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May 1, 2013 | Issue #128-1  

Tax Court KOs overvaluation penalty escape hatch

The Tax Court has overturned its own precedent in ruling that a taxpayer may not avoid the 40% gross valuation penalty for overvaluing a tax shelter. Taxpayers have been able to avoid the penalty short of trial merely by conceding on grounds unrelated to valuation or basis. But now, in AHG Investments, the court shifted gears and followed the majority rule in the appellate courts and sided with the IRS, which had waged a decades-long battle on this issue.

What it means: This ruling may trigger more trials focusing on valuation issues, since the value of the underlying assets is typically the fundamental issue in abusive tax shelter cases. It also means investors need to be more careful when presented with a business deal that promises tax benefits based on assets with a questionable valuation.

Valuing odd investments in an ERISA plan

A brewery, diamonds, liens, water rights—even a slaughterhouse—are the kinds of investments pension plan sponsors are adding to their portfolios, reveals an article in the New York Times. Plan sponsors like these investments because they avoid the need for cash they would otherwise have to use to plug funding gaps. Plus, if these assets yield high returns, it reduces the level of investment needed to fund the plan in full.

The ripple effect on valuation professionals is that the U.S. Department of Labor, which must approve large, in-kind pension contributions, could require the hiring of an independent fiduciary to bring in a valuation expert to assess the unusual asset, according to Susan Mangiero (Fiduciary Leadership), writing in Pension Risk Matters. “As a trained appraiser, I would tell anyone who asks that there are multiple items that must be assessed as a precursor to determining fair market value of the asset in question,” she says.

For example, if the asset has multiple owners, can the plan exercise authority over how it’s used, disposed of, and/or managed for purposes of adding to the asset's value? If others have claims on the asset, what is the plan’s pecking order if the asset throws off cash or gets sold? Since unusual assets may not trade in an active secondary venue, what is the appropriate discount for lack of marketability so that the ERISA plan does not overpay?

Watch out: The DOL wants to designate appraisers as a fiduciary for an assessment they render about an ERISA plan. This effort, along with other factors, has made pension and ESOP valuations a minefield for appraisers. To learn more, Mangiero will participate in a May 14 BVR webinar, Valuation and ERISA Fiduciary Liability: Traps for the Unwary Appraiser, along with Rob Schlegel (Houlihan Valuation Advisors) and ERISA attorney James Cole (Groom Law Group).

New FASB guidance spotlights valuation in face of liquidation

Companies on the brink of collapse must now use the liquidation basis of accounting, according to new guidance from the Financial Accounting Standards Board. Financial statements will now have to be prepared that show the values of assets and liabilities in terms of expected cash proceeds from liquidation. Plus, any assets not previously recognized under U.S. GAAP will need to be valued and presented in the statements, including intangibles such as trademarks, brand names, copyrights, and the like.

Accounting Standards Update No. 2013-07, Presentation of Financial Statements (Topic 205): Liquidation Basis of Accounting, requires an entity to prepare its financial statements using the liquidation basis of accounting when liquidation is “imminent.” Liquidation is imminent when: (a) a plan for liquidation has been approved by the person or persons with the authority to make such a plan effective and the likelihood is remote that the execution of the plan will be blocked by other parties or the entity will return from liquidation; or (b) a plan for liquidation is imposed by other forces, and the likelihood is remote that the entity will return from liquidation.

Measurement: Assets must be valued at the estimated amount of cash proceeds or other consideration that it expects to collect in settling or disposing of those assets in carrying out its plan for liquidation. An entity will recognize and measure its liabilities in accordance with U.S. GAAP that otherwise apply to those liabilities. In measuring the liabilities, there should be no expectation that the entity will be legally released from being the primary obligor under those liabilities, either judicially or by creditors. Also, any expected costs related to the disposal of assets or settlement of liabilities must be included.

“Stakeholders have requested guidance on when and how to prepare financial statements using the liquidation basis of accounting,” FASB Chairman Leslie F. Seidman said in a statement. “This standard addresses their concerns and reduces the diversity in practice that has resulted in the reporting of these activities.”

Effective date: The standard applies to all entities reporting under U.S. GAAP, except investment companies that are regulated under the Investment Company Act of 1940. It is effective for annual reporting periods beginning after Dec. 31, 2013, and interim reporting periods therein.

Causation to lost sales stumps plaintiffs’ expert

In lost profits cases, the causation element puts the plaintiff’s damages expert in a quandary, we reported here a few weeks ago. Do you assume liability and strictly focus on damages, or testify to it?

In a recent patent infringement case, the expert unsuccessfully opted to do the latter. Both parties produced “advanced energy” surgical products for laparoscopic and minimally invasive procedures. The plaintiffs claimed the defendant violated three of its patents for ultrasonic surgical devices and the federal court (D. Conn.) agreed.

To establish the requisite linkage between the defendant’s violation and their lost sales under the Panduit test, the plaintiffs tried to establish the market share allocation they would have had “but for” the defendants’ infringing devices. The court agreed with the definition of the market the plaintiffs’ expert proposed: a single market for advanced energy cutting and coagulating devices in which the litigants were the largest players and competed directly with each other. The plaintiffs did so with two different types of products, instruments using ultrasonic energy and those using radiofrequency (RF). Witnesses agreed that both types of energy worked for the same surgeries. This, the expert stated, meant they could function interchangeably.

If, in the 2010 “actual market,” the plaintiffs had a 24% market share, in the 2010 “but for” market, the plaintiffs would have a 54.2% market share, regardless of the defendant’s access to “immune” ultrasonic products and its own line of RF products, the expert calculated. For 2011, the plaintiffs’ actual market share was 27.5%, but, under the expert’s reconstruction, it would be 60.2%. This increase was due to a steady rise in the use of RF technology, he said, referencing a 2010 report from the Millennium Research Group (MRG) on vessel-sealing instruments.

The defendant’s expert claimed primarily that the “immune” products would fill in the “hole” the absence of the infringing devices left in the market. The court rejected this model but also found the market reconstruction of the plaintiffs’ expert problematic. The research study included information that “undercut” his “but for” market reconstruction. There was insufficient evidence to infer that “RF technology would have taken over the advanced energy market to the extent [the plaintiffs’ expert] claimed.” Because the plaintiffs did not prove causation, their case for lost profits damages failed.

However, the expert’s reasonable royalty analysis fared much better. Ultimately, the court awarded $141 million in royalty damages. Read the complete digest of Tyco Healthcare Group LP v. Ethicon Endo-Surgery, Inc., 2013 U.S. Dist. LEXIS 43992 (March 28, 2013) in the June Business Valuation Update; the opinion will be available soon at BVLaw.

Good news in healthcare M&A activity

Strong deal activity in the healthcare sector during 2012 by financial buyers is a “sure sign” that the economy is in recovery mode, says a new report from Irving Levin Associates. The Health Care Services Acquisition Report, 19th edition,which covers eight sectors of the healthcare services merger and acquisition market, reports an 11.9% increase in deal volume from 2011 to 2012. The number of deals carried out by financial buyers, such as private equity firms and REITs, was double that of 2011, a clear signal of economic recovery, the report says. The new report provides detailed transaction sheets plus a discussion of market trends, size and composition of the market, and prices paid. Sectors include hospitals, managed care companies, physician medical groups, behavioral health companies and labs, MRI and dialysis centers, and more. Download a free abstract here.

Front-burner topics highlight upcoming CPE events

The current real estate market adds importance to Valuing Real Estate Holding Companies: What to Do When Real Property Is the Business. So join Dennis Webb (Primus Valuation) and BVR on May 2 for a webinar that will focus on the critical intersection of business and real property appraisal and the all-too-common obstacles of tiered, fractional, and undivided interests.

How has the growth in the volume and prominence of patent infringement claims shaped the methods and analysis employed to present those claims? Find out as the Online Symposium on Economic Damages continues on May 7 with Hot Topics in Patent Royalty Damages, featuring expert Richard Bero (The BERO Group) and attorney Robert Surrette (McAndrews Held & Malloy Ltd.).

Emerging trends in the service industry are affecting the practice of business appraisal. Learn about this and how to avoid or overcome classic valuation pitfalls on May 8 during Valuing Professional Practices, a 100-minute webinar that features Kevin Yeanoplos (Brueggeman and Johnson Yeanoplos).


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