M & T Properties Pty Ltd v Commissioner of Taxation

[2011] AATA 857

Administrative Appeals Tribunal

DECISION AND REASONS FOR DECISION

[2011] AATA 857

ADMINISTRATIVE APPEALS TRIBUNAL      )

)          No 2010/2839

TAXATION APPEALS DIVISION		)
Re		M & T PROPERTIES PTY LTD

Applicant

And COMMISSIONER OF TAXATION

Respondent

DECISION

Tribunal Senior Member S E Frost

Date2 December 2011  

PlaceSydney

Decision The objection decision is affirmed.

......................[sgd]........................

S E Frost
  Senior Member

CATCHWORDS

TAXATION – income tax – capital gains – CGT event – CGT assets – Maximum net asset value test – Valuation – Valuation methodology – Taxpayer’s burden of proof – Objection decision affirmed.

Income Tax Assessment Act 1997 s 152-15

Taxation Administration Act 1953 s 14ZZK

REASONS FOR DECISION

2 December 2011   Senior Member S E Frost  

Introduction and background

1.      The issue before the Tribunal has been narrowed to a question of valuation of three properties owned by the Applicant. 

2.      The valuation question arises because during the 2005 income year a “CGT event” happened in relation to the Applicant when it disposed of a property it owned.  The Applicant claimed small business relief from capital gains tax on the basis that it satisfied the maximum net asset value (MNAV) test in s 152-15 of the Income Tax Assessment Act 1997 (ITAA).  To attract that exemption the total net value of CGT assets owned by the Applicant and by certain entities related to it must have been, immediately before the CGT event, no more than $5 million.

3.      The parties have identified which CGT assets need to be taken into account for the purposes of the MNAV test.  In relation to some of those assets, there is no dispute as to the value.  However, in relation to the three particular properties in question here, there is a dispute as to the value of each of them. 

4.      The task for the Tribunal is to determine whether to accept, in respect of each property, the value contended for by the Applicant as at 28 February 2005, the date of the CGT event previously referred to.  Unless the Applicant’s valuation is accepted in each case, the net value of all relevant CGT assets will exceed the $5 million limit and the relief claimed will not be available.

The three properties

5.      The three properties are all located in the Illawarra area.  The first is an industrial site and will be referred to as the Albion Park property.  The other two properties are residential sites, each of them containing a block of residential home units.  They will be referred to as the Windang property and the Wollongong property.

The valuers

6.      The valuer briefed by the Applicant is Harry Stefanou, the principal and owner of Warehouse King in Unanderra.  The valuations on which the Commissioner relies were performed by Frank Andreatta, a senior valuer with the Australian Valuation Office.

The valuations in general

7.      Valuation is not an exact science.  There is no single valuation methodology that is appropriate for all valuation assignments.  In fact, there is not always agreement amongst valuers as to the best valuation methodology for any given assignment. 

8.      In this case, there are three valuation methodologies that the valuers have used:

·direct comparison – where reasonably contemporaneous sales of other properties are used to estimate the value of the subject property.  This method requires the exercise of judgment in comparing, as between the comparison property and the subject property, factors including location, amenities, the size of the property, and the extent and quality of improvements on the property.  Since no two properties are exactly the same, adjustments based on professional judgment are always likely to be required;

·capitalisation – where the value of a property is derived by dividing the presumed rental income achievable, by a “capitalisation rate” (itself a function of the estimated period over which the capital value of the assets might be recovered by way of rental receipts).  So, for example, a capitalisation rate of 5% represents an expectation that the value of the property would be recovered over 20 years.  If the income capable of being generated is $100,000 per annum, then the estimated value of the property would be $2 million ($100,000 multiplied by 20);

·summation – where the estimated value of the land is added to the estimated value of the improvements on it, to produce an estimated value of the property as a whole.

9.      Mr Stefanou’s original valuations are very short affairs.  They were prepared in October 2010 (although with a valuation date of 28 February 2005) and they were apparently in response to the values that Mr Andreatta had arrived at in relation to the three properties. 

10.     Mr Andreatta himself had undertaken in September 2009 what he describes as “roadside inspections” of the properties.  These entail an assessment of the property’s value based on what it presented to him as he viewed it from the “roadside”.  He also undertook enquiries at the local council to discover what zoning applied to the property, and looked to see whether there were any development approvals so that he could make assumptions about the timing and extent of any refurbishment or renovation of the improvements.  He noted in each case that the valuation was based on:

… assumptions being made in regards to the nature, size, level and condition of the improvements situated on the land as at the date of valuation.  If it can be established that any of these assumptions was incorrect as at the date of valuation, this may materially alter the value of the property …

11.     He conceded during the hearing that some of the assumptions he made were not well founded.

12.     For each valuation he used the “direct comparison” method.  He had two comparison properties for the Albion Park property and three for each of the other subject properties.  His valuation reports are brief, but his reasoning is easy to follow.

13.     In Mr Stefanou’s original valuations he used a combination of the “summation” method and the “direct comparison” method.  For each property he attributed a value for the land and a value for the “main building”.  He added the two to arrive at the market value for the property.  For example, for the Albion Park property, he calculated as follows:

·Land: 5043 m² @ $75/m² app $378,225.00

·Main Bldg: 1728 m² @ $300/m² app $518,400.00

Market Value: $896,625.00

14.     Following the “summation” calculation in each valuation paper is a reference to other property sales around the valuation date.  In the case of Albion Park there are two sales mentioned; for the other two properties there are three.  Mr Stefanou’s paper does not explain how he arrived at the unit value (that is, the value per square metre) of the land or the building in any of his papers.  The paper does not explain, for example, how he arrived at a land value of $75 per square metre for Albion Park when the first comparison property, described as a “Vacant 4(a) Light Industrial block” and with an area of 2552 m², sold in April 2004 for $287,500, or $112 per square metre.  There may be good reasons why Mr Stefanou fixed upon $75 per square metre as the land value, but they are not explained in these valuation papers.

15.     In March 2011 Mr Andreatta provided to the Commissioner a “review/critique” of Mr Stefanou’s original valuations.  Aside from a few formal criticisms of the valuations, his main concern centred on the suitability of the comparison properties selected by Mr Stefanou.

16.     On 22 June 2011 the Tribunal made a direction granting leave to the Applicant to file a further report of Mr Stefanou no later than 29 June 2011.  There was a note to the direction in the following terms:

This report is not to be a new valuation but rather an explanation of the methodology and assumptions as presented by Mr Stefanou in his report of 27 October 2010. Importantly, the report will indicate why Mr Stefanou’s methodology is to be preferred to that of the Australian Valuation Office valuer.

17.     Despite the tight timeframe, Mr Stefanou’s report is very extensive indeed.  Forty-nine of its 61 pages are devoted to specific commentary, calculations and photographs of the three properties.  Ms McCarthy, for the Commissioner, complained that Mr Stefanou in his second report had exceeded the leave granted in the note to the 22 June direction.  There is some justification for that complaint.  For example, an examination of page 55 of the second report (Exhibit 10) shows an entirely different formulation of the summation methodology for the Albion Park property to that outlined in the original valuation (Exhibit 3 – and see [13] of these reasons).  The notional unit value of the land is now said to be $85 per square metre and the building $220 per square metre.  To that raw arithmetic Mr Stefanou adds “say” $35,000 as the value of fencing, paving and landscaping, and deducts $34,000 represented by 400 m² for “Road Reservation and Access”, thus reducing the value of that portion of the land to nil (even though both valuers seemed to agree that the council’s acquisition of the reserved area may never occur).  The revised valuation is $809,730.  (Mr Stefanou conceded during cross-examination that the figure of $858,140 shown in the report is incorrect.)  However, as I indicated to the parties during the hearing, that figure cannot be regarded as anything more than a “reality check” of the earlier valuation of $897,000.

The valuation of the Albion Park property

18.     Mr Stefanou’s valuation of the property is $897,000; Mr Andreatta’s is $1.1 million.

19.     Mr Stefanou’s valuation is based on the calculations in Exhibit 3 which are set out in [13] above.  His second report, commissioned to provide “an explanation of the methodology and assumptions as presented ... [in Exhibit 3]”, does not do that at all.  Under the heading “Valuation Rationale”, the second report explains at page 53:

... We have assessed and measured the subject improvements and then calculated the construction costs.  The cost of the improvements has then been depreciated according to their physical deterioration and functional obsolescence. ...

20.     But there is no connection between that “rationale” and the integers of the calculation in Exhibit 3.  Instead, it seems that it is the revised “summation” calculation in Exhibit 10 ([17] above) that applies the “Valuation Rationale”; I cannot perceive that rationale in Exhibit 3 at all.

21.     The impression is that the second “summation” calculation is meant to provide support for the original valuation of $897,000 by establishing that different integers, arrived at on an allegedly reasonable basis, could have justified a lower valuation than the one actually asserted.  However, instead of doing that, it actually undermines the integrity of the original valuation because the report fails to explain the factors that favour one set of integers over the other.

22.     In Exhibit 10 Mr Stefanou also took the opportunity to test his valuation by comparing it with a “capitalisation” calculation, as set out at page 54.  A calculation of this kind depends on the accuracy, or at least the reasonableness, of its two integers – the income and the capitalisation rate.  In respect of the first integer, Mr Stefanou has estimated the income and outgoings for the property, although actual figures were available for both the 2004 and 2005 financial years (T8-58).  Those actual figures must surely be a better indicator of the property’s income-generating potential (assessed as at the valuation date of 28 February 2005) than estimates.  Even if it were accepted that the second integer is well founded, the figure that results from a more reasonable capitalisation calculation, based on actual figures, is at least $1.1 million, and possibly as high as $1.4 million.

23.     I am not satisfied that Mr Stefanou’s valuation of the Albion Park property is reasonable.

The valuation of the Windang property

24.     Mr Stefanou’s valuation of the property is $365,000; Mr Andreatta’s is $550,000.

25.     The property contains a block of six residential units, all on the one title and not capable of being sold separately.  Both valuers originally thought the property comprised six one-bedroom units but a draftsman’s plan (Exhibit 6) shows it comprises two two-bedroom units and four one-bedroom units.  Each unit is a modest 39 m² in size.

26.     Mr Stefanou’s valuation (Exhibit 4) was undertaken by the direct comparison method: Exhibit 10, page 22.  Three comparison properties were nominated: one in the same street as the subject and the other two in a nearby location, Barrack Heights.  Mr Andreatta used the same two Barrack Heights properties for comparison purposes.  His third comparison property was also in the same street as the subject, but it was not the same property as that used by Mr Stefanou.

27.     In his second report (Exhibit 10) Mr Stefanou also sought to rely on a fourth comparison property, which is also located in Windang and is owned by the Applicant.  The basis of this attempted reliance was that the Commissioner appears to have accepted the value of that property, for the purpose of the MNAV calculation, as $295,000, and that value might inform the valuation of the subject property.  The problem with this approach is that there is no evidence as to the reason why the Commissioner accepted that value, and there is no evidence of a recent sale of the property which might enable it to be used for direct comparison purposes.  The Commissioner’s acceptance of the value of that property does not assist the Applicant.

28.     The key to the valuation of Windang is the way the valuers have assessed the comparison properties and how the value of those properties informs the value of the subject.

29.     In relation to the two Barrack Heights properties (both of them residential unit blocks), Mr Andreatta computed a notional value per unit ($139,167 in one case and $116,667 in the other).  For the subject property he considered a rate of $92,000 per unit to be “appropriate”.  He multiplied that figure by the number of units, to arrive at a valuation figure (rounded) of $550,000. 

30.     The critical step in the process is the attribution of the “per unit” value of $92,000.  I asked him how he arrived at that figure.  He said that the relevant factors were location, property type, condition, number of units, and income potential.  I asked him for the basis on which he carried out the comparison between a block comprising three two-bedroom units and the subject property, with six units of one or two bedrooms.  He said:

Well, I think the subject complex, as far as what its potential income generating can be, would offset the difference in the bedrooms, so to speak.  I think the amount of rent you’re getting between a one and a two-bedroom unit wouldn’t be as great as the size factor.  So, therefore, the subject has got six one-bedders, or what I thought to be at the time six one-bedders, as opposed to three two-bedders.  The income was more important to me when I was assessing that value.

(Emphasis added).

31.     He considered that there was a tolerance of plus or minus 10% in his estimated value of $92,000 per unit, so that the “acceptable valuation range” was between about $83,000 per unit and $101,000 per unit.  The bottom of that range converts to about $500,000 for the entire property.  When I asked him whether he thought Mr Stefanou’s valuation of $365,000 was within the range, he said:

No.  From the information I’ve been provided, no.

32.     Mr Andreatta thought that the Windang property could have returned about $800 per week in February 2005 whereas one of the Barrack Heights properties could have commanded $550 per week and the other one less than that.  But his estimate for Windang seems generous: gross rent received for the property in the 2005 financial year amounted to $37,253 (which averages about $715 per week).  Perhaps the property was partly vacant during the year; in any event, the actual figures must give rise to some discount from Mr Andreatta’s valuation of $550,000.

33.     I remain unconvinced, though, by Mr Stefanou’s figures.  Although his second report (Exhibit 10, page 20) says that he has used the capitalisation and the comparable sales (or direct comparison) methods, the way in which he applied the comparable sales method is by no means transparent.  In fact, his original valuation (Exhibit 4) is a hybrid, an injection of comparable sales data into a summation methodology.  And again, as with Albion Park, the reasoning underpinning the unit value of land and buildings is not exposed to scrutiny.

34.     The capitalisation method, used in Exhibit 10 as a cross-check, has as its starting point estimated rental figures for the six units.  The “total gross income per annum” based on those estimates is $30,680, but as mentioned earlier, the actual figures (on a financial year basis) were available: $37,253 for 2005 and $41,800 for 2004, both of them gross figures.  On that basis alone it appears that a more reasonable capitalisation calculation would result in a figure that is greater than Mr Stefanou’s figure by a margin of 25%, perhaps more.

35.     While I am of the view that a valuation lower than that proposed by Mr Andreatta might be appropriate, I do not accept that it could be as low as the figure put forward by Mr Stefanou.  I am not satisfied that Mr Stefanou’s valuation of the Windang property is reasonable.

The valuation of the Wollongong property

36.     Mr Stefanou’s valuation of the property is $675,000; Mr Andreatta’s is $940,000.

37.     The property is 1605 m² in area, and contains a block of eight one-bedroom residential units, all on the one title and not capable of being sold separately.  Mr Andreatta described the units as having been constructed “around 11 years ago”, although he explained in cross-examination that that was his “best guesstimate as to when the last sort of upgrading of that building took place”. 

38.     Mr Stefanou described the building as having been “built around the 1950’s as a local boarding house to lodge workers from the country working at the local steelworks.  During the 1960’s amenities were added to make the rooms self contained flats”.  I accept Mr Stefanou’s version of the age and history of the building.  Mr Andreatta conceded that his misunderstanding of the age of the building would “materially affect the rental valuation this property could achieve”. 

39.     A major easement for draining water runs through the property.  Apparently this was originally an open drain, but it was piped some years prior to the valuation date.  Building work on or over the area of the easement is prohibited.  That prohibition is of little relevance to Mr Andreatta, since the “highest and best use” of the property is its existing use (that is, eight one-bedroom units).  I understood Mr Andreatta to be saying that any building restrictions on the property might be of significance if the property’s “highest and best use” were as a redevelopment site, because its redevelopment potential might be severely diminished by the easement.  The position is different, in his view, if the existing use is the highest and best use – the restrictions are, in a sense, only theoretical.

40.     Both valuers used the direct comparison methodology although, as with Windang, Mr Stefanou’s approach appears to have been a hybrid, where he injected comparative sales data into a summation methodology (see Exhibit 5 “Sales Evidence”).  Both valuers took into account three comparison sales, but the three comparison properties used by Mr Stefanou were different from those used by Mr Andreatta. 

41.     Mr Stefanou performed his valuation as follows:

·Land: 1605 m² @ $175/m² app $280,875.00

·Main Bldg: 390 m² @ $1000/m² app $390,000.00

Market Value: $670,875.00

which he rounded up to $675,000.

42.     During the concurrent evidence session, Mr Andreatta asked him about the land valuation:

MR ANDREATTA:   ... I want to get your reasoning behind why you chose three houses, if you like, two of them which ended up being land value – blocks of land, and your comparability to a property which comprises eight one-bedroom units.

MR STEFANOU:   Because there was no sales in that close proximity.  There was no sales prior to that date on that close proximity or after – or shortly after.  There were a couple that were further away but were in different zonings, which I thought were quite effective on the sale prices and the locations.  The fact that this also had – was a zoning of 3D, commercial services.  So I got a mixture of zonings to get an understanding on the land value.

MR ANDREATTA:   The land value only?

MR STEFANOU:   Correct.

...

MR ANDREATTA:   So that your sales only relate to the land value?

MR STEFANOU:   Correct.

MR ANDREATTA:   Well, it’s not very comparable, is it?

MR STEFANOU:   Well, that’s why I used the summation method to get a price.

MR ANDREATTA:   Well, let’s go to that summation actually.  And can you please explain to us how your sales support a land value of 280,000?

...

MR ANDREATTA:   So I just want you to reconcile with your sales why – how do you, basically, justify a value of 280,000 in relation to the sales that you’ve used, which are all on considerably smaller sites and have sold for far in excess of the value you’ve put on the land?

MR STEFANOU:   Well, I’ve taken a couple of different things into consideration.  Obviously, all these properties here are different zoning.  None of them are 3D commercial zoning.  So I’ve looked at each site separately, looked at what its highest and best use is and then come back with a square metre rate of $175 a square metre, also including the easement, the restriction, the location of the property and what it could – and what effects these easements had on the site, and that’s how I got the 175.

(Emphasis added).

43.     The highlighted factors actually resolve into two – the easement over the land and the location of the property.  Clearly, and contrary to Mr Andreatta’s view, Mr Stefanou considers that the easement has a negative impact on the value of the property.  But the question remains: why did he fix upon the particular amount of $175 per square metre for the land?

44.     The comparison properties that Mr Stefanou took into account show the following:

Land size (m²)	Selling price ($)	Selling price/ m²
700	450,000	642
680	450,000	661
664	303,100	456

45.     If the sales of the comparison properties were effectively land value sales, then Mr Stefanou’s assessment for the subject property of a land value of $175 per square metre represents a significant discount, not adequately explained.  If they were not land value sales, then there needs to be an explanation of the notional, deduced unimproved land value so that the $175 figure can be placed in its proper context. 

46.     On the basis of the material before me, I am not satisfied that Mr Stefanou’s valuation of the Wollongong property is reasonable.

Some additional observations

47.     There are a number of aspects of the Applicant’s written submissions that I have not dealt with in these reasons.  For the most part they are criticisms of Mr Andreatta or of his valuations, opinions and methodologies.  They include submissions that:

·Mr Andreatta failed to detail many of the assumptions that he made when he performed his valuations;

·some of his assumptions were “improper” as they were not permitted by the Australian Property Institute (API) Standards;

·his valuations were “general, full of assertions and generalisations and not based on facts observed by [him]”;

·he provided a “superficial” and “cursory” level of detail and analysis in his reports;

·he was “expedient with the truth”;

·he breached Australian Taxation Office valuation guidelines by not applying a secondary valuation approach;

·he was prepared to “manufacture evidence and act as an advocate for the respondent”;

·he “tailored [his] evidence to meet the exigencies of the situation”; and

·he “lied to the Tribunal while under oath”.

48.     First, I reject the submission that Mr Andreatta was anything other than truthful in giving his evidence.

49. Second, I need simply to observe that the Applicant could not succeed in this application even if it totally undermined the valuations offered by Mr Andreatta. This is because of the burden of proof provisions in s 14ZZK of the Taxation Administration Act 1953, by which the Applicant must prove the Commissioner’s assessment “excessive”.  It does not do that by proving simply that the valuations on which the Commissioner relied were wrong; it must positively establish that its own valuations are right, or (at least in the context of a valuation dispute, where there is no single, absolute, correct answer) reasonable.  Otherwise it will not have established that the value of relevant assets was less than or equal to $5 million at the relevant time.  On my analysis of the evidence, the Applicant has failed to establish that proposition.

Conclusion

50.     The objection decision is affirmed.

I certify that the 50 preceding paragraphs are a true copy of the reasons for the decision herein of Senior Member S E Frost

Signed: ................[sgd]..............................................................
  Casey Comans, Associate

Dates of Hearing  19 and 27 July 2011
Final submissions received      19 September 2011
Date of Decision  2 December 2011
Counsel for the Applicant         Ms L McBride
Solicitor for the Applicant          Ms K Grafenauer
  DGB Lawyers
Counsel for the Respondent     Ms M McCarthy
Solicitor for the Respondent     Mr E Chiaw
  ATO Legal Services