expert was not, however, supported by any substantive experience or training.

Contrary to the Commissioner’s position, Regis’ land valuer valued PGI’s land holdings on a standalone basis rather than as a portfolio of assets. That is, the land was valued as if it had been sold in individual parcels rather than as a collection of assets. The land valuer did opine, however, that based on his research and experience relating to the aged care industry, a valuation on a portfolio basis could have provided a premium or a discount of up to 10%.

The Court held that whether a portfolio or standalone basis of valuation was appropriate depended on the proper application of the “Spencer principle” to the circumstances of the case. The principle inSpencer v Commonwealth (1907) 5 CLR 418 is that market value is determined by considering:

“from the point of view of persons conversant with the subject at the relevant time, what, according to the then current opinion of land values, a willing but not anxious purchaser would have to offer to induce a not unwilling vendor to sell the land.”

In the context of the Regis case, the Court decided that a portfolio basis appropriately reflected the most profitable use to which PGI’s land could be put and that it correctly reflected the Spencer test.

With this in mind, the Court accepted the variance of 10% put forward by Regis’ valuer. In doing so, the Court drew an adverse inference against the Commissioner for his failure to call a land valuer that he had previously engaged to prepare a valuation report in the case. The Court was also critical of the evidence that the Commissioner put forward in the matter with respect to land valuations.

Goodwill

A key component of the Commissioner’s case was that there was no material goodwill value in PGI, relying on the High Court decision in Commissioner of Taxation v Murry (1998) 193 CLR 605. The Commissioner’s position was largely based on the contention that as a regulated aged care provider, PGI was taken to be a passive recipient of custom. The Commissioner also contended that given the nature of PGI’s business, any goodwill necessarily inhered in the value of its land.

Based on the evidence before it, the Court did not accept that PGI had no material goodwill. The Court preferred the view of Regis’ experts that effective management combined with a skilled workforce could significantly impact the profitability of a residential aged care facility. This is a sensible outcome in the context of the facts and the aged care sector more generally.

The Court also rejected the proposition that substantially all of the efficient characteristics of the business (i.e. the goodwill) would inhere in the value of PGI’s land, on the basis that the contrary conclusion would produce “improbable results”.

Synergies

The transaction on which the Regis case was based was a merger between aged care providers. As such, it was agreed between the parties that Regis would derive synergies from the transaction (e.g. a reduction in head office costs of the combined entity). These would need to be taken into account in determining the land rich ratio.

The Commissioner’s expert opined that the whole amount of expected synergies would be included in the market value of PGI. This view was based on an argument that as the synergies were primarily cost synergies, not revenue synergies, their value was certain at the time of the merger and did not depend on the proficiency of the management team. It was further contended that the synergies were properly attributable to the value of PGI’s land.

The Court preferred the view of Regis’ experts that the realisation of the synergies depended on the proficiency of management of the newly-merged entity. Further, the Court was unconvinced that a hypothetical purchaser would pay over the entire value of such synergies or that the value of the synergies inhered in the value of the land.

Implications

The case has some very important implications for valuations of land where it is necessary, for duty purposes, to isolate a land value where the land owner also has other business assets. In particular, it clarifies the approach that should be adopted when considering the impact of synergies and goodwill. It also supports the use of a portfolio (rather than standalone) valuation in appropriate circumstances.

It is not yet clear whether the Commissioner will seek to appeal the Regis case. Taxpayers must remain mindful of this possibility as the Commissioner digests the decision.