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.