Inheritance tax aspects in the valuation of private equity funds
First of all, it should be noted that although the inheritance tax reform is not the minimally invasive reform that was announced, ultimately much has remained the same. The adopted amendments lead to tightening of the so-called administrative assets, tightening of large assets and tightening of the payroll regulation for small businesses. There are special exemptions for family-owned companies and additional relief in inheritance cases, e.g., for the tax authorities. the avoidance of taxation of administrative assets by investing in favored assets within two years of the inheritance and the unconditional, interest-free ten-year deferral of inheritance tax on favored assets.
Although the valuation of investments in private equity funds is not affected by these changes, it is becoming increasingly important in day-to-day taxation practice. Shares in private equity funds are transferred by gift inter vivos or by inheritance. In the absence of explicit legal regulations on the valuation of (shares in) private equity funds, the consulting community — especially in the case of a large number of private equity funds to be valued — is confronted with a number of challenges which, at least in part, also offer room for maneuver.
The valuation of a private equity fund share for inheritance tax purposes is based on the Inheritance Tax Act in conjunction with the Valuation Act. In the absence of codification of statutory regulations on the valuation of participations in private equity funds, the general regulations on the valuation of asset-managing and commercial partnerships and thus the regulations on the so-called “fair market value” apply in principle.
The fair market value is in fact the general clause under tax law for the required valuation of assets and thus also for the shares in corporations held by the asset management or commercial fund company. The fair market value is determined by definition by the price that would be obtained in the ordinary course of business in accordance with the nature of the asset in the event of a sale. All circumstances that influence the price must be taken into account. The tax law term “fair market value” is synonymous with the term “market value” used in business life.
In practice, various approaches have developed to derive the fair value for unlisted shares in corporations. According to the basic legal rule, shares in unlisted corporations are to be derived primarily from actual sales among unrelated third parties that took place less than 1 year ago (so-called comparative value method). If no sale of the asset to be valued has taken place in the ordinary course of business, the price must be estimated — taking into account all circumstances influencing the price and excluding unusual or personal circumstances. The law allows for this in principle. (a) the valuation taking into account the earnings outlook; or (b) valuation by any other recognized method that is also customary in the ordinary course of business for non-tax purposes.
A determination of the fair market value by capitalizing the earnings encounters several problems and challenges in practice Not least due to the difficulties in obtaining the necessary information, the investor is generally not able to carry out the valuation according to the capitalized earnings method, so that he must focus on the valuation according to another recognized method.
As part of the quarterly reporting to investors, fair values are determined on a quarterly basis for private equity funds. The sum of the fair values of the individual portfolio companies leads arithmetically to the NAV (net asset value) of the private equity fund and thus represents the market or fair value of the portfolio companies of the private equity fund before taking into account any factors affecting the value of the fund share. This is a very suitable starting point for deriving the fair value of a share in a private equity fund.
Private equity funds, or the valuation of these fund shares, do indeed exhibit a number of special features, which may be present individually or cumulatively. These are, for example. at (a) any charge for a latent carried interest of the sponsor, (b) Restrictions on the transfer of the private equity fund share, © Exclusion of the investors’ right of termination, (d) Consequences of non-payment of the called-up capital, (e) no suitable trading platform in the form of a functioning stock exchange, etc.
The aforementioned special features and the factors influencing value (a) Stock market environment, (b) Cash flow until the end of the term of the private equity fund, © early versus late stage investments of a private equity fund, (d) volume of the private equity fund and (e) Amount of subscription have a significant impact on the valuation of a private equity fund share.
Depending on the specific portfolio of an investor’s private equity fund units, there may also be interesting opportunities in the context of anticipated succession.