England and Wales Lands Tribunal

 


HSBC Trust Company (UK) Ltd v Revenue and Customs -Capital Taxes [2006] EWLands TMA_130_2005 (24 August 2006)

TMA/130/2005

LANDS TRIBUNAL ACT 1949

TAX – Inheritance Tax – valuation of 13/80^th share in freehold of two blocks of flats and shops – discount for minority share – effect of restriction on sale in Trust Deed - value determined at £425,000 - Inheritance Tax Act 1984, s160

IN THE MATTER of a NOTICE OF REFERENCE

BETWEEN HSBC TRUST COMPANY (UK) LIMITED Appellant

(As executor in the estate of GWENDOLINE MAISIE FARMBROUGH deceased)

and

PETER TWIDDY Respondent

(H M REVENUE AND CUSTOMS – CAPITAL TAXES)

Re: Old Park House and New Park House,

Alderman's Hill, New Southgate, London, N13 4RB

Before: P R Francis FRICS

Sitting at: Procession House, 110 New Bridge Street, London, EC4V 6JL

on

31 May 2006

Charles Holbech, instructed by Shepherd Harris & Co, solicitors of Enfield, for the appellant

Timothy Morshead, instructed by Jeremy Burrows, solicitor to HM Revenue and Customs for the respondent

The following cases are referred to in this decision:

Charkham (Deceased) v Inland Revenue Commissioners [2000] RVR 7

Wight v IRC (1982) EG 935

Cust v IRC (1917) 91 EG 11

DECISION

1. This is an appeal, pursuant to section 222(1), (4) and (4B) of the Inheritance Tax Act 1984 as amended against a determination by H M Revenue and Customs – Capital Taxes ("HMRC") under section 221 of that Act. Under those provisions, a person on whom a notice of determination has been served may appeal against it to the Lands Tribunal on any question as to the value of the land. The notice of determination dated 30 March 2005 was served upon HSBC Trust Company (UK) Ltd, the executors of the estate of Gwendoline Maisie Farmbrough who, at the date of her death on 5 January 2001, had been the owner of a 13/80^th minority share in Old Park House and New Park House, Alderman's Hill, New Southgate, London, N13 4RB ("the subject property"). The determination valued the deceased's share at £565,000, however, in its case before the Tribunal HMRC, as respondent, contended for a valuation of £520,000. The appellant sought a figure of £366,800, being derived as a "fair average" between two valuations undertaken on the investment method (gross and net returns), and one based upon a discount from the deceased's 13/80^th share of a (now agreed) entirety value of £4,150,000.
2. The hearing was held in London on 31 May 2006, and closing submissions in writing were received, by order of the Tribunal, by 14 June 2006. Mr Holbech called David G Williamson FRICS, a chartered surveyor of Ware, Herts who gave expert valuation evidence for the appellant taxpayer. Mr Morshead called Mervyn A Farnsworth MRICS of the Valuation Office Agency as expert valuer for HMRC.

Facts

3. The valuers produced a statement of agreed facts and issues from which, together with their expert evidence, I find the following facts. The subject property is a mixed commercial and residential development comprising two blocks constructed of brick under conventional tiled roofs in the 1920s. New Park House had, when built, 9 self-contained lock-up shops, each of about 780 sq ft, although some of these have since been interconnected, and there are currently 4 separate leases of the retail units. The shops, known as 30–46 Aldermans Hill, front onto a wide pavement next to the junction of Old Park Road, and immediately adjacent to Palmers Green mainline station. Above the shops, and with access from the rear (shared with Old Park House), are 10 purpose built first and second floor flats. Immediately behind New Park House, with access off Old Park Road, is Old Park House which comprises a "U" shaped 3 storey block of 18 purpose built 2 bedroom flats together with an area of communal gardens and a block of 10 lock-up garages. The access road for the two blocks is subject to a right of way to a further, unconnected, block of garages to the rear of the station.
4. The majority of the 28 residential units are let, furnished, on assured shorthold tenancies although 4 are unfurnished and subject to statutory controlled tenancies. The shops are all let on conventional commercial leases with review patterns varying between 3 and 5 years. The annual gross rent roll, as at May 2001, was £270,000. It was agreed, from an analysis of the previous 6 years' profit and loss accounts of the Old Park House Company, that for the purpose of assessing net income, an average level of annual expenditure would be £100,000, this figure including a contribution to a reserve fund. It was also agreed that, if the subject property were to be valued on an entirety basis (vacant possession value of flats subject to discounts for nature of occupancy, and capitalisation of gross rental income from shops and garages) the capital value of the whole, at the date of death, would have been £4,150,000. On this basis, the discount contended for by the appellant from 13/80ths of the overall capital value to reflect the minority shareholding would be 50%, and for the respondent, 23%.
5. The entirety valuation was thus:

Flats let on assured shorthold tenancies (24)

Old Park house

15 x £125,000 VP £2,250,000

New Park house (flats over shops)

9 x £125,000 VP £1,125,000

£3,375,000

Less 5% to allow for problems

obtaining possession £ 167,750

£3,206,250

Controlled Tenancies (4)

3 x £140,000 VP £ 420,000

1 x £115,000 VP £ 115,000

£ 535,000

70% to reflect controlled tenancies, say, £ 374,500

Garages

Gross rents received £ 1,688

Y P @ 15% 6.67

£ 11,260

Shops

Gross income £ 59,250

Y P @ 10% 10

£ 592,500

£ 4,184,510

Say £4,150,000

6. The Trust Deed under which the deceased held her shares was dated 13 December 1975 and clause 5 provides:

"5. THE Members hereby covenant with the Trustees and as a separate covenant with each other not to call for the sale of the said lands or any part thereof before the expiration of seventy five years from the date hereof unless Members representing an absolute majority of the interests in the Trust hereby constituted have signified in writing their desire for such a sale".

In the light of this it was agreed that whilst individual shareholdings could be sold in the open market, the Trustees could not call for a sale of the whole until December 2042, unless more than 50% of the shareholding consented in writing. The parties also agreed that it would be unlikely that a Court, on the application of a minority shareholder under section 14 of the Trusts of Land and Appointment of Trustees Act 1996, would make an order for sale.

7. At the date of death, there were 6 shareholders whose holdings were in the following proportions:

G M Farmbrough (the deceased) 13/80

V M Challis 7/80

R A R Challis 13/80

D M Child 13/80

H S Emery 13/80

C R Trechsel 21/80

and it was common ground that the purchaser of a minority share would not be able to control the management of the property.

Issues

8. There are two issues for determination in respect of this appeal. Firstly, the appropriate valuation methodology – the "entirety" basis, or the investment (income) method and secondly, the adjustments required to reflect the deceased's minority interest, and the restriction on sale imposed by clause 5 of the Trust Deed.

Case for the Applicant

9. Mr Williamson is a chartered surveyor in practice on his own account and has been, since qualification in 1964, involved with the valuation, sale and letting of commercial and residential properties in north and central London and Hertfordshire. He said that during the course of his negotiations with HMRC's valuer, the two different valuation approaches had been considered, but that the Revenue did not accept the entirety basis which was how his original valuation had been constructed. On that basis he had arrived at a total value of the subject property of £4.15 million (that figure now being agreed), and whilst accepting that "in normal circumstances a [minority share] discount would be in the region of 10% to 20%", in this instance it should be 50% to reflect the restriction on sale imposed by clause 5 of the Trust Deed. 13/80ths of the total value was £674,375, 50% of which was £337,187. In valuing on the entirety basis, Mr Williamson said that it was accepted that management costs and expenses are reflected in the interest rate used for capitalisation, rather than being brought directly into the calculations.
10. He then went on to consider the valuation on an investment basis which, whilst having been initially rejected, was now accepted as "not inappropriate" due to the fact that the deceased's share could be sold in the open market without infringing the Trust Deed and, further, it was unlikely that, due to clause 5 of the Deed, a court would accede to an application for sale of the whole. He said valuing to a net income was likely to be most reliable, as all relevant aspects of the costs of running the estate could be taken into consideration. This would include, in addition to management and repair costs, such matters as rent arrears. Having analysed the estate's accounts, he said that there were some arrears at the relevant date, and reduced the agreed gross income of £270,000 to £257,200 to reflect this. He then deducted the agreed £100,000 average annual expenditure (which included an allowance for a reserve fund) to give net income of £157,200. The calculation became:

Net Income £157,200

Y P @ 7% 14.28

£2,244,816

13/80 share £364,783

Say, £364,750

In arriving at his proposed yield of 7% to be applied to the net income, Mr Williamson said that it was necessary to adopt a quite different approach from the analysis of individual yields for the residential, retail and garage elements that had been appropriate in building up the entirety value. It was necessary, he said, in determining the correct average yield that would apply under the net income method to compare what an investor could expect to achieve in other markets. Secure and relatively risk free investments such as Government 10 year gilts, Lloyds TSB Bank and Land Securities stock were producing yields of between 4.1 and 4.8% but an investment in a share in the subject property would be subject to considerably higher risks such as rent arrears and bad debts, void periods and the inability to realise enhanced value due to the Trust Deed restriction. This would result in an uplift of at least 2.5% (from an average of say 4.5% in other markets) to give 7%.

11. Although he was of the view that, to take average gross income and use a yield that would normally be applied by the market in respect of similar properties (from, for instance, auction results), was a crude valuation method, he did produce a valuation on that basis:

Gross income due at May 2001 £270,000

Y P 11.25% 8.89

£2,400,000

13/80 share £390,000

Mr Williamson said that auction results indicated average yields for similar investments at between 8.25% and 11.25%, and produced some examples. 4 The Town, Enfield was a retail investment located in a prime area favoured by banks, and let to Woolwich Plc. It sold in July 2005 at a gross yield of 7.09%. 104 to 110 Upper Fore Street, N.18 comprised premises entirely let to NatWest Bank in a prominent main road position, achieved a yield of 11.33% in May 2001 and 159 to 161 Bowes Road, N.11 achieved 9.17% in July 2004. Whilst 9% to 10% might, under normal circumstances, be appropriate for the subject property, the disposal restriction forced the yield out to "at least" 11.25% in his opinion. He accepted in cross-examination that he was unaware of the circumstances that might have led to the disappointing yield on the NatWest premises in Fore Street, Edmonton which, it was put to him, may have been due to the fact that the lease had only 3 years to run, and the bank's intentions for renewal were uncertain. Mr Williamson did not agree that Bowes Road was a poorer shopping location, or that 4 The Town was an absolutely prime location, although he did acknowledge that that was a pure commercial unit, with no residential element.

12. He accepted that the 140-152 Bowes Road and 1-11 Powys Court ("Powys Court") comparable produced by Mr Farnsworth was very similar to the subject property, and perhaps more appropriate than the ones he had found. He also conceded that the traffic noise problems and poorer location of Powys Court could, on the face of it, justify a difference in yields between it (8.5%) and the subject property, but not as low as the gross 7% contended for by Mr Farnsworth (before adjusting for minority share). Although he accepted that that was a "ball-park" figure, he felt that 7.5% to 8% would be more appropriate, but before arriving at a definitive figure, he would want to analyse the income streams, and types of tenancy. He said the fact that specific details behind the bald figures produced by analysing auction results were not normally available or known proved the dangers of relying purely on gross returns. A prospective purchaser, seriously considering bidding for an investment, would obtain all the background information and would be more likely to base his bid on the net yield that was achieved.
13. Mr Williamson summarised by saying that he had taken an average of the 3 alternative valuations to produce the claimed figure of £366,800 as a fair and reasonable assessment of value at the relevant date for Inheritance Tax purposes.
14. As to the 50% discount he had used on the entirety basis, Mr Williamson said the 8% addition to the "normal" discount of around 15% applied by Mr Farnsworth was nothing like sufficient in this case. As he had said in his report, he had been advised that, in a situation of this kind, case law would indicate that a discount in the order of 50% to 60% would not be unreasonable. However, in cross-examination he admitted that he had not referred to any such cases and was relying upon counsel's opinion. He said, in justification of the discount applied, that a purchaser would be buying into a family trust where there could well be political and personality conflicts, and he would not be likely to achieve any significant control over important management or other decisions. He would be entering unknown territory and would have to "go with the flow" in terms the decision process. Furthermore, whilst accepting that this particular property was well maintained and managed, the restrictions on disposal were a significant deterrent that had a marked effect on the attractiveness of this minority share to a prospective investor. He produced letters from the other shareholders which confirmed they would be unwilling to sell.

Case for the respondent

15. Mr Farnsworth is a chartered surveyor and a specialist valuer based at the Westminster office of District Valuer Services, Valuation Office Agency. He has 40 years valuation experience, 35 of which have been with the VOA. He said that, in his professional opinion, the correct method by which to value the subject property, a mixed residential and commercial property investment, was to capitalise gross income. This is what the market does in making its bids at auction. Furthermore, he said his view was supported by the Tribunal's decision in Charkham (Deceased) v Inland Revenue Commissioners [2000] RVR 7 (a case involving similar issues and to which Mr Morshead would be referring in detail in submissions) where the Member, Mr A P Musto FRICS said (at 27):

"I agree with Mr Thomson's [District Valuer for the Revenue] approach that no specific deduction should be made for the management charges in the valuations of the minority shareholdings. I find from the evidence that such costs are normally reflected by the investment market in the yield adopted for capitalisation of the covenant and reversionary incomes. I consider that a consistent approach should be adopted in both the valuation of the entirety and the minority shares".

16. The primary valuation produced by Mr Farnsworth analysed appropriate gross yields for the shops, flats and garages on individual bases as that was, he said, the approach that had been consistently taken during the negotiations with Mr Williamson, although he acknowledged that the market analyses yields from auction sales on a single basis without differentiating between the various elements. He thought that the individual approach was helpful in conducting a detailed analysis. The valuation was set out thus:

INVESTMENT VALUATION – GROSS INCOME METHOD

(1) INCOME

Shops

Total rents £59,250pa x 13/80 = £ 9,628

Y P in perpetuity @ 11% 9.09

£ 87,518

Garages

Total rents £1,688pa x 13/80 = £ 274

Y P in perpetuity @ 16.5% 6.06

£ 1,660

Flats

Total rental income £209,100pa x 13/80 £ 33,978

Y P 41 yrs @ 9% 10.757

£ 365,509

(2) REVERSION (Residential)

Reversion to £3,910,000* x 13/80 = £635,375

P V of £1 in 41 yrs @ 9% 0.3

£ 19,061

£ 473,748

(3) HOPE VALUE

The possibility of capital being released early, by

some or all of the properties being sold before the

expiry of 41 years

Potential full value of 13/80 share £706,000**

Less Value on gross income approach £473,748

£232,250 x 20% £ 46,450 £ 520,200

Say, £520,000

* Made up of £3,375,000 agreed capital value of shorthold flats (per entirety method), but with no deduction of 5% to allow for potential problems obtaining possession, and agreed value of controlled tenancies at £374,500.

** Entirety value assumes Statutory Controlled Tenancies have come to an end during this period .

17. Mr Farnsworth explained that in preparing this valuation, he had examined auction sale results of residential flat investments during the period 1999 to 2003 which produced yields ranging from 9.58% (4 blocks of purpose built flats in Tunbridge Wells) to 1.66% (a block of 10 flats, 7 with registered rents and 3 vacant units in Chiswick, W4). He accepted in cross-examination that the latter was an aberration probably caused by the fact that there were some vacant units, and that generally the average yields on those residential investments were between 8.5% and 9.5%. Mr Farnsworth said he also considered the sale by auction in September 2001 of 140-142 Bowes Road and 1-11 Powys Court, N11, which he felt was the best comparable. This was a mixed residential and commercial development comprising 3 double shop units, 8 flats and 8 garages. It produced a gross rental income of £71,599 pa (although he was not aware of the breakdown of rents between the residential and commercial elements) and sold for £856,000 representing a yield of 8.36%, which he rounded to 8.5% for comparison purposes. That investment was about 1km from the subject property and was in a run-down locality, with incessant traffic noise (as Bowes Road is part of the North Circular). Conversely, the subject property was in a much more pleasant area, was only 50 metres from the station and was also close to a pleasant amenity area. In Mr Farnsworth's view, if Powys Court warranted a gross yield of 8.5%, then the appropriate yield for the subject property would be 7% - that figure also reflecting the hope value that existed, but not the minority share or sale restriction. Although his valuation of the subject property had been calculated on a component basis, he said, in response to a question from the Tribunal, that the overall gross yield amounted to 9.25%. That extra 2.25% reflected the minority share and the clause 5 restriction. It was put to him by counsel that his 9.25% was lower than some comparables where there were no restrictions, and did not appear to reflect potential problems such as rent arrears, bad debts and the saturated residential rentals market (this property being unusual in that all the flats are let rather than sold on long leases). He responded that at the valuation date there were no bad debts, and any other aspects not being unique to the subject property were already catered for in the gross yield.
18. He explained that the 11% gross yield he had applied to the shops at the subject property and the 16.5% relating to the income from the garages were in perpetuity, as that was the correct basis for valuing commercial investments. It was in connection with the flats, where he had taken a 9% gross yield, that Mr Farnsworth had capitalised the rental income over 41 years, and he did not accept that, as Mr Williamson had done, it was more appropriate to value all elements in perpetuity. He also made an allowance for hope value and said that in his view, the very considerable adjustment for the sale restriction that the appellant was seeking was more than met by this addition.
19. Mr Farnsworth also produced two valuations calculated on the net income basis. Firstly, he assessed the income from the individual elements as he had done previously, but using a 9% yield for the shops, 13.5% for the garages and 7.25% for the flats and then made a simple deduction of 15% for management fees (plus VAT). This produced an identical valuation of the deceased's 13/80 share of £520,000. Secondly, he did the same exercise deducting the agreed £100,000 costs and yields of 7% (shops), 10.5% (garages) and 5% (flats). This produced a valuation of £523,000. Having carried out these alternative valuations, he stressed that he was not happy with the net income basis, even though it produced very similar figures, as this was not how the market worked. Whilst he did not oppose its use, he said that it should not be used in isolation. As to the fact that his valuation on a net income basis, deducting all expenses, produced an overall yield of 5.75%, Mr Farnsworth admitted that this was not sufficiently above the returns that the market expects from gilts and stocks to reflect the minority share aspect and the restrictions.
20. Finally, in relation to the £520,000 value that he was contending for, Mr Farnsworth carried out a cross-check against the entirety value. He took a gross income of £290,500 (which was the anticipated receipts for 2000/2001 financial year, rather than the £270,000 actual income) as he considered that a prospective purchaser might anticipate a rental uplift, and applied a 7% yield. This produced, as it happened, exactly the agreed entirety value figure - £4.15 million. It was to be noted, he said, that the property company to which the Trust Deed related was performing to the same expectations as when it was set up, providing a continuously growing income and capital value. The hypothetical purchaser would have, in his view, a good investment whilst needing to be little involved in its management.

Submissions

21. Both counsel referred at length to Charkham where the Tribunal was charged with determining the value of minority interests under Trust Deeds in circumstances not dissimilar to the instant case, although in that case there was no express restriction on sale.
22. Mr Morshead, for HMRC, said that in determining the issues in this case, no true question of law arises; it is simply a question of identifying and applying the correct valuation principles. As the Member, Mr A P Musto had said in Charkham (at 10):

"It is agreed by the parties that the real question to be decided in the instant cases by this tribunal is what are the advantages and disadvantages of owning only a percentage share in the property, rather than an entirety and, what discount would the market seek to apply by using either the 'income' method, by adjusting the yield, and/or by adopting the 'entirety' method by making a discount from the entirety value.

The issues in the instant appeals are restricted therefore to matters of valuation and raise no issues of law".

In the present case, Mr Morshead said, Mr Williamson had admitted that his approach, based upon decisions in other cases had failed to identify any, or to examine how those cases bore economically on the present case. As such, it was the respondent's view that his valuation was significantly undermined.

23. Whilst it was accepted that clause 5 of the Trust Deed has some effect on the valuation, it was submitted that there was no justification for the application of a 50% discount from the entirety value. Mr Williamson had concentrated, in examining matters only from the viewpoint of the potential purchaser, solely upon the perceived disadvantages of being unable to liquidate the trust before 2042 without considering the advantages that there were in keeping it in place. It had been accepted, Mr Morshead said, that this was a well managed estate, there were, at the valuation date, no bad debts and as Mr Williamson had specifically accepted in a letter of 29 August 2002 (whilst negotiations were continuing):

"Quite apart from the higher income achieved by retaining the estate there is also the ability to benefit from increases in capital value and income levels over the years. It is therefore difficult to envisage a circumstance in which any one beneficiary would consider it advantageous to agree a sale – let alone more than 50% of the beneficiaries".

Whilst that letter was seeking to explain why there was likely to be little opportunity for a hypothetical purchaser to liquidate his share early if he wished to, it clearly identified good reasons why he would not want to. Although the appellant had produced letters from the other shareholders stating that they would be unwilling to dispose of their interests, this was just as likely to be a reflection of the quality they saw in their investment. Mr Morshead said that, in following basic valuation principles, the matter had to be looked at as much from the point of view of the hypothetical vendor as from that of the hypothetical purchaser. The vendor would be fully aware of the underlying quality and economic benefits of the trust, and would be most unlikely to agree, in anything other than a forced sale situation (which is not required to be considered under the Act), a price that effectively represented a 50% discount.

24. It was submitted that Mr Farnsworth's approach – primarily relying upon the gross income method, but also providing check valuations against net income and the entirety method was even handed, objective and proportionate. His 23% discount (from the entirety value) was in itself significant and gave ample weight to the downside of owning a minority interest, and to the acknowledged restrictions in clause 5. It was some 8% higher than the highest point in the "normal" range of discounts applied to minority interests (10% to 15%). Indeed, in the case referred to by the appellant in closing submissions – Wight v IRC (1982) EG 935, the Tribunal applied a 15% discount to a minority share where it was considered "unlikely" that the court would order a sale. The additional 8% applied by Mr Farnsworth therefore reflected clause 5, and it was submitted that this was more than sufficient.
25. Mr Morshead said that the appellant's arguments, based partly upon Charkham, that discounts of more than 15% should be used as a mere starting point, distorted the particular valuation exercise that took place in that case. For instance, the Tribunal had applied 15% to the commercial units and 22.5% to the residential flats within the trust for the period during which the number of regulated tenancies was at its highest, and 20% for later years following the advent of assured shorthold tenancies to reflect the opportunities for increased income and for earlier vacant possession. In that case 40% of the flats were regulated, whereas at the subject property only 14% were. Also, it could be concluded from the decision that, despite the Member having found that a court would be likely to grant an order for sale where an application was made under s.30 of the Law of Property Act 1925, that had little effect because, as he went on to say: "In overall summary therefore, I find the provisions [of s.30] would be of limited benefit to a potential purchaser of a minority interest [due to the uncertainty of the outcome and the costs involved]". Thus, in reality, the respondents position in this case can be taken as the same as in Charkham except as to the provisions of clause 5. Mr Morshead said that Mr Williamson seemed to be attempting to establish an appropriate discount from settled cases as a matter of law, whereas he should have exercised his own valuation judgment on the circumstances of the instant case. As the Member had been at pains to say in Charkham, he was undertaking a pure valuation exercise, not a legal one. In any event, Mr Williamson's 50% discount was more than 3 times the "starting point" which was, he said, ludicrously high. Such a figure was wholly unsupported by any application of valuation judgment to the economic factors that actually applied to the subject property.
26. As to overall yields, Mr Morshead said that it appeared to have now been agreed that Powys Court was the best comparable. That was analysed at 8.36% (adjusted to 8.5%). On the strength of the subject property's better location and other factors, Mr Farnsworth had suggested a figure of 7% for that, to which he had added 2.25% to reflect the minority share and clause 5 disadvantages. This was considered to be an ample adjustment, and following Mr Williamson's acknowledgement in cross examination that in the light of the Powys Court comparable, "7.5% to 8%" would be appropriate for the subject property before applying a further figure for the disadvantages, his proposed figure to reflect them at 11.25% was much too high and not justified by the evidence.
27. Mr Holbech, for the executors, referred to a number of cases, including Charkham, Wight and Cust v IRC (1917) 91 EG 11 which, he submitted, provided the bases for deciding the minimum discount that should apply for minority shares. Adjustments would then need to be made in this case to take account of the restrictions imposed by clause 5 of the Trust Deed, which was a significant additional factor as it prevented a sale without majority consent until 2042. He said that since Trusts for Sale had been abolished by the Trusts of Land and Appointment of Trustees Act 1996, and there was little chance of any application to the court (under sections 14 and 15 of that Act) being granted in respect of the subject property (a fact that was agreed between the parties), the circumstances of this case were entirely different from those in Charkham. In that case the Tribunal had adopted an approach based upon a percentage discount from the entirety value. In applying discounts of between 15% and 22.5% it had concluded that, in the particular circumstances of the Trust for Sale applicable to that case, an application made to the court under s.30, would be likely to be successful. Such an order would force the trustees to sell the properties, or force them to acquire the minority share at a fair price. However, the Tribunal went on to say that a purchaser in the open market for a minority share would perceive some uncertainty as to the outcome, or the costs involved, and it was appropriate therefore to make some discount from what a purchaser would pay to reflect that uncertainty. Mr Holbech implied that whatever the discount that might have been made in Charkham to reflect that uncertainty would have to be very substantially increased where there was no chance at all (as made clear by s.15 of the 1996 Act) of an order being granted.
28. In all the circumstances, he said, a deduction of 50% from the entirety value of the 13/80 share to reflect the fact that, as the respondent had acknowledged, there was only a 20% chance of realising the capital value of the flats before 2042. At the very least, he said, the deduction should be 40%.
29. Mr Holbech said that the main reason for adopting the income method of valuation in this case was the restriction on sale imposed by clause 5. That was the most appropriate method where a sale is unlikely to be agreed, there are no grounds for an order (under the 1996 Act) and there is no special purchaser. He said that it was more appropriate to apply an overall yield to the estate, rather than, as Mr Farnsworth had done, to apply different figures to the shops, garages and flats. Whilst it was acceptable to either apply yields in perpetuity (as Mr Williamson had done) or to reflect, in connection with the flats, the reversion in 42 years (as Mr Farnsworth had done), the value of the reversion should be reduced by 5% to reflect potential problems in obtaining vacant possession. Whichever approach was taken. Mr Holbech said that the use of net income rather than gross was the preferred method.
30. Mr Farnsworth's overall yield, on the net income approach at 5.75%, was far too low having regard to the returns from gilts and other stocks, bearing in mind the significant risks relating to this investment. Mr Williamson's approach of adding 1.5% for the risk elements of investing in property, and a further 1% to give an overall yield of 7% on the net income basis was far more realistic.

Conclusions

31. Section 160 of the Inheritance Tax Act 1984 provides:

"160 Market Value

Except as otherwise provided by this Act, the value at any time of any property shall for the purposes of this Act be the price which the property might reasonably be expected to fetch if sold in the open market at that time; but the price shall not be assumed to be reduced on the ground that the whole property is to be placed on the market at one and the same time".

The valuers acknowledged that whilst in reality placing all the flats on the market at the same time would significantly affect values, the above proviso prevented them from doing so in this hypothetical exercise. This had enabled them to agree the entirety value in the sum of £4,150,000.

32. Although the entirety value was agreed, both valuers had, by the time of the hearing, concluded that the income method was the most appropriate way for determining the value of the deceased's undivided share particularly as there was a substantial restriction on sale imposed by clause 5 of the Trust Deed. In Charkham, where the experts had also produced valuations on both bases (but where there was no similar restriction), the Member preferred the percentage deduction from the entirety value principally on the grounds that there was a lack of evidence of sales of undivided shares in commercial property. He also said (see p28) that there was a lack of authorities (from this Tribunal) relating to such types of valuation. Mr Musto went on to say that he had great difficulty in deciding which methodology to adopt, but "on balance" preferred the evidence of Mr Thomson that a purchaser in the open market of an undivided share in commercial property would adopt the entirety approach as there is likely to be evidence of open market sales of comparable property within the investment field. Making a single discount had the attraction of simplicity, and avoided the possibility of double counting for any perceived disadvantage or advantage of the ownership of an undivided share when compared with the ownership of the entirety.
33. Whilst I accept that a percentage discount from an agreed entirety value has the attraction of simplicity, and note that the parties have agreed the methodology by which the figure of £4,150,000 was reached, I have some doubts whether the market would approach the exercise in that way if considering the purchase of a minor share and where there is a specific restriction as included in clause 5 of the Trust Deed. If 100% of the equity were to be offered as an investment, prospective purchasers may well look to achieving vacant possession value on all the flats by offering them for sale on long leases whilst retaining the shops and garages as an income producing investment. This would maximise capital return in the shortest possible time, and by having full control, the purchaser would be free to deal with the property as he wished. However, in this case, we are considering a 13/80^th undivided share in what is agreed to be a well managed mixed residential and commercial investment portfolio where, historically, there is no evidence that the trustees have, since it was set up in the 1960s, taken the sales route on any of the units. A purchaser of such a share would therefore, as Mr Williamson said, have to "go with the flow", would not be able to demand a sale of the whole under the 1996 Act (at least until 2042), and would have little management control. To derive a discount therefore, from an entirety value that could, in reality, only apply in circumstances where the whole of the shares were being offered, seems to me to be inappropriate. The fact that it takes a 50% reduction from that entirety value to get to a figure for the deceased's share in the same region as the values produced by the appellant's two income based calculations, adds support to my view that the figure of £4.15 million must be questionable in these circumstances.
34. I turn, therefore, to the investment (income) method, and it was most helpful that whilst each of the experts argued for a different primary approach, they produced valuations in the alternative. Mr Williamson adopted a quite straightforward approach in his primary income valuation, whereby he applied what he considered to be an appropriate overall yield to all of the net income in perpetuity, having first deducted the agreed annual costs. However, he appears to have strayed from the agreement as to the appropriate gross income applicable at the valuation date in deducting £12,800 (from £270,000) to reflect rent arrears. The YP of 7% reflects, he said, the minority share and the clause 5 restriction, and in his view, the additional 2.5% over the average return in other markets represented an appropriate uplift. In his alternative valuation, from the gross income as agreed, he applied an 11.25% yield which was at the top end of a range of comparables that he had analysed.
35. Mr Farnsworth capitalised the income from the shops and garages in perpetuity using appropriate yields for each element, but as far as the residential income was concerned, he capitalised the income for the 41 years remaining on the sale restriction, and then deferred the prospect of capital receipts on that date. He made certain assumptions, such as that the controlled statutory tenancies would have fallen in by then and that there was, in terms of hope value, a 20% chance of the early release of capital by flats becoming vacant and possibly being sold before the 41 years had expired. The overall yield, on a gross income basis which, he said was how the market calculated values, was 9.25%, some 2% less than Mr Williamson's equivalent.
36. I am of the view that he has unnecessarily complicated the issue, particularly when he was espousing the simplicity of applying an appropriate yield to gross income, rather than, as Mr Williamson has done, considering the management and other costs, and thus working from a net income basis in all respects in perpetuity. Furthermore, I think that he is attaching too much importance to the fact that in 2042 the restriction in clause 5 will disappear, and is assuming that the full capital value of all of the flats will be achievable on that date. Under present statutory provisions, any minority shareholder will still have to apply to the court for an order for sale, and there is no cast iron guarantee that it would be granted, even when the restriction no longer exists. I also reiterate the doubts I expressed earlier regarding the assumptions as to a reversion to capital values; it has been agreed that this is a well-managed investment producing a reasonable income, and it cannot, in my view, be assumed that a majority of the shareholders will suddenly opt for a different strategy when the restriction ceases to have effect. Mr Farnsworth's alternative net income valuations were calculated on the same principle as his gross basis, and achieved virtually the same results. The appropriate net yield on those bases was 5.75% which compares with Mr Williamson's 7% - a 1.25% difference.
37. It is a fact that in analysing investment sales the market normally capitalises the gross income at an appropriate rate, the net returns not being known. However, I accept the argument that a purchaser of a minority share in which he is but one of a number of parties to the ownership, and will thus have much more limited input into the management and, for that matter, any strategic decisions as to whether to achieve capital returns rather than rental income, will be interested in the net return. He will want to know how efficiently it is being managed, what the trust's strategic policies are and whether he can expect to achieve early capital returns, or long term rental income. For those reasons, I prefer the net income approach in this case and in so doing, I accept that a purchaser will have in the back of his mind the returns that he could achieve for his money in other markets, and set those against the additional risks inherent in this type of investment.
38. It appears that the parties have agreed that the best comparable was Powys Court, but that was analysed on a gross basis (at 8.5% yield), and no comparative net yield was given. Mr Farnsworth thought that, against that property, 7% gross was applicable to the subject, excluding any consideration of the minority share. Mr Williamson said it would be nearer 7.5 to 8% but accepted in cross-examination that 7% was not far out. In comparing gross with net, Mr Williamson added 4.25% (from 7% net to 11.25% gross) and Mr Farnsworth deducted 3.5% from his gross figure of 9.25% to give 5.75% net. As to the net yield, the valuers are only 1.25 percentage points apart, and I accept the submission that Mr Farnsworth's net figure did not anything like sufficiently take into account the minority share and other disadvantages of the subject property against returns from other markets. On the other hand, Mr Williamson's 7% net yield, in the light of all the evidence, appears to me to be rather too high and does not, as submitted by Mr Holbech, adequately reflect the hypothetical vendor's position. This, as I have said, appears to be a sound and well managed investment, and a willing seller would be unlikely to agree a sale at a price that over-played the disadvantages and did not adequately reflect the inherent advantages that there undoubtedly are. Doing the best that I can, therefore, I conclude that an appropriate net yield is 6.5% based upon the agreed net income of £170,000 and for the reasons I have given, I do not break that income down into individual components. That yield also, as did the valuers' net yields, reflects the allowance for the minority share and the clause 5 restriction.
39. The valuation becomes:

Net income £ 170,000

YP in perpetuity at 6.5% 15.38

£2,614,600 x 13/80 = £424,872

Say £425,000

In the light of this conclusion, I find that HMRC's determination was wrong, and confirm the value of the deceased's 13/80^th share in the subject property at 5 January 2001 was £425,000.

40. This decision determines the substantive issue in this case and will take effect when, and not before, the question of costs has been decided. A letter regarding submissions on costs in writing accompanies this decision.

DATED 24 August 2006

(Signed) P R Francis FRICS