MACKIE et al., Appellants, and THE ATTORNEY-GENERAL Respondent

001-NLR-NLR-V-52-MACKIE-et-al.-Appellants-and-THE-ATTORNEY-GENERAL-Respondent.pdf

THE
NEW LAW REPORTS OP CEYLONVOLUME LI I
1950Present: Jayetileke C.J. and Gratiaen J.MACKIE et al., Appellants, and THE ATTORNEY-GENERAL,
■Respondent
S.C. 88—j3. C. Colombo,' 71
-Estate duty—Valuation of “ Management shares ” in a company—“ Tangible assets "basis and profits basis—“ Balan-^s sheet method ”—Circumstanceswhere
“ tangible assets ” method of valuation is appropriate—“ Goodwill ” non-existent in a speculative business—Estate Duty Ordinance {Cap. 187), section 20(2)—Amending Ordinance No. 8 of 1941, section 6 {a).
In regard to valuation, for purposes of estate duty, of shares (not beingpreference shares) held by a deceased person in a Company at the time of hisdeath in September, 1940—.
Held, (i) that the price which the nulling vendor could reasonably expect toobtain and a willing purchaser could reasonably expect to have to pay for theshares in question is the measure of the value contemplated in section 20(1)
-of the Estate Duty Ordinance. In order to estimate the price which a prudentpurchaser might reasonably be expected to pay for the shares it is necessary toexamine the nature and history of the business, the risks involved and theextent to which the Articles of Association might be expected to depreciatethe value of the shares.
that where the; Article of Association impose restrictions on the alienation■of shares, such restrictions generally depress the value of the shares. Wherethe Articles restrict the right to transfer shares, the shares must be valued, forthe purpose of estate duty, on the basis that in spite of the Articles of Associationthe notional purchaser of the shares would be entitled to be put on the Company’sregister in respect of them, and if, by reason of the restrictions, the shares- have■depreciated in value such, fact should be taken into consideration.
that the “ tangible assets ” or “ balance sheet ” method such as iscontemplated in section 6(a) of the amending Ordinance No. 8 of 1941, wasthe appropriate .method for valuing the shares, where the business carried onby the Company was a highly speculative one and, therefore, it was notpossible to predict that the profits earned in the years preceding the death■of the deceased would he maintained in the future.
that “ goodwill " is non-existent in a. speculative business.
that in valuing shares provision must be made, out of the profits, for
reserves and income tax.'
APPEAL from an order of the District Court, Colombo.
One C. W. Mackie died at Aberdeen, Scotland, on September 7, 1940,leaving property in Ceylon which included two assets namely, 9,201Cumulative Preference Shares, and 5,000 Management Shares in C. W.Mackie & Co., Ltd.
W. Mackie & Co., Ltd., was a private company incorporated in’Ceylon in the year 1922. The business of the company was to buy andsell rubber on a very lai'ge scale. It was a highly speculative business and,further, the right to transfer shares in the company was restricted bythe Articles of Association. The question for consideration, in this appealwas in regard to the valuation, for purposes of estate duty, of the 5,000Management Shares held by the deceased.
1—J N.B.—51481—500 (12/55)
2
R. V. Perera, K.O., with S. J. Kadirgamer, for the executors-appellants..
R. R. Crossette-Thambiah, K.C., Solicitor-General, with Douglas JanszeCrown Counsel, for the Crown respondent.
Cur. adv. vult.
May 22, 1950. Jayetileke C.J.—
This is an appeal by the appellants who are the executors of the lastwill and testament of C. W. Mackie, deceased, against an order made bythe Additional District Judge of Colombo on an appeal preferred by themto the District Court under section 34 of the Estate Duty Ordinance,Chapter 187, confirming the valuation made by the Commissioner for-purposes of estate duty of 5,000 Management Shares held by the deceasedin C. W. Mackie & Co., Ltd.
C. W. Mackie died at Aberdeen, Scotland, on September 7, 1940, leaving;property in Ceylon which included two assets, namely, 9,201 CumulativePreference Shares, and 5,000 Management Shares in C. W. Mackie & Co.,Ltd..
On December 22, 1942, the appellants delivered to the Commissioner-of Estate Duty a declaration of property -under section 29 (1) of theOrdinance in which they valued the 9,201 Cumulative Preference Shares-at Es. 758,438.43, and the 5,000 Management Shares at Rs. 4,925 on thefigures appearing in the balance sheet as at December 31, 1939 (P8)-adopting the method of valuation known as the ‘ ‘ tangible assets ’ ’method. They valued the Cumulative Preference Shares at Rs. 82.43-per share and the Management Shares at 98J cts. per share.
On February 15, 1943, the Assessor made a provisional assessment in.accordance with the figures furnished by the executors and on April 21,1944, he made an additional assessment under section 33 (1) of the Ordi-nance in which he assessed the 9,201 Cumulative Preference Shares atRs. 828,090 and the 5,000 Management Shares at Rs. 1,500,000 which,works out re Rs. 90 and Rs. 300 per share, respectively.
The appellants delivered to the Commissioner of Estate Duty a written:notice of objections dated May 19, 1944, by which they objected to the-increased assessment on the following grounds : —
That the Cumulative Preference Shares could only be valued at-
par plus the proportion of such profits available for dividend asthe holders of the shares were entitled to receive in respect ofpreference dividends in arrears. On this basis they wereprepared to accept a valuation of Rs. 87.601 per share of" Rs. 806,017 as certified by the .auditors of the Company.
That the Management Shares could only be valued on the
nett value of the Company's assets at the date of death of thedeceased after providing for the value of all the Preference' Shares. On this basis they were prepared to accept a valuationof Rs- 203,094 at Rs. 40.6188 per share as certified by theauditors less Rs. 10.6188 for depreciation under the proviso•to section 20 (1) Cf the Ordinance by reason of the death of the
deceased.
The appellants raised the figures given by them in . their declaration ofproperty to Rs. 806,017 and Rs. 203,094 as a certain sum had accruedas profits between January 1, 1940, and September 6, 1940-
On May 20, 1946, the Commissioner of Estate Duty notified to theappellants bis determination to maintain the assessment dated April 21,1944, subject to a reduction of the valuation of the Management Shares±o Rs. 250 per share. The reason for the reduction is not known.
The appellants appealed to the ^District Court of Colombo against theCommissioner's assessment. Section 40 of the Ordinance says thatupon the filing of the petition ol appeal and the service of a copy thereofon the Attorney-General, the appea? shall be deemed to be and maybe proceeded with as an action between the appellant as plaintiff andthe Crown as defendant.
At the trial the following issues were framed: —•
Is the market value of the Preference and Management Shares inthe assessment excessive ?•
Should the Preference Shares be valued as stated in paragraph10 (c) of the petition and if not at what sum ?
Should the Management Shares be valued as stated in paragraph10 (c) of the petition and if not at what sum ?
Did any goodwill attach to the Management Shares at the date ofthe death of the deceased and if so what figure ?
Was the Management Shares as computed in terms of section 20 (1)of the Estate Duty Ordinance Rs. 1,250,000 and if not whatsum ?
After the issues were framed the learned Attorney-General acceptedthe value placed on the Cumulative Preference Shares by the executorsas the difference was very small and the trial proceeded on issues 1, 3, 4,and 5. After trial the learned Additional District Judge answered theissues as follows : —
No.
No.
Yes, Ns-. 250.
Yes. The value of the Management Shares is Ps. 1,250,000,and dismissed the action with costs.
The present appeal is against that judgment.
At the argument before us the claim for depreciation by reason of thedeath of C. W. Mackie was not pressed.
The appellant’s valuation of the shares is based on the “ tangibleassets ” value whilst that of the Commissioner is based on the profitsvalue.•
Two questions arise for decision on this appeal, (1) whether on the factsof this case the “ tangible assets ” basis is the appropriate basis of valua-tion of the shares, (2) if it is not, whether the valuation according to theprofits basis is excessive.,
The answer to these questions does not depend upon the credibilityof the witnesses, which I may say was not questioned at the argumentbefore us. Counsel for the appellants pointed out that the judgmentof the learned Additional District Judge is not helpful as he has failed to
the shares for the appellants. JLs valuation is as follows : —
appreciate the evidence, For instance he failed to appreciate whyMr. Lander raised his valuation of the Management Shares from 98 1/2 cents;each to 11s. 40.6188 each.
Mr. Lander, a Chartered Accountant of considerable experience, valued.
Rs. c.Rs. c.
Total assets. .. . 2,286,005 2
Due to creditors. .®. .400,186 27
Preference Shares. .. .209,988 0
TOC o "1-5" h z
Dividend arrears 1930-32,
Preference Share dividends 1933—
1940 . .. .. .522,7200
Preference ShareCapital. .900,000O
2,286,00522,121,994 27
Balance. .. .164,010 75
Add profits from January; 1, 1940, up
to January 6, 1940. .. .46,982 96
210,993 71
Book value of investments in excess
of broker’s valuation , .. .7,899 30
203,094 41
Divide by 5,000. .. .40-6188
Mr. Gunasekera, the Assistant Commissioner of Estate Duty, andMr. Satchithananda, a Chartered Accountant, valued the shares for the-.Commissioner. Mr. Gunasekera’s valuation is as follows :—
Rs. c.Rs-. c..
TOC o "1-5" h z
Profit….97,3910
Loss. .. .42,0030-1938 Profit….149,4850
Profit….787,640‘ 0
(1.1.40—6.8.40) Profit..454,532 0'
-1,489,048042,0030-
Total profit….442,0030
1,447,0450
Average profit pel year..310,0800
Deduct Preference Share dividends..79,2000
230,880 0
Capitalize at 15 per cent…1,539,2000
Divide by* 5,000. .-.307.84pershare
Mr. Satehithananda’s valuation is based on the “ weightage methodHe took the nett profits for five years up to the end of 1940 and weightedthe profits and losses by multiplying the figures from 1 to 5.
Ms. c.Ms. c.
His valuation is as follows :—
31.8.36….29,039 O !
TOC o "1-5" h z
31.8.37….5,3370
31.8.38….73,894O
31.8.39….489,7750
31.8.40….507,4200
When weighted 29,0390>£l. .29,039 O
5,3370 x 2..10,6740
73,8940 x 3..221,682O
489,7750 x 4*..1,959,1000
507,4200 x 5..'2,537,1000
. 29,0390 4,728,556 O
29,039 O
4,699,517 O
Weighted average 4,699,5170
. .313,300 O
15
Less Preference dividends. .67,300 O
Reserve. .. .. .30,000097,300 O
*.
215,980 O
Average yield at 16 per cent.
215,980×100
… .1,349,875 O
16
Value of share. .. .2700
Mr. Gunasekera’s and Mr. Satchithananda's valuations are based on theassumption that the profits would be maintained for at least five years.
Mr. Lander, Mr. Gunasekera and Mr. Satchithananda valued the shareson the footing that the business was a going concern.'
In Abraham v. Federal Commissioner of Taxation the report of whichis not available to us but a note of which appears in Adamson2,' it washeld that the final assessment of the value of the shares must be madeprincipally on the basis of the income yield but where owing to exceptionalcircumstances the valuation on this basis presents enormous difficultiesit is legitimate to rely more than .usual on the assets value.
In Findlay’s Trustees v. Commissioners of Inland Revenue 3 Lord Flemingsaid:.
I do not doubt that when one is seeking to ascertain the profitswhich will probably be earned by a business in the future it is quiteusual to do so by taking an average of the profits actually earned forthe three preceding years. This probably operates quite equitablywhen one is dealing with a well-established business which- has normalups and downs but has no violent fluctuations in either direction.”
70 Commonwealth L. R. 23.
The Valuation of Company Shares and Businesses.'
22 A. T. C. 437.
Mr. Lander gave as his reason for adopting the “ tangible assets ” methodthat the business carried on by the Company was a highly speculativebusiness and therefore it was not possible to predict that the profitsearned in the years preceding the death of the deceased would be main-tained in the future. Mr. Gunasekera and Mr. Satchithananda agreed'with Mr. Lander that the business was a very speculative one but they^thought that as the war was on the profits would be maintained in thefuture. Mr. Gunasekera said “ I cannot think of a more speculativebusiness than Mackie’s. Mr. Satchithananda said “ A rubber businesscan be said to be a speculative business because the risk is greater. It is a-very risky business.”(
Section 20 (1) of the Ordinance which is identical with section 7 (5)of the Finance Act, 1894, provides that the value of any property shall beestimated to be the price *which, in the opinion of the Assessor, suchproperty would fetch if sold in the open market at the time of the death ofthe deceased. Section 20 (1) was amended by Ordinance No. 8 of 1941as follows : —
“ (6) (a) Where the property to be valued consists of shares (notbeing preference shares) in any company which by its articles restrictsthe right to transfer its shares or which is a company controlled bynot more than five persons, and the Commissioner is satisfied that theshares have hot, within the period of twelve months immediatelypreceding the death of the deceased, been quoted in the official list of arecognized stock exchange in the United Kingdom or in a list of a-like nature issued in Ceylon by any association of brokers approved bythe Financial Secretary for the purposes of this sub-section, the Com-missioner may direct that the principal value of such shares for thepurposes of this Ordinance shall not be ascertained in the mannerprovided by sub-section (1), but shall be ascertained by reference to the’ value of the total assets of the company.”
The amending Ordinance does not apply to this case because it cameinto operation after the death of the deceased but it shows that the“ tangible assets ” method is an appropriate method to be adoptedin the valuation of shares which are subject to restrictions. In Ellesmerev. Inland Revenue Commissioners 1 Sankey J. said:
‘ ‘ What is meant by the words ‘ the price which it would fetch if soldin the open market ’ in Section 7 (5) of the Finance Act 1894 is the bestpossible price that is obtainable, and what that is is largely, if notentirely, a question of fact.”
The price which the willing vendor could reasonably expect to obtainand a willing purchaser could reasonably expect to have to pay for theshares in question is the measure of the value under the section. In orderto estimate the price that a prudent purchaser might reasonably beexpected to pay for the shares it is necessary to examine the nature andhistory of the business, the risks involved and the extent to which therestrictions in the Articles*-might be expected to depreciate the value ofthe shares.
(1918) 2 K. B. at 740.
W. Mackie & Co., Ltd., was a private Company incorporated in Cey-lon in the year 1922 inter alia to take over and cprry on the business-carried on by the deceased as a dealer in rubber. It had a paid up capitaLof Bs. 1,000,000 divided into 19,800 8 per cent. Cumulative PreferenceShares of Bs. 50 each and 5,000 Management Shares of Bs. 2 each. Clause5 of the Memorandum of Association provides that the ManagementShareholders are entitled to all profits and other monies of the Companyavailable for dividend which the directors determine to distribute aftermaking provision for reserve and depreciation and after paying thecumulative preferential dividends and the directors’ fees. By Articles91 and 94 of the Articles of Association the deceased was appointed a lifedirector and was given full control of the business of the company and thepower to arrange the policy of the company. It -appears from P2 thatup to the year 1926 the deceased held 8,625 out of the 5,000 ManagementShares and that in that year he purchased the remaining 1,375 shares.The right to transfer shares in the Company was restricted by the Articlesof Association.
Article 38 provides that any person proposing to transfer any shareshall give notice in writing to the Company that he desires to transfer thesame. Such notice shall specify the sum he fixes as the fair value and shallconstitute the Company his agent for the sale of the share so fixed, or,at the option of the purchaser, at the face value to be fixed by the Auditorsin accordance with the Articles.
Article 39 provides that the shares specified in the transfer notice shallbe offered by the Company in the first place to the Life Director, and,if they are not taken up by him within 90 days, shall be offered by theCompany to any person selected by the Life Director whom he maydeem it desirable in the interests of the Company to admit to membership.Subject as aforesaid the share shall be offered by the Company to the othermembers.
Article 41 provides that in case any difference arises between theproposing transferor and the purchasing member as to the fair value of ashare the Auditors shall, on the application of either party, certify inwriting the sum which, in their opinion, is the fair value and such sumshall be deemed to be the fan* value and in so certifying the Auditorsshall be considered as acting as Experts and not as Arbitrators.
Article 43 provides that the proposing transferor shall be at libertyto sell or transfer the shares to any person and at any price if the Companyfails to find a member willing to purchase the shares. But Article 45provides that the Directors may refuse to register any transfer of shareswhere they are not of the opinion that it is desirable to admit the proposedtransferee to membership.
There are certain Articles which relate to the compulsory acquisitionof shares, and which, prevent a shareholder from owning or being interestedin any other business in rubber to which reference should be made. Xrefer in particular to Articles 46, .47, 48, 49, 50, 53 and 54.
Article 45 provides that the holders for the time being of 9/10ths of theissued capital may at any time serve the Company with a requisition td
enforce the transfer of any particular shares not held by the requisitionists■Whereupon the Company shall forthwith give notice to the holder of suchshares notice of such requisition; and unless within 14 days afterwardsifche holder shall give to the Company a transfer notice in respect of his"Shares in accordance with -Article 3S he shall he deemed at the expirationof that period to have certainly given such notice and to have specifiedtherein the amount of capital paid up on the shares as the sum he fixesas the fair value.
Article 49 provides that in the event «of the death of an ordinary directorthe Life Director and the surviving ordinary directors for the time beingmav at any time within four years thereafter serve the Company with arequisition to enforce the transfer to them in proportion to the existingshares held by them respectively of any shares standing in the name ofany ordinary, director and the provisions of Article 46 as to giving noticeand other relevant provisions of that Article shall apply to every suchrequisition.
Article 48 provides that no member of the Company other than the LifeDirector shall, without the consent of all the members for the time of theCompany, or the Life Director, be interested as a shareholder, Director,Partner, Manager or otherwise in any concern carrying on any businessin competition with the Company or any interests opposed to thoseof the Company and if it be proved to the satisfaction of the shareholdersthat any member has committed a breach of this Article they may servehim with a notice in writing requiring him to retire from or otherwisedetermine his'-interest in such concern and stating that in the event of non-compliance with such requisition within 28 days his shares shall be liableto forfeiture and unless within 28 days after the service of such noticeit shall be proved to the satisfaction if the Directors that the requisitionhas not been complied with the whole of or any of the shares of suchmember may be forfeited by resolution of the Directors to that extent.
Article 49 provides that a member of the Company other than the LifeDirector shall not, without' the Company’s consent or the consent of theLife Director, either solely or jointly with, or as Director, Manager orAgent" of or for, any other Company or person or persons directly orindirectly carry on or be engaged or concerned or interested as a share-holder or otherwise in any business which the Company is authorised tocarry on and the Directors may by resolution forfeit without prejudiceto the previsions of Article 30 the shares of any member who acts incontrayenticn of this provision. Article 30 provides that a memberwhose shares have been forfeited shall be liable to pay to the Companyall calls made as payable and not paid on such shares at time of forfeitureand interest thereon bp to the date of payment without any deduction orallowance for the value of the shares at the time of forfeiture.
Article 50 provides that a person who ceases to be a member of theCompany shall not without the Company’s consent or the consent of theLife Director at any time within five years from the date he ceases to be amember, either- solely or jointly with, or as Director, Manager or Agentpf or for any other Company or person or persons directly or indirectly,carry on or be engaged or concerned or interested in the business of a
Tvlerchant, Produce Broker or Commission Agent in. the Island of Ceylonor permit or suffer his name to he used or employed in, carry an or inconnection with any such business.
Article 54 provides that the Directors may call on the executors oradministrators of a deceased member (other than the Life Director) totransfer the shares of the deceased to some person to be selected by suchExecutors or Administrators and approved by the Life Director or (ifthe Life Director be dead) by the Ordinary Directors and if the Executorsor Administrator’s do not comply forthwith with such call they shall bedeemed to have served the Company with a transfer notice under Article38 and to have specified therein a sum equal to the amount paid uponthe shares as the fair value and the provisions of that and the subsequentArticles shall take effect.
In the case of Commissioners of Inland Revenue and others v. Crossman 1where there were restrictions similar to those contained in Articles 38 and41, the House of Lords held that the value of the shares for the purposeof duty must be estimated at the price which they would fetch if soldin the open market on the terms that the purchaser should be entitled tobe put on the Company's register as the holder of the shares and shouldhold them subject to the provisions of the Articles of Association includingthose relating to the alienation and transfer of shares in the Company.In the course of his judgment Viscount Hailsham, L.C., said:
“ I think full justice is done to the meaning of the sub-section if theproperty to be valued is determined by the earlier Sections and Section7 is treated as being merely a statutory direction as to the methodby which the value is to be ascertained. In order to comply with thatstatutory direction it is necessary to make the assumptions which theStatute directs. This is not to ignore the limitations attached to theshares. In the present case a share in such a company as this, with anunrestricted right of transfer would probably be worth twice as muchas the £355, which is fixed by Findlay J. ”
The shares must therefore be valued on the basis that in spite of theArticles of Association the notional purchaser would be entitled to beput on the Company’s register in respect of them, and if, by reason ofthe restrictions, the shares have depreciated in value such fact shouldbe taken into consideration.
The business of the Company was to buy and sell rubber on its ownaccount on a very large scale. It was carried on by the deceased himselffrom 1922 up to 1931 when he retired and settled down in England leavingMr. Williams in charge. The deceased, however, kept in touch with thebusiness and controlled its policy right up to his death. The Companyhad a very large store which cost nearly Us. 300,000 to build in 1926.Betweeu 25 per cent, to 30 per cent, of the Island’s exports of rubberpassed through the hands of the Company. The manner in which thebusiness was carried on was described by Mr. Williams. He said :.
Maekie kept a large stock of rubber in listed. He bought whetherthere was an immediate prospect of selling or not. His plan was to
(1936) 1 A. JE. R. 762.
– buy as much, rubber as possible and stock. He used to buy 50 or 60tons of rubber a day. He would buy in a railing market and try tosell in a irsing market. It was very difficult to find out what a fallingmarket was and what a rising market was. We could not wait for afalling market to buy. We had such large stocks that the rubber hadto be turned over. In a falling market we had to sell 50 or 60 tonsand try to cover up buying it at a lower price. It we had 5,000 tonsof rubber in stock at any one time ar-d if the price went up by one centa pound we would make Es. 110,000 and if the price went down by onecent we would lose that amount. We used to send rubber to Germany,Australia, Holland, CzechoslovdtKia and London. We had dealeragents and broker agents in London and other places. We ship therubber and they sell it. They send bids. If we pay more here we senda counter-offer. Sometimes they take, sometimes they don't. ”
As I said before Mr. Lander said that the business was a speculative oneand the experts called by the Crown admitted it. It may be useful forme to state in detail what the witnesses called by the appellants said onthe point.
Mr. Lander said :
“ The results show quite clearly that it was a business with a verysensitive produce—rubber, and they indicate that a highly speculativepolicy had been indicated. There were large profits made in certainperiods and very large losses in certain other periods. In 1926 therewere large reserves about 3/4 million rupees. The losses graduallyeliminated that reserve. In 1932 the Company was insolvent. Themovements of rubber over history have been unpredictable. Largefortunes have been made in rubber and large fortunes have been lost inrubber. Rumours of extended production in other countries, changesin policy of consumers and also availability of shipping affect the price.At any time it would have been a gamble to buy any interest in theCompany. ”
Mr. Williams said:
“ I have a large experience in the commercial aspect of rubber. It isvery difficult to predict with any accuracy the future rubber market.It is not known what is going to happen except on a very few occasions.Mr. Mackie carried on a very speculative business. Buying of anyinterest in Mackie’s at any time would have been a gamble.”
Mr. Hayward, the Managing Director of the Rubber and Produce Traders’Ltd., which, carried bn a business similar to that of Mackie & Co., Ltd.,up to 1938, when it was closed down owing tc» heavy losses, said:
■“ Dealing in rubber is a highly speculative business. There is anexchange for dealing in rubber in London, iSiew York and Singaporeand in these three places people gamble in the turnover. Change ofGovernment, over-production, rumours of war, synthetic rubber,large production of rq.otor cars all- affect the price of rubber. TheCompany made half a million rupees in 9 months- in 1940. All thatcould have been lost in three months if it took a wrong view of themarket.' ’
Mr. Cumming, a partner in E. John & Co., a firm of produce brokers,said:
“ In a company like Mackie & Co., Ltd., very much risk in thebusiness is involved because one must be certain of taking the right view.It is a speculative business like the races. At normal times the pricesfluctuated.”
The fluctuations in the price of rubber between 1922 and 1940 are to beseen in P10 and the profits and leases of the Company and the dividendspaid in P7. P7 shows that between 1922 and 1926, there were profitsamounting to Rs. 3,441,369, between 1927 and 1932, there were lossesamounting to Rs. 1,804,304, and btetween 1933 and 1940, there wereprofits amounting to Its. 1,911,233. It also shows that dividends werepaid on the Preference and Management Shares in 1926, and a sum ofapproximately Us. 750,000 was carried to the general reserve, that thepreference share dividends for 1927 and 1928 were waived, no dividendswere paid on the Preference Shares from 1930 to 1940, and for the firsttime between 1927 and 1940 the assets exceeded the .liabilities in 1940’-It is clear from the figures in P7 that any five years is not comparablewith the next five years and cannot be taken as a reasonable anticipationof the next five years. The fluctuations in the profits and losses havebeen so violent that there is no normality in the history of the companydisclosed in the balance sheet P7. One cannot of course expect normalityin a business which is not carried on on business principles but is in thenature of a gamble. Yet Mr. Gunasekera said:
“ If Mackie died in 1926, I would probably have valued the sharesstill higher than I have done now unless there was some known factor.After a person had bought them he would have received nothing up to1940. Prom 1926 up to 1932 he would have lost all his capital and theCompany would have been wound up.”
It was argued that the losses during that period were due to the worlddepression. The depression commenced in the latter part of 1929, butthere were losses in 1927 and 1928. There are no materials before uswhich lend the slightest support to that contention. P10 shows thatfrom 1929 to 1932, the price of rubber dropped steadily and the probabilityis that the losses were due to the Company .speculating heavily in' a fallingmarket. The passage quoted above from Mr. Gunasekera’s evidencedemonstrates how fallacious his method of valuation is when it is appliedto a speculative business. With regard to the future prospects of rubberhe said that as the market in 1940 was good there was no prospect inthe fall in the price of rubber in the next six years. This seems to hepure speculation on his part. It is true that rubber was a munition ofwar but- what guarantee was there that there would be no fluctuations inthe price of rubber and that the war would go on for six years.Mr. Hayward, who according to Mr. Gunasekera had an intimate know-ledge of the rubber market and knew much more about the rubber marketthan he did, said that, though the Company had made half a millionrupees in the first nine months of 1940, it eoul^l have lost all that in thenext three months if it took a wrong view of the market. It must heremembered that the deceased died at a time when the war had reached
a very critical stage for England. France was out of the war and Eng-land and the Empire were alone against Germany and Italy. TheBattle of Britain had begun and everyone was in doubt whether the RoyalAir Force would be able to withstand the tremendous attack by theGerman Air Force which was superior in strength. It is with the pricewhich a hypothetical purchaser must reasonably expect to have topay for the shares at this critical period with which we are now concerned.
A ■ prospective purchaser may be an investor or a speculator. In normaltimes an investor would probably nqj> have been interested in theseshares because no dividends had been paid for 14 years. A speculatormay have been interested in them but could the seller have reasonablytexpeeted him to pay anything mord than the “ tangible assets ” valuefor them? I think not. Could the seller have reasonably expected himto pay even that at a critical period like 1940, when there was the possi-bility of all human affairs being dislocated? I think not. Mr. Williamsand Mr. Gumming gave useful evidence on this point. Mr. Williams saidthat on the, death of the deceased if he goti the shares very cheap he wouldhave bought them as a gamble. Mr. Cumming said that in 1940, hisfirm would not have been willing to make any underwriting propositionfor these shares because the risk was too great owing to the nature ofthe shares and the war conditions. It was difficult to foresee things andpeople were anxious to keep their money in their Banks.
The learned Additional District Judge says in his judgment that-Mr. Hayward was optimistic about the future of rubber when he wascoming back from England in August, 1940. If the learned Judgeintended to' say that Mr. Hayward was optimistic about the future ofrubber for a long period it is a clear misdirection because Mr. Haywardexplained in his cross-examination that what he meant was that as thewar was in progress he could not take a long view. On a short viewhe was optimistic, that is, for the next three or four months.
For the reasons given by me I am of opinion that Mr. Lander’s methodis the more appropriate method to be adopted for the valuation of theshares. That is the method contemplated in the amending Ordinance 8of 1941 for the valuation of shares of this nature and that; was the methodwhich was adopted in 1926 when the deceased acquired the outstandingshares which belonged to Mr. Robertson and others. The figure paidby the deceased represented only the value of the “ tangible assets ”remaining for each share. Nothing was added on account of goodwill,presumably because in a speculative business there can be no goodwill.
Leake says:,
“ There seems to be no doubt about the truth of the proposition
that before it is possible to justify value being put upon the goodwill of■ any undertaking it must be shown that the expected future annual
profits exceed the normal annual wage or hire of the capital invested
having regard to the nature of the risk.”.
In a speculative business one cannot expect profits but can only hope forprofits. .r.–.
1 On Goodwill.
There remains the question whether Mr. Gunasekera’s valuation is■excessive. It was mainly on Mr. G-unasekera ’s valuation that the Crownrelied.
Mr. Perera argued that the rate of conversion adopted byMr. Gunasekera was too low and that Mr. Gunasekera should have made-provision for reserves and Income Tax and an allowance for depreciationin view of the restrictions.'
There is a conflict of evidence between Mr. Gunasekera andMr. Satchithananda as to what $he risk rate should be in a speculativeproduct like rubber. Mr. Gunasekera said that he took 10 per cent, asthe risk rate in adopting 15 per cent.^ as the appropriate rate of conversion,but Mr. Satchithananda said that he would allow 20 to 25 per cent, forTisk. Mr. Satchithananda’s evidence is supported by the evidence ofMr. Gumming, who said that, in a business of this kind, a person wouldexpect 25 to 30 per cent, as profits. There is the further fact that, whenthe shares held by one Mr. G. L. Lvon in Heath & Co. were valued in1943, for purpose of Estate Duty, the rate of conversion adopted was14 per cent, though there was no risk in the business at all. Heath & Co.carried on business as exporters of tea and,, occasionally, rubber On acommission basis. Mr. Gunasekera said that, if the rate of conversionadopted in the valuation of those shares was 14 per cent., he would agreethat the rate adopted by him in this case should be higher.
If the risk rate is taken as 20 per cent, and the rate of conversion as25 per cent, in the present case which, in my opinion, is by no meansexcessive Mr. Gunasekera’s valuation of the shares will be reduced toRs. 190 per share.
An examination of Mr. Gunasekera’s valuation, which I have set forthfully above, shows that he has made no provision for reserves and IncomeTax and no allowance for depreciation. Mr. Gunasekera said that he-generally allows a reasonable amount for reserves, but he made noallowance in the present ease for the reason given' in the following passage-in his evidence : —
“ I did not apply the principle of weightage because I did not deductfrom these figures any tax payable. I also did not 'allow a sum that■ should be withheld from distribution to maintain reserves as I thoughtthat the two items would be counterbalanced.”
Mr. Gunasekera did not demonstrate how the two items were counter-balanced. I find it extremely difficult to understand what he intended"to convey in the passage quoted above, and "I have ho alternative but toignore his evidence on the point. Mr. Satchithananda said that in valuing-shares provision must be made out of the profits fpr reserves and IncomeTax. P7 shows that a sum of Rs. 750,000 which works out to Rs. 150,000a year was carried to the general reserve in 1926. If that had not beendone the Company would, in all probability, have been wound up before1932, and the necessity to decide the problems we are confronted withwould not have arisen. Again, PO shows -that, in-the year 1940, when the-Company became solvent after a period of about ten years, a further■sum of Rs. 150,000 was carried into the general reserve. It seems to methat Rs. 150,000 is not too large a sum to be put into the reserve annually
' Having regard to the highly speculative nature of the business carried onby the Company. If that sum is deducted out of the average profitsMr. Gunasekera’s valuation would be reduced to approximately Its. 80a share. If Income Tax at 15 per cent., the rate current at the date ofdeath of the deceased, is also deducted the nett balance available for theManagement Shares would be Bs. 45,248 which when capitalised at25 per cent, would result in reducing Mr. Grunasekera’s valuation toIts. 36 a share.
Adamson 1 gays that restrictions on fee alienation of shares, either byvesting in the Directors a general power to refuse to register a transfereewhom they consider would be an undesirable member, or by specificrequirements as to the consideration payable to an intending seller, or asto the method of offering the shares for sale, or by giving them or theauditors the power to fix a fair value to be paid to. the sellers, and similarrestrictions detract from the value of the shares for certain purposes,unless a controlling interest is being dealt with, namely, a holding of morethan 75 per cent, of the total issued shares, which would place the purchaserin a position to use his voting power to remove the restrictions. Hesays further that such restrictions limit the market, and make the sharesunattractive to many investors and to banks for security purposes. Evenif all the preference shares belonging to the deceased were sold alone withthe management shares the purchaser would have had only 14,000 out of24,000 shares, which would not have given him a controlling interestin the Company. The extent to which restrictions, similar to thosecontained in some of the articles referred to above, depress the value of theshares can be gathered from the passage in the judgment of the Lord.Chancellor quoted above and from the following observations of LordEleming in the Trustees of J. T. Salvesen v. Gom.missioners of InlandRevenue 2: —
‘ ‘ I may say at once that I regard these restrictions as depreciatingtheir value very considerably …. All the witnesses wereagreed that the restrictions would depreciate the value of the sharesbut the only witness who put a money value on the restriction wasMr. Hobertson-Durham who said that, in his opinion, it might make adifference as much as 8s. 4cZ. on his value of £1—6—8 and, in my opinion,this figure is by no means excessive.”
Mr. Lander did not get an opportunity of putting a money value on therestrictions because the Crown did not disclose Mr. Gunasekera’s methodof valuation either in the pleadings or in his cross-examination. This isindeed a matter to be regretted. On the materials before me I can onlysay that the value of ^the shares is depressed by the restrictions I havereferred to.
Mr. Satchithananda’s method of valuation is, as I have said before,also based on the maintainability of future profits, and for the reasonsgiven by me is inapplicable to a speculative business. But it seems to-me that there are other reasons for rejecting it. For instance, accordingto Pi 6, which Mr. Satchithananda referred to as the Students* Note
» '
The Valuation of Company Shares and Businesses. .
9 A.. T. C. 42.
issued to him by H. Foulk, Lynch & Co., Ltd., when he was a student,there must be a trend of profits to apply the ' weightage method”. An-examination of P7 shows that there was no trend of profits from August 1,1935, up to July 31, 1940. There is also the fact that Mr. Satchitha-nanda admitted in his evidence that in valuing shares all abnormal and.all war profits must be excluded and that he failed to exclude theabnormal and war profits made in the years 1938, 1939 and 1940. He.admitted further that if the profits made in the war years 1939, 1940•and 1941 were excluded the weighted average would be nil.
would accordingly uphold Mr. Lander’s valuation of the 5,000 Manage-ment Shares held by the deceased. * On the basis of this valuation it isagreed that the appellants are entitled to a refund of Rs. 166.929.57. Iwould set aside the order made by the learned Additional District Judgeand enter judgment in favour of the appellants for the sum ofRs. 166,929.57 with interest as prayed for in para, (d) of the prayer of.their petition of appeal dated June 14, 1946. The appellants will beentitled to costs here and in the Court below.
•GratiaeN J.—
This appeal relates to the valuation for purposes of estate duty of 5,000
Management Shares” held by the deceased C. W. Mackie in the firm of•C'. W. Mackie & Company, Ltd., at the time of his death. A separatedispute regarding the value of 9,201 Cumulative Preference Shares"belonging to the deceased in the same Company was settled in the course<of the proceedings in the Court below.
W. Mackie died in Scotland on September* 7, 1940, and was at that-date possessed of a considerable estate in Ceylon and abroad- The•Company in which he held the “Management Shares” with which thisappeal is concerned was a private Company incorporated in Ceylon in1922. He was the Life Director and as such he had a controlling interestin the Company’s affairs under the Articles of Association. The paidup capital was Rs. 1,000,000 divided into 19,800 Cumulative 8 per cent.Preference Shares of the par value of'Rs. 50 each (of which the deceasedheld 9,201} and 5,000 “Management” or ordinary shares of the parvalue of Rs. 2 each (of which he had held the entirety since December 31,1926). The Preference Shareholders had a prior right to be paid their■dividends at the rate prescribed for them, but had no further right to■participate in the profits of the Company. Any profits left over were.-available for payment as dividends to the Management shareholders—hat only to an extent which the Directors might recommend ; in theevent of liquidation, all undistributed profits were to be paid to them■aff.er repayment of the capital and' arrears of dividends due to the Pre-ference Shareholders. I shall refer later to the restrictions imposed by theArticles of Association on the transfer of a shareholder’s interests in theCompany.
On December 22,1940, the executors of the deceased’s estate
furnished the Commissioner with a declaration in which, for purposes ofestate duty, they valued each of the “Management Shares” at 98J cents,■this valuation was based (by reference to the figures in the last audited
balance sheet of the Company available before Mackie’s death, i.e., forthe year ending December 31, 1939) on a computation of the nett assets-remaining for each “Management Share” after making provision fortaxation and for the liability to preference shareholders in respect ofcapital and arrears of dividends. The valuation was accepted by theAssessor in his provisional assessment dated February 15,1943. On
April 21,1944, however, he made an additional assessment whereby
among other items, he increased the estimated value of each “Manage-ment Share” to Rs. 300 on a basis of (computation which was not dis-closed to the executors until December, 1948, when he gave evidencein the Court below. They appealed from this additional assessment to-the Commissioner on May 19, 1944, b&t stated that they were now willingto accept a valuation of Us. 40.6188 per “Management Share”. Thelearned District Judge has wrongly assumed that this higher figureinvolved a serious inconsistency on their part. In actual fact, the sameprinciple of valuation—i.e., “ the balance sheet method ”—was againadopted, but the higher figure of Rs. 40.6188 was arrived at by reasonof an increase in the amount of the undistributed profits earned sinceJanuary, 1940, as shown in the later balance sheet for the year endingDecember 31,1940—proportionate adjustments having been made in
those figures so as to ascertain the. approximate position of the Companyas at September 6, 1940.
On May 20, 1946, the Commissioner’s determination on the appeal(at which there was no formal inter partes hearing) was communicated to-the appellants, and, apart from items with which we are not now con-cerned, the Assessor’s estimate of the value of each “Management Share”'was reduced to Us. 250. No reasons for the Commissioner’s determina-tion were then or at any later date notified to the appellants; nor werethey made available during the proceedings before the learned DistrictJudge or in this Court; the record of the evidence and of Counsel’s obser-vations indicates that even the Assessor and the (then) Solicitor-Generalwho presented the case for the Crown in the lower Court seem to havebeen left to speculate as to the process by which the learned Commissionerhad computed the value of the shares. Repeated attempts of the execu-tors’ lawyers, both before and at the commencement of the litigationwhich followed, to seek enlightenment as to the case which their clients,were required to meet were either resisted or ignored. Full advantagewas taken of the defective machinery of the Estate Duty Ordinance(Chapter 187) and of our Code of Civil Procedure for refusing to discloseinformation which, if available, would have helped to shorten theproceedings which followed. In the result, the executors, on whom laythe burden of disproving the correctness of the Commissioner’s computa-tion at the hearing of the appeal which they preferred in June. 1946rto the District Coui*t of Coloimbo under section 34 .of the Ordinance,entered upon a most unusual task. Indeed, the method of computationultimately relied on by the Crown (whether it was the same as thatadopted by the Commissioner is still a closely guarded secret) was noteven specifically put in cross-examination to the appellants’ expertwitnesses for their criticisnl. I cannot commend this technique oflitigation.
It is hoped that early steps will be taken to modernise the procedureregulating appeals between the Crown and its subjects in estate dutycases. Proceedings of this kind cannot be conducted satisfactorily unless-the substantial points of contest are clarified at the earliest possiblestage. In the present action, the precise nature of the controversy—namely the proper basis of valuing the deceased’s shares—did not clearlyemerge until after the case for the executors had been closed. In this-country the Crown, as a litigant, still enjoys many immunities andprivileges which have been swepl away by the provisions of the Crown.Proceedings Act, 1947, in England. So long as these and other immuni-ties and privileges continue to exist, officers of the Crown should, forreasons, of fairness and in the interests of justice, respect the long-established and honourable convention “not to throw any difficultyin the way of any proceeding for the purpose of bringing matters beforea Court of Justice where any real point of difficulty that requires judicialdecision has occurred …. unless there be some plain over-rulingprinciple of public interest concerned which cannot be disregarded”.(Vide the English decisions approved by Lord Chancellor Simon inDuncan v. Gammel Laird and Company1}. There should be no con-fusion in this connection between the claims of the public interest (towhich the rights of every private litigant must of course give priority)and the desire for financial advantage to the public revenue.
After a protracted trial in the Court below the learned District Judgeupheld the Commissioner’s assessment, and valued the 5,000 “Manage-ment Shares” belonging to the deceased at the time of his death atRs. 250 each- The present appeal is from his judgment. The groundson whichI differ fromthe learned Judge sufficientlyappearinthe
reasons whieh follow. The relevant facts are not in dispute, and so.questions as to the credibility of witnesses arises for consideration; themain question for decision relates to the principle of valuation which ismost appropriate to the present case.
The value of the shares must be estimated to be the price which theywould have fetched “if sold in the open market at the time of the deathof the deceased.” The language of Section 20 (1) of the Estate DutyOrdinance(Chapter 187)corresponds to that of Section7 (5)ofthe
Einanee Act, 1894, of England. Admittedly the restrictions imposecl bythe Articles of Association upon the free transfer of shares in C- W.Mackie and Company, Ltd., would have prevented such a sale in theopen market from taking place. It is. nevertheless necessary to valuethe shares at the relevant date by reference to the price which theywould have fetched at a notional sale to a hypothetical purchaser “on theterms thatthe purchasershould be entitled to be registered andtobe
regarded asthe holder of the shares, and should hold themsubjecttothe
provisions of the articles of association, including those relating to the aliena-tion and transfer of shares in the Company”. Commissioners of InlandRevenue v. Crossman2. This principle of valuation which was laid downby the majority of the distinguished Judges who decided Crossman’scase2 is, I should imagine, seldom easy to apply in a particular case. As
(1937) A. C. 26.
1 (1912) A.. G. 624.a
Lord Fleming pointed out in Salv eson’s Trustees v. Commissioners of InlandRevenue1 “ the estimation of the value of shares by a highly artificialstandard which is never applied in the ordinary share market must be amatter of opinion and does not admit of precise scientific or mathematical•calculation ”. It was no doubt for this reason that the Legislaturedecided, shortly after Maekie’s death, to prescribe a statutory basis of•computation in such cases. The Estate Duty Amendment Ordinance.No. 8 of 1941, sanctions a method of valuation—i.e., by assessing thevalue of the deceased shareholder’s irfcerest in the Company’s assets'{including goodwill, if any)—which is analogous to that laid down forsimilar cases in the Finance Act, 1930, and the later Finance Act, 1940,■of England.
It is now common ground that the provisions of the amending Ordi-nance do not operate in the present case. Apart from the questionwhether the Ordinance may be regarded as having retroactive effect,the Legislature has, for some reason which is obscure, departed from theEnglish model by leaving it entirely to the Commissioner to decidewhether these provisions should operate or not in any particular case.There is no evidence that the Commissioner has so decided in regard toIVIackie’s shares, although the evasive averment in paragraph 4 of theanswer filed on behalf of the Attorney-General seems to indicate that therevenue authorities were at one stage undecided as to which alternativeposition should he adopted in this connection with best advantage to the"Crown.
As far as I can judge, the “balance sheet method’’ is, in some cases,a method which a Court of law may legitimately adopt when the applica-tion of other recognised methods for assessing the “market value” ofshares presents great difficulty. In other words, whenever the provisionsof the amending Ordinance do strictly apply, the method of valuation■thereby prescribed is of course imperative; where the Ordinance doesnot apply, the method is nevertheless permissible if in all the circumstancesof the case it is found to be the most appropriate method of estimating“market value” for purposes of estate duty. The value of a businessis on this basis arrived at by adding the value of its goodwill, if any,to the value of its tangible assets. If no goodwill, in the commercialsense, exists the value of the business cannot exceed, although it maysometimes be less than, that of its tangible assets., Similarly, the valueof a “share” in such a business is arrived at by reference to its properproportion of the sum so computed, regard being had to the rights andbenefits attaching to such “share” under the Articles of Association.
Various matters must be taken into account in order to assess the“market value” of the "Management Shares” held by Mackie at thetime of his death. Of the many decisions which were cited to us, I havefound the judgment of Lord Fleming in Salveson’s case1 specially instruc-tive in the present context. “The problem can only be dealt with”,he says, “by considering all the relevant factors as known at the dateof the deceased’s death, in order to determine what a prudent investor,who knew those facts, might be expected to be willing to pay for theshares”. I propose to adopt this method of approach in the present case.
.Having first discussed what appear to me to be the factors for considera-tion by a prudent purchaser invited to make an offer for the shares, Ishall then proceed to apply the method of valuation which seems mostappropriate to the case.
In my opinion the chief factors for consideration, as they existed andwere hnown at the time of Macltie’s death, were (1) the nature of the busi-ness of the Company, (2) the history df the Company from its inception upto September 6, 1940, (3) the future prospects of the business generally*and of the Company in parfciculaj, (4) the state of the investment marketat the relevant date, and (5) the extent, if any, to which the restrictionscontained in the Articles of Association might be expected to depreciatethe value of the shares. I shall de£l with these questions in the order inwhich I have set them down.-
The Nature of the Business:C. W. Mackie & Company, Ltd.,
had since its incorporation in 1922, been engaged in the business ofrubber dealers, regularly purchasing in the open market and taking-delivery of large stocks of rubber with a view to their sale and export indue course. Prices in the rubber market have throughout history beennotoriously sensitive, and the Company, when dealing in this commodity,had invariably adopted an extremely speculative policy. Mackie and hisCo-Directors did not undertake the safer functions of an agency businesspurchasing rubber for outside principals on a commission basis ; theirpdJLicy was to make purchases on their own account in the hope, butnot the certainty, of selling the rubber at some later date at a higherfigure ; when their predictions as to the future of the market provedcorrect, the Company earned very considerable profits ; but when theirpredictions prc*ved wrong, the Company had no option but ultimately tosell its stocks at the lower market price and would in consequence sustaincorrespondingly heavy losses ; the risk of a falling market or the benefitof a rising market was on each occasion voluntarily undertaken by theCompany. It was possible of course to tide over brief periods of adverseprice fluctuations by holding its stocks, but this policy could not be carriedout indefinitely. Mr. Williams, who had been a Director of the Companyand its Manager for over twenty years, stated that it was not possibletot predict the future market of rubber except on very rare occasions ;indeed, it is this unpredictability in the movements of the market whichhas tempted so many speculators to deal with this commodity in theworld markets in the same manner as Mackie and Company, Ltd., haddone since 192-2. The element of chance is of the essence of such a busi-ness. The witnesses Williams, Hayward, Cumming and Lander spokewith authority regarding the nature of the business, and the witnessescalled by the Crown did not seriously dispute their evidence on this point.Mr. Gunasekera, for instance, has had the benefit of long experienceas an assessor in estate duty cases, and he admitted that he “ couldnot think of a business which was more speculative than that of thisparticular Company ”, while Mr. Satchithanarida, who is a qualifiedAccountant, described the business as “ very risky ”. The actualtrading results of the Company year by year since 1922 themselves providethe most compelling evidence on the point. ^
The History of the Company: The audited annual balance sheetsand profit-and-los's accounts from 1922 to! 1939 would have been available
to an intending purchaser, who must be assumed to be “ a person ofreasonable prudence anxious to ascertain the relevant facts before making•a bid for the sharesFindlay’s Trustees v. Commissioners of Inland
Revenue1. He would have found in those documents that during theyears 1922 to 1926 the Company had, in consequence of very favourablefluctuations in the price of rubber, made enormous trading projfits amount-ing in the aggregate to Rs. 3,441,359. Out of this sum, the preference■shareholders regularly received their annual 8 per cent, dividends ; and•dividends amounting to as much as Us.*.1,950,000 had been declared anddistributed on the “ Management SharesIf the story had ended there
■one might well have imagined that Mackie and those associated with'him had succeeded in discovering ^me secret which' had eluded andhad continued to elude so many speculators in the rubber market. Mackieand the other Directors, however, made a more cautious assessment oftheir ability to predict the unpredictable. Out of the Company’s un-distributed past profits, they placed Bs. 747,901 toi general and sundryreserves, and carried forward the balance sum of Bs. 356,913 .to the tradingaccount for 1927.It was indeed fortunate that at least this precaution
had been taken.Within the next six years the Company, in conse-
quence of consistently unfavourable fluctuations in the price of rubber-sustained an aggregate loss of Rs. 1,804,304 so that the Company, bytrading on its issued capital as well as its hidden capital of unpaid pre-ference dividends, reserves and undistributed profit of an earlier period,was now virtually insolvent. The same speculative policy was however-persisted in after 1932 with the help of overdraft facilities which Mackie,largely by his persotaal influence, was able to arrange. The years 1933and 1934 showed favourable trading results. Then followed 1935 with aloss of Rs. 281,907. A slight profit was made in 1936 followed by acomparatively small loss in 1937. In 1938 the profits earned amountedBs. 149,S46. The year 1939, which was the last year for which theaudited balance sheet- woud have been available to an intending purchaser,showed a welcome gross profit ctf Rs. 787,641. Nevertheless, the positionas at December 31, 1939, was still “ far from healthy ” as the Assessoradmitted. A sum of Rs. 793,000 was due to .the preference shareholderswho had not. been paid their dividends since 1927. The .overdraft withthe Rank stood at Rs. 1,485,471.25, and in spite of an extremely favour-able year of. business there was still a nett trading deficit of Rs. 150,828after allowing for taxation and for the accumulated arrears of preferencedividends (ignoring two years for which payment had been waived).One cannot think that any prudent business man wctuld have been greatlyattracted by a proposal that- he should invest a very large sum of money,inadequately secured by tangible assets, in a business over which hewould have no control, and whose fortunes had in the past been subjectto such violent fluctuations. Even if the substantial profits earned upto the date of. Maekie's death in 1940 (owing to the, market prices havingcontinued for the time being to show an upward trend under early warconditions) had been ascertained, I do not see how an optimistic ;viewfor all time could be considered .justifiable. For how long and to whatextent this upward trend wtOuld continue it was impossible tol say. It-1 (1938) 22 Annotated Tax Cases, 436.
has been proved that the trading profits during the second half of 1940bad appreciably declined in comparison with those of the earlier sixmonths.
During the period January 1, 1927 to September 6, 1940, dividendshad not been paid cm either preference shares or on “ Management'Shares ” • and the nett trading loss sustained (after allowing for taxation)amounted to Us. 107,614. Even if there was a reasonable prospect ofhistory repeating itself and producing in the near future subtantialprofits comparable to those of 3622 to 1926, it had to be borne in mindthat income tax had come into force in Ceylon since 1931 and that, asMr. Satchithananda admitted, business circles had become apprehensiv'e{justifiably, as things* ‘turned ou^ of the early additional impositionof an Excess Profits Duty. Besides, the history of the Company hadmade it clear that in favourable years it was prudent to build up sufficientreserves to meet the reverses of unfavourable periods which, in a businessof this nature, could not be eliminated in spite of the admitted advantagesof skilful management. No doubt the war years 1939 and 1940 had,up to date, induced a rising market favourable to the speculator. Butfor how long those conditions would last, no man could sensibly predict.It is relevant in this connection to consider the view which Maekie’sfellow directors in Ceylon had themselves taken of the Company’s pros-pects two days before he died. In spite of a marked improvement intrading results since 1939, they recommended to him that, for the timebeing, only a small proportion of the arrears of preference dividends whichhad accumulated since 1927 should be paid out. This cautious attitudestands in sharp contrast to the reckless optimism with which, in thesubmission of the Crown, a hypothetical purchaser would have bidBs. 1,250,000 for an investment backed at the relevant date by tangibleassets worth only Bs. 203,094.41.
The Future Prospects of the Business ; I can find nothing in theevidence to justify the assumption that, taking a long view of the■Company's future trading, the risks and hazards of speculation had nowbeen eliminated, and that a prudent investor could confidently predictthat the fortunes of C. W. Mackie & Company, Ltd., would no longer,.as in the past, be subject to violent fluctuations. On the evidence, myview is that it still was, as it had always been, unsafe to form a conclu-sion in either direction. The Assessor claimed that there was goodreason to anticipate that the market would continue to rise for abouttwo years after September 6, 1940, after which smaller profits wouldagain be earned. (He does not tell us why .the possibility of losses infuture trading should be excluded.) X do not know whether the viewwhich he expressed was actually held by him at the relevant date ; itseems more probable that when he gave- evidence at the trial he wasfortified by “ wisdom after the event ” or by what the learned Solicitor-•Oeneral, quoting an Australian decision, referred to as “ hind-sightIn prophesying the future of rubber prices, one man’s guess is. I shouldimagine, no better than another’s. At any rate, a Court of Law, whencalled upon to make assessments for estate duty purposes, cannot justifi-ably assume that a prudent investor would* take a view as to the future-which is not supported by reliable evidence of facts which were known
at the time. The events which happened after September 6,1940,.
cannot he regarded as relevant unless they were reasonably predictable onthat date. I have examined the Assessor’s evidence with care, and I amnot at all satisfied that any cautious person, reviewing the past andattempting “to gauge the future at the time of Mackie’s death, would,have been willing to make a firm offer for the shares on the assumptionthat within 'the next six years he would receive back an aggregate sumequivalent to its. 1,250,000 in the form of annual dividends. Theopinion of an expert is of special assistance only when he gives convincing-reasons foir his faith. In this respect the evidence of the Crown witnesses-seems to me to have failed the test. It must not be forgotten that in thepast even Mackie’s predictions, in spiffs of all his accumulated experienceof the rubber market, had proved completely wrong throughout the six-year period 1927 td 1932. That knowledge would, I think, have satisfied,an investor that it is unsafe to attempt a forecast of the prospects of arubber dealer’s business wihout entering the realms of pure conjecture.
The Investment Market in September, 1940 : The notional saleof Mackie’s shares in the open market would have taken place duringa critical period in world history. France had capitulated before Hitler’sinvading armies ; .Europe was over-run ; the Battle of Britain hadcommenced, and its issue was still in doubt. The evidence in the caseproves that these events had produced a marked reaction on the mood,of investors in Ceylon. As far as this particular Company’s activitieswere concerned, the general uncertainty df world conditions had beensuper imposed on the special hazards inherent in speculative trading.Mr. Lander stated tha it was difficult at that time to find anyone willingto risk large sums of money on speculative investments. Mr. Cumming,who is a senior broker in Colombo, suppcfretd this statement. Peoplepreferred to keep their money in the banks, he said, and he doubted ifMackie’s shares would in fact have 'been purchased at all if they couldhave been offered for sale in the open market. Mr. Cumming asserted that“ no broker would have made an underwriting proposition for the saleof Mackie’s shares ; at that time the risk was too great These witnesses,were not expressing mere opinions on this aspect of the case ; they werestating uneontradicted facts. Mr. Williams was asked if he would havebeen willing to buy the “ Management Shares ” himself. “ I wouldbuy them if 1 got them aheap for a gamble ” he replied. A prudentinvestor, I do not doubt, would have taken into consideration the viewsof persons conversant tvith conditions in the rubber market and theinvestment market before making a bid. The Assessor did not disputethis evidence. He suggested, however, that some buyer from abroadmight have been interested in purchasing the shares, though he admittedthat such an eventuality was ‘‘ not very likely ”. Mr. Satchithanandasimilarly thought that American or Canadian buyers might perhaps beattracted. I think that these vague suggestions carry the notion of a.hypothetical purchaser much too far from reality. It is no.t clear how,at a notional sale, a bidder from abroad, could have been induced to offervery much more than local bidders were prepared to offer. The conclu-sion at which I have arrived is that under the existing conditions it wouldhave been an extremely difficult matter to find a buyer for Mackie’sshares for a figure in excess of such security as was afforded by the pro-portionate interest at the time in the available tangible assets. Thereis evidence that at least one comparable business, discouraged by tradinglosses and diffident as to the future, had closed down in 1939, and that itsproprietors had failed at that time even to find a buyer for their rubberstores. No suggestion has been made that its “ goodwill ”, if offered forsale, would have fetched any sum at all.
Had any speculator confident^ predicted a rising market for the periodimmediately following September, 1940, he would surely have preferred,through a reputable broker, to make purchases and sales of rubber in the•open market during that period an his own account, and to personallycontrol the destinies and the duration of his investments rather than tieup his capital in a business managed by persons whom he could not control.Any advantages which existed in the established business of C. W. Mackie.<& Company Xitd., would presumably have been rendered unnecessaryby the allegedly “ universal knowledge ” that prices were certain to rise,and would in any event be counter-balanced by the restrictive covenantsimposed by the Articles of Association. I shall now deal with thataspect of the matter.
The Articles of Association: The special attraction of an invest-ment in the shares of a public Company is that a shareholder (or, on hisdeath, his legal representative^ has under normal conditions little difficultyin selling his holding in the open market whenever he desires to do so.The hypothetical purchaser of Mackie’s shares and his heirs would havebeen placed in a very difficult position in this respect. Articles 38 to 43lay down stringent restrictions on the sale and transfer of shares. If amember of the Company were willing to take over the shares of a memberwho desired to sell out, the price payable would be a sum which theCompany’s auditors, and not the transferor regarded as their “ fair value ”nt the time. If no member of the Company were willing to take themover, the owner could not sell them except to a third party whom theDirectors would agree to admit to membership (Article 43), and in-any event, that third party would himself be discouraged by the samerestrictions after securing his registration as a new shareholder.
On the death of a shareholder, his executor could be compelled totransfer the shares to a member of the Company at a price fixed asTheir “ fair value ” by the Auditors (Articles 54 and 38). It wasargued for the Crown that a purchaser could circumvent this provisionby floating a private Company, in which he would hold the major interestto purchase the shares. Ho doubt this would be possible, but thedepreciatory effect of Article 54 on market value ^is self-evident.
A purchaser of the 5,000 “ Management Shares ” belonging to Mackie■would further realise that, as the holder of less than 1/10 of the issuedcapital of the Company, his interests were .liable to be compulsorilyacquired by the majority holders at the Auditors’ valuation (Articles 46and 38). When this difficulty was pointed to the Crown witnesses in‘Cross-examination, they were forced to admit that it was very unlikelythat any person would buy the holding of the “ Management Shares ”unless he could protect himself by purchasing at the same time a sufficientnumber of Preference Shares from Mackie’s estate so as to remove this
handicap. This, I imagine, would have greatly clamped the enthusiasmand reduced the number of bidders interested in purchasing the “ Manage-ment Shares In valuing a deceased person’s property for purposes ofestate duty, it is of course legitimate to consider the possible advantage-of pooling all or some- of his assets in the hope of fetching a higher figurethan would be realised by a sale of each asset separately. Ellesmere mInland Revenue Commissioners 1. There must be good reason to anticipate,however, that a sale of the properties in this fashion would in fact haveproved more advantageous to the seller a? well as to the buyer. In thepresent case, the Assessor and the Commissioner had in the first instancefixed the value of the “ Management, Shares ” on the basis that theywould be sold as a separate holding. Having regard to the state of theinvestment market in September, 1940, I doubt if it would have beendesirable to confine the bidding for the “ Management Shares ” to personswho possessed sufficient capital to purchase Mackie’s Preference Shares-as well for their agreed value of Rs. 806,017. On the contrary, it mightwell have been more prudent to offer the “ Management Shares ” ineven smaller blocks so as to attract more bidders willing to risk smallsums in such a speculative investment. My own impression is that thebelated suggestion of pooling these two groups of Mackie’s assets for thepurposes of a notional sale was not present in the Assessor’s mind untilhe was confronted at the trial with the implications of Article 46.Mr. Satchithananda obviously did not originally contemplate a poolingof the shares. His valuation report does not refer to the Preference Sharesat all in this connection and his evidence indicates that he had not takenthe trouble to study the Company’s Articles of Association closely beforehe entered the witness-box.
Further discouraging features in the Articles of Association were therestrictions which prevented a shareholder from holding interests in anyother business which the Company was carrying on or was even authorisedto carry on (Articles 48 and 49).
The Basis of Vahiation.—It is now necessary to consider whichmethod of estimating the “ market value ” of shares in this particularprivate Company is, in the light of the unusual circumstances to whichI have referred, the most appropriate. By the very nature of thingsno quotations in the public share market for investments in the same orin a comparable business are available to guide us. There is, however,a record of a private transaction which took place at the end of the tradingyear 1926, whereby Mackie had himself purchased 1,375 “ ManagementShares ” from a retiring member of the Company, Mr. N. J. R. Robertson,and from certain others. These transactions took place as between willingsellers and a willing buyer at a time in the Company’s history when thetrading results for five consecutive years had been exceptionallyfavourable, and when the “ goodwill ”, if any, of the business could not,an any reasonable hypothesis, have been computed at a lower figurethan in September, 1940. The Company’s balance sheet then showedsubstantial reserves which were available to meet losses in future trading;and the introduction of income tax was not in contemplation at thattime. In spite of these advantages, the basis of valuation agreed upon
i (19IS) 2 K.B. 43-5.
by the parties to the transaction in 1926—namely “ the balance sheetvaluation ”—was precisely the same as that on which the appellantshave relied in the present case. Mackie voluntarily paid, and his sellersvoluntarily accepted, a figure representing only the value at the relevantdate oi the tangible assets remaining for each “ Management Share ”in the balance sheet of the Company as a going concern, no additionalallowance tvhatsoever being made for goodwill. This strongly indicatesto my mind that the persons best acquainted with the risks attendant onthe Company’s activities realised that “ goodwill ” (measured in terms ofthe “ value of the capacity to earn super-profits ”) is non-existent in aspeculative business whose profits or losses depend so largely on un-predictable market fluctuations. #This same element of uncertaintywhich existed in 1926 had not been eliminated in September, 1940.
Mr. .Lander’s opinion is that for a business of this kind “ the balancesheet method of valuation ” is the most appropriate. He has since1900 been a member of the iirm of Messrs. Ford, Rhodes and Thornton,who are the Company’s Auditors. His professional qualifications andthe honesty of his views were not challenged at the trial, and I think thathis opinion is entitled to considerable weight. Certainly, the implica-tions of Article 38 would have led a prospective purchaser to hesitatebefore he made a higher offer than the figure at which the Company’sAuditors valued the shares at the relevant date.
The Company’s business was no doubt a well-established businessconducted by a reputable management ; nevertheless it was essentiallythe business of a gambler or a speculator (call it what you will). If itwere possible to place a market value on the Company’s goodwill ”—which, for purposes of valuation, represents “ the benefit and advantageof the good name, reputation and connection of a business ” (Commis-sioner of Inland Revenue v. Midler 1)—the value of Maekie’s interests inthe tangible assets should undoubtedly, as was done in Findlay’s case,2be correspondingly increased. Where, however, there is no “ goodwill ”capable of assessment except by guess-work, it follows that (even if nodeductions be allowed for the depreciatory effect of the restrictions con-tained in the Articles of Association) no prudent investor could reasonablybe expected to offer more for a “ Management Share ” than the value ofits present interest in the tangible assets. This sum represents the fallamount which he would be prepared to stake in the hazardous enterprise ofspeculating on the future price of nebber. I cannot agree that this methodof valuation is applicable only when there is an immediate prospect ofliquidation. The figure arrived at does admittedly reflect the amountwhich would be available for distribution (less a proportionate share ofliquidation expenses) in that eventuality. Nevertheless, the sum socalculated may, in an appropriate case, where no commercial “ goodwill ”exists as a separate asset, properly be regarded as the maximum valueat the relevant date of the shareholder’s interest in the business of theCompany “ as a going concern ”.
Mr. Crown Counsel Jansze, who very ably argued a part of the 'casefor the Crown, suggested that some additional allowance should be madefor the fact that the purchaser of a “ Maniigement Share ” would enjoy
the additional advantage of gambling with, the capital contributed by the-Preference Shareholders. His argument would have much force if it,could be demonstrated that such an advantage would attract to aManagement Shareholder a reasonably predictable assurance of higherdividend returns on his investment. In that event, the measure of this-advantage could logically be assessed in terms of “ goodtoill ” by reference-to the super-profits which the “ Management Shares ” would be expectedto earn by way of dividends. In the present case, however, the businessof C. W. Mackie & Company, Ltd., is such as to leave its future prospectsvery largely, if not entirely, to chance, and. for this reason I fail to see howthe “ advantage ” to which Mr. Jansze refers can be assessed on anyscientific basisl An issue was specificafly raised at the trial as to whether-any “ goodwill ” attached to the “ Management Shares ”, and, if so..what value should be placed on it. The Crown chose not to lead anyevidence as to how ‘‘ goodwill ”, if it existed in this business should bevalued as a separate asset. I understood the learned Solicitor-Genera!to argue that in a Company constituted like C. W. Mackie & Company,Ltd.. ” goodwill ” attaching to a ‘‘ Management Share ” cannot be-separately assessed. I am not satisfied that this is so except for thedifficulty of recognising that it does exist at all. To my mind, if " good-will ”, measured in terms of “ the capacity to earn super-profits ”, hadin fact been established it would have been a comparatively simple-matter to assess its value separately in accordance with recognisedaccounting principles. In the firm of O. W. Mackie & Company, the-“ goodwill ”, if it existed, of the business would have attached exclusivelyto the ‘ ‘ Management Shareholders ” to whom alone the maintainable“ super-profits ” must be ultimately paid. This presupposes that one-could have reasonably pi-edicted a higher investment return on the
tangible assets value ” of a “ Management Share ” as at September G,_1940 (i.e., Es. 40.6188) than a prudent investor would normally expectto receive at the “ risk-rate ” appropriate to a rubber dealer’s business(say, 25 per cent, per annum). In that event the value of the goodwillcould be computed by capitalising these anticipated1 annual “ super-profits ” at the appropriate risk-rate. This sum, added to the value of"the shareholder’s interest in the tangible assets, would—subject to suchallowance as was considered necessary for depreciation owing to the-restrietions in the Articles of Association—represent the total value ofeach share for estate duty- purposes.
am satisfied that the “ balance sheet method ” of valuing shares in a-highly speculative business, whose past history lacks evidence of anysteady earning-power, is the most appropriate method to adopt because-it is not possible to arrive at a logical assessment of the future maintain-able profits from which dividends could be paid to the shareholder as a=.return for his investment. No evidence was led at the trial, and no-authorities were referred to us in this Court, to induce me to take a differentview.
The learned Solicitor-General asked for a ruling that the only acceptable-method of estimating the market- value of shares in any business is to*capitalise (at the “ risk-rate ” appropriate to the business) the estimated;
annual average of future maintainable profits which, would be available-to the shareholder concerned. I do not see how tins principle of valuationcan legitimately be extended beyond the limit of its logic. No doubtthe method is preferable when it is possible, by reference to past history•and present knowledge-, to predict future maintainable profits undernormal conditions. But the principle seems to me to break down whenit is sought to be applied to a business where the element of incalculablerisk which is inherent in its trading activities cannot be eliminated. As Xread the judgment in Salveson’& case the method was not adopted byLord Tieming in valuing shares in a Company engaged in a speculativewhaling business, and he later pointed out in Findlay’s case 2 that to takethe average profits of the last few years for this purpose would only
operate quite equitably where one is dealing with a well-established busi-ness which has normal ups and downs, but has no violent fluctuations in■either direction I therefore reject for the present ease the method ofvaluation adopted by the Assessor who seems to have valued the shares‘ ‘ by the application of what is at last merely a rule of thumb ”. I donot propose to deal specifically with Mr. Satchithananda’s valuation.Wherever his valuation did not subtantially agree with that of theAssessor it was specially unconvincing. I have already expressed mv•opinion that in a business of this kind it is not possible to estimate futuremaintainable profits. A fortiori, the ‘‘ weighted average ” principlerelied on by Mr. Satehithananda cannot be seriously considered. It is,I think, significant that at no stage of the Company’s trading historywould a valuation based on the formulae advocated by either of thesewitnesses have, in the light of subsequent events, been found to bejustified. This only proves, in my opinion, that the profits or losses ofany particular period of time cannot in this business be regarded as areliable guide to the prospects of a later period.
adequate reserves during profitable years to meet tbe losses of un-successful periods of trading. I have already pointed out that duringtbe first five successful years of tbe Company’s activities, the Directorstook the sensible precaution of accumulating reserves at tbe rate ofapproximately Us. 150,000 a year. In 1940, when funds were availablefor tbe first time since 1927 a similar sum was placed to reserve. Iftbe balance sheets for 1941 and 1942 are relevant at all, they only serveto show that the Directors acted precisely as one would have expectedthem to act in successful years o,f trailing. At the end of 1941, the-amount standing to general reserve was increased to Its. 300,000. In-1942, when the Company was fortunate in earning very large profits inconsequence of having temporarily undei-taken new and safer functionsas buying agents for the Ceylon Government on a commission basis(a position not anticipated in September, 1940), the reserves were increasedto Rs. 700,000 out of undistributed profits; and for the first time since1926 a dividend of only Rs. 50,000 was declared on the “ ManagementShares”. This figure represents only a 25 per cent, return on the-“ tangible assets ” value of the shares in September, 1940, and is veryconsiderably less than the annual dividends optimistically foreshadowedby the Assessor for his hypothetical purchaser-. Moreover, it was reason-able to expect that the Directors, being Preference Shareholders, who-now at last enjoyed a controlling interest in the business since the date ofMackie’s death, would build up adequate reserves from the profits of a-good year so as to ensure for themselves the regular payment of theii-own dividends in spite of any trading losses which might be sustained infuture years. Even if the Assessor's anticipated future maintainable-profits of the business could be accepted as reliable the market valueof the shares must be substantially reduced if the proper allowanees-be made for taxation and reserves. I regret to say that I was not con-vinced by the explanation that he did not make these necessarydeductions because, in his belief, they would have been counterbalancedby an increased figure for future maintainable profits on the “ weightedaverage ” principle (which principle he does not claim to have used in anyof his previous assessments as an Estate Duty Officer). jSTo Court canreasonably be invited by a valuer to accept a bald assertion that onematerial but undisclosed figure in a sum in simple arithmetic will probablycounterbalance another figure which is also undisclosed. Finally, Icannot accept the view that a prudent purchaser investing his money insuch a speculative business would have been content with a return of only-15 per cent. Mr. Satchithananda conceded in cross-examination thata rate of 20 per cent, to 25 per cent, would be more reasonable. I findthat the Crown expert ,in Salveson’s case 1 took the view that for aninvestment in the whaling industry (which certainly had not proved'less speculative than the business of this Company) an expected returnof 40 per cent, was not unreasonable. Moreover, in Salveson’s case..the financial position of the Company at the date of valuation was such-that sufficient reserves had already been accumulated to ensure the pay-ment of dividends for the next five years even if no profits were earnedduring that period, still leaving an ample margin to meet trading losses as.
large as those which had ever been experienced in the past. In myopinion the market value of Mackie’s shares on the basis of the Assessor’smethod, after making the necessary adjustments for taxation and sufficientreserves, and after applying a higher “ risk-rate ”, would not have beenappreciably higher than Rs. 40.6188 per share. If, in addition, thedepreciating effect of the restrictive clauses contained in the Articles ofAssociation be taken into account, this figure is certainly not too low.In Crossman’s case 1 Lord Halisham expressed the opinion that the valueof the shares under consideration by him, if not subject to rigid restrictions,would probably have been twice as high as the figure which he finallyapproved. In Salveson’s case 2 Lord Fleming considered a depreciation!by approximately 33 1/3 per cent, to be fair and reasonable.
The appellants did not press then- earlier contention that the figure ofRs. 40.6188 per share should, in terms of the proviso to section 20 (1)of the Ordinance, be further reduced by reason of Maekie’s death. Nordid they claim depreciation on • account of the restrictions contained inthe Articles of Association. I would therefore hold that the “ marketvalue ” of each of the deceased’s 5,000 “ Management Shares ” shouldbe fixed for estate duty purposes at Rs. 40.6188, which admittedlyrepresents the proportionate interest of each .share in the tangible assetsof the Company as at September 6, 1940. My view is that no sum fallsto be added to this sum on account of “ goodwill ” which, in my judgmentand for the reasons which I have given, was non-existent and thereforeincapable of assessment as an asset of the business.
Appeal allowed.
Since preparing this judgment I have had the opportunity of readingthe judgment of my Lord the Chief Justice. I respectfully agree with himthat the appeal should be allowed and that judgment for the appellants-should be entered, with costs, as indicated by him.