November 2, 2011 | Issue #1110-1  

Reminder: Expert reports still discoverable in Tax Court

The long-awaited amendments to Rule 26 of the Federal Rules of Civil Procedure, made effective at the beginning of this year, have largely been “great,” according to attorney Edward M. Robbins (Hochman Salkin Rettig Toscher & Perez, P.C.), who presented in last week’s “Lawyers Roundtable,” part 2 of BVR’s 2011 Tax Summit, moderated by Jay Fishman (Financial Research Associates). Prior to the amendments, which specifically exempt draft expert reports from discovery in federal court proceedings, “you wasted a lot of time trying to ‘get behind’ the reports—and frankly, by the end of the day, it wasn’t worth your time,” Robbins conceded. “But you did it anyway because everybody did.” Under the amended rule, an expert’s compensation is still discoverable, along with any facts or assumptions the attorney may have provided the expert to form his or her opinion. But the bottom line: In federal court, “‘collaboration’ is no longer a bad word,” Robbins said, and attorneys and experts no longer have to “walk on eggshells” every time they communicate.

But not in Tax Court: Roughly 80% of the tax valuations that appraisers perform are related to federal tax cases, Stephanie Loomis-Price (Winstead PC) reminded listeners—and the U.S. Tax Court has not yet adopted an analogous rule to the amended Rule 26. As a result, “we still struggle with what we can say to our experts, what we can get from them, whether we can edit or even comment on their drafts,” Loomis-Price said. When an attorney writes on a draft report, the comments are protected under the work product privilege—but as soon as the expert receives the draft, the protection disappears. This means that tax experts should still “assume everything you do, say, or write will be discoverable to the other side,” Robbins said. Hopefully, the Tax Court will “see the light,” he added, and Loomis-Price agreed: Members of the tax bar as well as appraisal associations “ought to be pestering the Tax Court,” she said, to amend its rules.

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Will I-bankers ever understand what BV appraisers do?

Last week’s report from an investment banker on providing the “market value” of an ambulatory surgery center (ASC) prompted Gary Trugman (Trugman Valuation Associates) to point out that the I-banker’s comments were “not only self-serving, but it shows his ignorance about business valuation. A business appraiser interprets the market and does not make the market,” Trugman says. “A proper business valuation will use the information from sales of similar properties to assist in the valuation project.” Take the I-banker’s encouragement to let buyers determine an ASC’s value, rather than valuation experts. “This only proves that the writer does not understand what we do,” Trugman says. “It is time for the investment bankers to follow some set of standards and learn about business valuation rather than do the slipshod work that is being seen in the market. Maybe they would be sued less often!”

In the healthcare field, the I-banker’s remarks may be “misleading and potentially dangerous,” says Jason Ruchaber (HealthCare Appraisers, Inc.). “In many instances the sale of a surgery center (or interest therein) is subject to healthcare regulations that preclude the buyer from paying anything other than FMV,” which “has a very specific definition in the healthcare industry,” more nuanced and perhaps more restrictive than the standard FMV definition used in other fields. “Deviating from the ‘hypothetical world’ of FMV to the real world of investment bankers may also lead buyers and sellers of these interests to face the real world possibility of fines, loss of their Medicare license and/or jail time,” Ruchaber warns.

 “For example, if a hospital buys an ASC, it will need to demonstrate that they are not paying above FMV; otherwise this could be construed as a kick-back to fill beds by referrals through the ASC,” adds Kevin Jackson (PwC Transaction Services) in a separate comment. And, taking a step back from healthcare, “Aren’t we potentially mixing standards of value—i.e., fair market value vs. investment or strategic value?” asks Michael Prost (Mueller Prost PC).

Another example: When pricing a business for sale, “Why would you ever use a BV expert . . . when using ‘fair market value,’ as the standard of value excludes strategic or synergistic value?” asks David Bishop, an attorney/CPA with Bishop Dulaney & Joyner, who also provides BV services through Bishop & Co. “I never have figured out how you could have a ‘willing seller’ at a price lower than what the best buyer (perhaps a strategic buyer) will pay unless the seller is not ‘reasonably informed of the relevant facts,’” he adds. “I suppose the BV expert could use a different standard of value but I rarely see that.” Not to criticize BV experts or brokers, Bishop adds: “There are plenty of good professionals—too bad we don’t always work together.”

Key takeaways from Turner and recent
FLP cases

As we recently reported, the taxpayer in Estate of Turner failed to persuade the Tax Court to preserve the discounted value of a family limited partnership (FLP), due largely to the passive character of the transferred assets (marketable securities) and the partnership’s lack of any legitimate, non-tax business purpose, including any overriding investment philosophy.

The takeaways from Turner: If asset consolidation and centralized management are among the stated, non-tax purposes for the FLP, then “don’t hold passive assets; don’t have the same management [before as after formation]; and don’t have the same investment philosophy,” said Stacey Delich-Gould (Cahill Gordon & Reindel LLP), who spoke at the recent 2011 Fall Meeting of the ABA Section of Taxation and Section of Real Property and Trust & Estate Law in Denver. “Do have arms-length bargaining” among the designated general and limited partnership interests, she added. The bottom line: “The [FLP] cases in which the estate has been successful in Tax Court have all come under the protection of the bona fide sale exception,” Delich-Gould said. “Therefore, a real, significant non-tax purpose for the partnership is an essential element of any successful plan.”

For the first time: Valuation Advisors adds foreign transactions

Exciting news from the Valuation Advisors Lack of Marketability Discount Study: We’ve just added 867 new deals to the database, including—for the first time—757 international transactions from 26 countries, with a median revenue of $42 million. China tops the list of new foreign transactions, making the current breakdown by countries (top 10):



United States





United Kingdom














Hong Kong


Digging deeper into the data, “although we haven’t statistically analyzed the relationship between U.S. and international DLOMs,” says Brian Pearson, president of Valuation Advisors, the general trend appears to parallel results from the domestic data; that is, “the international discounts tend to increase over time from the IPO date,” he says. Predictably, analysts will want to use the international data when valuing international companies or a company that has a considerable portion of its sales, earnings, or operations overseas, using new tools that permit searches by aggregate or individual country, in addition to the existing search parameters for U.S. companies.

At the same time, “If you are trying to calculate discounts by industry or for a particular time period only, you may want to use all the companies (foreign and domestic) in the database,” Pearson suggests, noting that with over 9,000 transactions—2,487 added this year alone—Valuation Advisors is currently the “largest valuation discount database in the world.”

Preview of new data from Pepperdine Private Capital Markets survey

New from the Pepperdine Private Capital Markets Project Fall '11 Survey: During the past year, the bank loan success rate was 44% for businesses with less than $5 million in revenues; 72% for businesses with $5 to $25 million in revenues; and 90% for businesses with greater than $25 million in revenues.

That’s just one data point, provided by John K. Paglia, associate professor of finance at Pepperdine University, who will present more from the survey at next week’s AICPA National BV Conference in Las Vegas. BVWire will be there, covering multiple sessions, news, and updates. Stay tuned . . .

Must an LLC turn over the valuation records of its subsidiary?

The Delaware Chancery Court just provided a good checklist of documents to request and require in a “books and record” action by the controlling member of a limited liability company (LLC), particularly when the purpose of the request is to ascertain the value of the member’s holdings, not just in the LLC but in its subsidiary. In this case, the LLC held the assets of a company that owned and operated eight wine brands. When the subsidiary started to founder, the LLC’s limited partners petitioned the Delaware Chancery to access the books and records of the LLC as well as the subsidiary. The LLC objected under Delaware law, maintaining that since the subsidiary was near insolvency, the valuation was zero (or a simple matter of mathematics), the request was “meaningless.” The LLC also said the relevant operating agreements gave members no separate contractual right of access to the sub’s records.

The court disagreed on both points. The operating agreements gave members inspection rights equal to those provided by Delaware law. And under the case law, since the defendant had no separate value from the subsidiary, it would be “unfair” to require the member to attempt to value its holdings without providing access to the records of the LLC’s only asset—in particular, those records pertaining to value, the court held. It then approved most of the petitioner’s 16-item request for books and records, excepting only those that did not relate directly to value (e.g., the subsidiary’s ability to pay its creditors) and permitting redaction for trade secrets. Read the complete digest of DGF Wine. Co., LLC v. Eight Estates Wine Holdings, LLC, C.A. No. 6110-VCN (Del. Ch.)(Aug. 31, 2011), in the November Business Valuation Update; the court’s opinion is posted at BVLaw.

Filings for 2010, 2011 decedents: new insights on IRS requirements, including determining FMV of undivided interests

Last August, the Internal Revenue Service released Notice 2011-66 , concerning the methods for electing and applying a carryover basis treatment under Sec. 1022 of the Internal Revenue Code (IRC) to 2010 estates, and Rev. Proc. 2011-41 , providing optional safe harbor guidance under Sec. 1022 IRC. In a detailed, thorough analysis, Steve Akers (Bessemer Trust) summarizes what’s new and important in the IRS guidance, and highlights the provisions relevant to fair market value appraisals. In particular, Akers observes that under the “Aggregation Rule” in Section 4.04 of Rev. Proc. 2011-41:

The “Basis Increase” allocated to any asset cannot result in the basis of that asset exceeding the fair market value of the asset on the date of death. If Basis Increase is allocated to an “undivided portion” of an asset that is distributed to a particular recipient, the IRS takes the taxpayer-favorable position that discounts do not have to be applied in determining the fair market value limit of each recipient’s “undivided portion.” Instead, “the FMV of an undivided portion of the decedent’s property that is acquired from the decedent at death is a fractional share of the FMV of the decedent’s property at death.”

“That rule would apply explicitly to undivided interests in real property,” Akers observes. “Presumably, it will also apply to minority interests in partnerships, LLCs, and corporations that are distributed among the estate beneficiaries.” Read Akers’ complete overview, written for Leimberg Information Services and presented to the National Association of Estate Planners Council, here.

Appraisers know the importance of a single letter—and of continuing education

There’s a world of difference between the IRS and IFRS. A CVA is not a CBA, just as a DLOM is never a DLOC. So when we ran a headline last week on options for “CLE” instead of “CPE”—we misplaced an important letter in the acronym for continuing education for appraisers, standing for: “Professional.” Our apologies—and here’s our current overview of Continuing Professional Education for business appraisers, to complete your year-end requirements as well as your penchant for getting all the facts, information, and important details in any valuations:

  • Judges Roundtable: View From the Bench, Part III of BVR’s Tax Summit, with Hon. David Laro, Hon. Julian Jacobs, Hon. Mary Ann Cohen (all U.S. Tax Court), moderated by Jay Fishman and hosted by Georgetown Univ. Law Center, on Friday Nov. 4.
  • Valuing a Majority Fractional Interest concludes the Tax Summit and features Neil Mills-Mazer (Internal Revenue Service), who will introduce his controversial “minority premium” model of fractional interest valuations, on Friday Nov. 11.

ASA will move forward with healthcare, strategic initiatives

In its meeting prior to last month’s national conference in Chicago, the ASA’s Business Valuation Committee approved a proposal representatives from the business valuation, machinery and technical services, and real property sections to design and teach a “multi-discipline course in valuing health care entities,” reports Linda Trugman, chair of the BV Committee, in her monthly e-update to members. “The committee will also be making a recommendation to the Board of Governors to go forward with this initiative,” Trugman adds. “I know that many of you are interested in health care valuation and we are looking forward to meeting those needs.” Another major item on the agenda: the design and implementation of a strategic plan, which the committee will continue to work on over the next few months.

FASB to try new outreach program with next release

In her remarks to the National Association of State Boards of Accountancy last week, FASB chairman Leslie Seidman announced a “new technique” to solicit feedback from the financial community regarding its standards convergence project with the IASB. Starting with the joint release of a revised exposure draft on revenue recognition in the next few weeks, the boards will hold workshops with representatives from certain key sectors, asking companies to prepare “before and after” examples of their common transactions under current GAAP and the proposed standard. “This will reveal whether companies understand the requirements and help identify any unintended consequences,” Seidman said. “We then plan to use these materials to discuss the results with users of financial statements to help them understand the nature of any changes that may result. We have other forms of field work planned,” she added, “which we view as an essential element of our due process to evaluate the costs and benefits of new standards. We welcome your input and involvement in the process.” In addition to addressing the status of the international convergence project, Seidman also discussed her views on the SEC’s proposal to incorporate IFRS and “where we stand on the issue of standard-setting for private companies.” Read her complete remarks here.



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Copyright © 2011 by Business Valuation Resources, LLC
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