Responsibilities of an Expert Witness
G D CLEWS
A PAPER FOR THE 2004 TAX CONFERENCE
15-16 OCTOBER 2004
CHRISTCHURCH, NEW ZEALAND
Make three correct guesses consecutively and you will establish a reputation as an expert –
Lawrence J Peters, 1969
1.1 Anyone who has ever perused the classified advertising in the American Bar Association’s monthly journal will be struck by the number of professional expert witnesses who advertise their services to the legal profession in the United States . In that jurisdiction the phenomenon of “witnesses for hire” has tarnished the respect that might otherwise be afforded experts in a range of fields. Similar concerns have recently been voiced in Australia where at least two organizations have begun to advertise the availability of expert witnesses in various disciplines in a manner not hitherto considered either seemly or professional .
1.2 The purpose of this paper is to canvas the role and responsibilities of the expert witness in the New Zealand setting by reference particularly to the art of valuation. Expert valuation testimony is often presented in tax cases and all tax advisers ought to be broadly aware of the principles that govern such evidence.
1.3 While the paper addresses the role of an expert by reference to valuation testimony, it is not an exposition on valuation itself or on the methodologies employed by experts in that field when arriving at their opinions. Neither is it intended to debate actuarial or other principles that are often brought to bear when determining issues of valuation. Instead, it is intended as a reminder of the importance and role in taxation disputes of expert valuation testimony. It will review the obligations of the expert witness generally and examine recent cases dealing with expert testimony. It will refer to areas of tax practice here and overseas that involve valuation controversy and attempt to suggest how tax professionals should approach the briefing and use of expert valuation testimony, using one recent case as a guide.
2 AN INTRODUCTION TO EXPERT EVIDENCE
2.1 The general rule of evidence is that a witness should confine his or her testimony to facts and leave the Court (whether Judge or jury) to draw what inferences or conclusions seem appropriate. An exception to this general rule is made for the opinions of expert witnesses. These are admissible to assist the Court with independent information that is likely to be outside the experience and knowledge of a Judge or jury.
2.2 While the Evidence Act 1908 provides for certain specific instances of medical testimony being treated as expert , the general rules regarding expert testimony have developed as matters of common law and the procedures of our Courts. Thus it has been held that evidence cannot be treated as expert unless it relates to a sufficiently recognised branch of science at the time the evidence is given . In advancing this view the Courts have sought to limit what may be tendered as expert evidence and to preserve as much as possible the role of Judge or jury in arriving at conclusions based on proved facts by the application of common knowledge and common sense.
2.3 The same effort has led to interesting results in other jurisdictions. For example, in the United States two key decisions have been directed at weeding out so-called “junk science”. The first of the two cases, Daubert named several factors that a Court should consider before allowing testimony to be admitted as expert. The factors included whether the method can be tested; whether it had in fact been tested; whether it was subject to peer review and publication; whether the method had a known error rate; are there standards applicable to the methodology and is it generally accepted? Daubert focused on scientific method but the second of the two cases, Kumho , expanded the Daubert factors applicability to all types of expert testimony. It shifted the focus from scientific method to the concept of knowledge.
2.4 Here, as in the United States and the United Kingdom, Judges are the gatekeepers of all expert testimony and determine its admissibility. The limits referred to above will be illustrated in a number of recent United Kingdom cases cited later in this paper. The New Zealand equivalent of Daubert is probably Makoare in which the Court of Appeal stated that before testimony can be treated as expert the subject matter must be supported by a body of knowledge or experience that is recognised or accepted as reliable and literature or other verification of the pedigree of the asserted expert’s opinion.
2.5 It has been generally accepted that even expert witnesses may not pronounce on the ultimate issue, ie, the very question that the Court must decide, but this rule is now of doubtful application . There will be many instances in which valuation will be the ultimate issue and expert evidence directed to that matter cannot help but address the issue in dispute. In most tax contexts where valuation arises, opinion evidence need not be led as to the tax outcome of a particular valuation so the injunction against determining the ultimate issue seldom arises.
2.6 In tax litigation the role of the expert is governed by the High Court Rules or Taxation Review Authority Regulations and Practice. Experts may be appointed by the Court itself. The relevant rules in that regard are Rules 324 to 326 of the High Court Rules. The conduct of party appointed expert witnesses is regulated by Rules 330A to D of the High Court Rules.
2.7 Central to the High Court’s regulation of expert testimony is a Code of Conduct (“Code”) that became effective from 1 July 2002. A party’s expert must be given a copy of the Code set out in schedule 4 to the High Court Rules. A copy of the Code is attached to this paper. It is mandatory that an expert giving testimony consistent with the High Court Rules must agree to comply with the Code. The expert must also manifestly comply and the failure to provide a statement of agreement to comply with the Code may lead to the expert’s testimony being inadmissible.
3 HIGH COURT CODE
3.1 The Code enshrines an over-riding duty of impartial assistance to the Court. In short, the expert is enjoined not to be an advocate in the cause of any party in the proceedings but to assist the Court in arriving at a decision that the Court would otherwise be ill-equipped to reach .
3.2 The Code mandates the requirements for an expert’s evidence . Broadly they are:
(a) The expert must acknowledge the Code and agree to be bound by it;
3.3 In addition to these matters expert testimony consistent with the Code must state any necessary qualifications on the opinion being rendered and whether or not the opinion is concluded . An expert has a duty to confer, if directed to do so by the Court, and the duty extends to try to reach agreement with others if that is consistent with assisting the Court to achieve a result that it would otherwise not be equipped to reach . However, in conferring it is clear that the expert must remain independent and not act at the direction of parties or counsel .
4 EXAMPLES OF PRINCIPLES BEING APPLIED
4.1 The Code enshrined in schedule 4 to the High Court Rules reflects longstanding common law principles. Some recent cases in the United Kingdom dealing with expert witnesses illustrate the limits and dangers of the role. These cases are not necessarily leading or seminal authorities but are illustrative of some of the problems that can be encountered when purportedly expert evidence is tendered in proceedings.
4.2 A first example is Clonard Developments , a 1999 decision of the English Court of Appeal. In that case the valuation evidence of both parties was rejected on the basis that each had adopted the role of advocate and while claiming to be impartial clearly ceased to be because of the way in which they had argued in a partisan fashion during the course of giving evidence. In those circumstances the Court felt duty-bound to advance its own view of the valuation to be adopted and declined to follow either of the experts’ opinions.
4.3 In Field v Leeds City Council , a United Kingdom decision in 2000, the Court was asked to deal with the possibility of an expert being called who was an employee of the party. The Court held that an expert was not necessarily excluded because of employment by one of the parties but in this case the Court refused leave for the expert’s evidence to be tendered because of bias. The case appears to illustrate a failure to properly qualify the expert in circumstances where, had that occurred, the Court might well have been prepared to accept a lack of bias. The case concerned a dilapidations claim in the course of which the Leeds City Council proposed to call one of its officers as an expert. It is illustrative of the difficulty likely to arise in any situation where a party’s employee seeks to tender expert evidence. The Court will need to be satisfied that any implication of bias arising from the employment of the witness can be set to one side and his expertise left unimpugned as a result.
4.4 In Stevens v Gullis , another Court of Appeal decision in 1999, a claim arose from a building dispute as to the liability in damages of the architect. A joint meeting of experts was convened at the Court’s direction but one of the parties’ experts refused to sign a joint memorandum. The Court concluded that the expert had failed or refused to attempt to reach agreement on a good faith basis with the other expert involved and was therefore debarred from giving evidence unless the evidence was of fact alone. The evident partisanship of the witness discredited him as an expert and precluded him offering opinion evidence.
4.5 In Anglo Group PLC v Winther Brown , a 2000 decision, a computer dispute arose and a claims consultancy was called in by one of the parties to assess a claim. Evidence was led that disclosed a first report had been produced by the expert claims assessor avowedly as a “negotiating tool”. The Court made it clear that it was normally inappropriate for a negotiator to then adopt the mantle of expert in the same case and the evidence of the claims consultancy was disregarded for lack of independence. The Anglo Group case is a salutary reminder of the way in which documentation relating to expert testimony can sometimes be accessed by discovery in civil proceedings to the embarrassment of the expert concerned. The manifest expectation of the so-called expert that his first report might have set the bar somewhat higher than the point at which he considered the claim should ultimately be resolved, meant that he could not sustain the report as having been prepared without partisan interest.
4.6 It is clear, therefore, that an expert cannot act as advocate for one of the parties. Equally clearly the expert must confine his or her testimony to matters of special skill and expertise. Michael Hyde v J D Williams , a decision of the English Court of Appeal in 2000, illustrates the latter proposition. A claim was brought against architects as to whether they ought to have investigated certain matters relating to the design and engineering of a building beyond a particular step in its construction. Court held that this was not a decision requiring particular skill and that usual practice in a profession is not necessarily the subject of expert testimony. Decisions or judgments not requiring special skill are still the prerogative of the Court and the Court alone, and in this case the expert tendered by one of the parties was denied leave to give evidence because the Court considered the issue was peculiarly a matter for its judgment, rather than a matter requiring technical or specialist expertise. It said that evidence which really amounts to no more than an expression of opinion by a particular practitioner of what he thinks that he would have done had he been placed, hypothetically and without the benefit of hindsight, in the position of the defendant, is of little assistance to the Court
4.7 It is equally the case that the expertise offered to the Court must be in a recognised field. In Pride Valley Foods v Hall & Partners , one of the parties sought to bring expert evidence on building project management. The Court declined to receive the evidence as expert and limited the testimony of the witness to matters of fact. The Court held that project management is not a recognised profession and that the essence of expert testimony is in informing the Court of technical matters not within the everyday “lay” knowledge of the tribunal of fact. In the circumstances opinion as to how a project might have been managed was not considered to be either a matter on which the Court could not itself arrive at a reasonable decision or one which required an outside specialist to assist the Court to that end.
4.8 These cases are not intended as an exhaustive review of those which illustrate the limits and difficulties sometimes encountered when preparing and leading expert evidence in litigation. They do, however, emphasise the importance of ensuring impartiality, the relevance of the testimony to a field in which the Court can reasonably be expected to require assistance in arriving at a conclusion, and the need to ensure that the testimony offered to the Court is strictly within the purview of the expertise claimed by the expert in question.
5 BRIEFING THE EXPERT WITNESS
Counsel cannot settle the brief
5.1 The matters illustrated by the cases referred to above make it clear that when briefing an expert witness it is vital to preserve their non-partisan status. The involvement of counsel in the process of briefing the witness requires great care. Assistance and guidance of the expert in preparing evidence is perfectly permissible. However, counsel cannot be permitted to settle the expert brief of evidence.
5.2 As to that, the cynicism with which some commentators view expert evidence bearing too obviously the mark of counsel’s involvement is nowhere better expressed than by Lord Denning in Whitehouse v Jordan when he said:
Whenever counsel “settle” a document, we know how it goes. “We had better put this in”, “we had better leave this out” and so forth.
The hierarchy of duties
5.3 The briefing of expert testimony must recognise a hierarchy of duties. There are three tiers in that hierarchy. The primary obligation owed by any expert witness (and indeed by counsel briefing and facilitating the production of that evidence to a tribunal), is to the tribunal itself. The second tier in the hierarchy of duties is sometimes described as a duty to the expert body of knowledge. This effectively means that the expert must be true to his profession and the body of information available to the expert, so that the opinion offered is one that does appropriate justice to the matters in which the expert professes expertise. The third level in the hierarchy of duty is to the parties concerned. It is only after having considered duties to the tribunal and to the body of knowledge in which the expert claims specialty that an obligation to the parties is recognised. Arguably also, that obligation is fulfilled by the expert properly recognizing the foregoing duties in the hierarchy rather than in any advocacy in the cause of one or other of the parties. As the cases referred to above illustrate, manifest partisanship when putting forward expert testimony is liable to see that testimony discredited or discounted.
Choosing the expert and working with them
5.4 Prior to briefing expert testimony, of course, the expert must be identified. In that context an advisor seeking an expert’s testimony must consider that person’s reputation and the consistency of the advice and testimony they may have offered in other causes. Advisor referrals to an expert must be even-handed. There is no earthly point in involving an expert known to have a particular “axe to grind”. Other opinion is likely to identify that in the course of trial and undermine the weight given to such an expert’s testimony. There is often a temptation to shop around for an expert to support a particular proposition. If as counsel or an advisor you face difficulty finding an expert prepared to agree with your client’s proposition or to support your client’s position, you may well be dealing with the “good” experts who are available. You may do your client’s cause a disservice by continuing a search into what might be described as “fringe” elements in the relevant area of specialty, or worse still “evidence for hire”.
5.5 As Lord Denning noted, briefing the evidence of an expert witness must not involve settling the brief per se. It does, however, require a complete understanding of the facts and context in which the evidence is to be offered. An illustration is the 1999 New Zealand case of Rotoaira Trust v Attorney General , a case that involved an appeal from an arbitration award dealing with the forestry lease of Maori land. The case resolved how the land owners were to participate in the value achieved from the harvest of trees from their land on the basis that the lease in question was not to be treated as a standard lessor/lessee relationship. In context the lease amounted to a joint venture between the Maori land owners and the Crown for the development of the land into forest, the harvesting of that forest and the sharing of the proceeds of sale. A lease was the legal manifestation of the arrangement but the way in which the land owners’ rights to participate should be valued was based upon quite a different construct of the arrangement.
5.6 It is those facts and that context that become all important when one seeks to challenge an expert opinion. That is because in most cases expert opinion is challenged through factual omission or distinction. The process of briefing the expert witness requires a rigorous testing of opinions as those are developed. There are any number of means by which this might be done. At the very least counsel and any other advisors involved in the cause ought to plan for the way in which their expert may be cross-examined and to prepare carefully for that before trial. It is not unusual for a “devils advocate” to be briefed as well. A second expert may be engaged to critique the opinion to be offered by the primary witness. In whatever form this preparation takes, counsel and advisors in the matter must have an intimate grasp of the facts, the issues, and the language of the expert opinion, but must not form that opinion.
5.7 It is in the nature of Judges that they dislike extremes. Expert testimony that is extreme is unlikely to be accepted. It may be regarded as partisan but at the very least it will be regarded as lacking reflection, judgement and balance. Those three elements are inherent characteristics of expertise which most Courts find attractive. An example is the 1991 High Court case of Dancorp Developers Limited v Auckland City Council . In that case His Honour Smellie J considered a claim in negligence against certain local authorities alleged to have caused loss to the plaintiff by failing to advise of the industrial contamination of land the plaintiff sought to acquire. His Honour said that the expert evidence called before him varied enormously but it is pertinent for present purposes to note that he was not persuaded by experts whose evidence involved what he described as “a measure of emotive over-reaction”. While he was prepared to accept that the experts in question proffered their views sincerely, he concluded the views were not based upon any careful analysis of exactly what the level of contamination was, or how dangerous the level might have been, particularly to human beings.
5.8 By contrast the Judge referred to other evidence as having been “balanced and convincing”. That evidence had been nowhere near as shrill as the evidence of the experts who had suggested to His Honour that the only safe course in dealing with the land in question was to seal the site off and “treat it as a toxic dump”. The more balanced evidence recognised that there may be some “hot spots” that required particular work to be done but that modest remedial action would generally allow a development of the land to proceed.
5.9 In most expert testimony there is really no room for absolutism or dogmatism. If balance and the recognition of competing possibilities is a hallmark of a considered expert opinion, then a truly expert witness ought to be able to anticipate all possible opinions and address them when arriving at his or her own. Similarly, expert testimony ought to address differing available methodologies so that each may be considered and reasons advanced for why one might be preferred over another.
5.10 An example of the importance of anticipating and commenting on valuation methodology is Poverty Bay Electric Power Board , dealt with by the Court of Appeal in 1999. This is one of the several cases dealing with upgrades in utility reticulation systems. The case is pertinent for the review of valuation evidence undertaken by Blanchard J when delivering judgment of a five Judge bench. The expert testimony for the Board had asserted that the additional value per kilometre of new reticulation was less than the expenditure incurred by the Board but the Judge noted that an important aspect of that testimony made it suspect.
5.11 The assumption that had informed the expert’s opinion was that the Poverty Bay Electric Power Board was not, at the time in question, a “normal profit maximizing entity”. For its part the Court considered that when arriving at a realizable market value, an assumption was required of a willing but not eager buyer and that it was also necessary to consider how such a buyer might view the prospect of increasing electricity tariff levels once it became owner.
5.12 This key point had been anticipated and addressed by one of the Commissioner’s witnesses who opined that a value should have been struck having regard to realistically achievable commercial use of the Power Board’s system. A proper valuation was thought to require a consideration of expected cash flows and operations in the future, taking account of the probability that power boards would become commercially oriented (as had happened in the meantime). The Commissioner’s expert described the assumptions underpinning the Board’s specialist evidence as a “naïve and factually incorrect assumption” that there would be a continuation of the breakeven philosophy for 60 or 70 years. The Board’s evidence was left a little high and dry.
5.13 Practically speaking there is really only one chance to have expert testimony accepted and that is before the tribunal of fact. In Poverty Bay the Court of Appeal cited the Privy Council’s decision in Rangatira Limited v CIR in 1996 and noted:
The Privy Council has recently reminded us, and did so in a taxation context, that an Appellate Court should not depart from the views of a trial Judge on a question of fact, which an assessment of valuation is, unless the decision is shown to be wrong, notwithstanding that it may have been one which could have gone either way at first instance…
5.14 The reluctance of Appellate Judges to depart from findings of fact unless they can be shown to be manifestly wrong means that counsel and advisors must set about the process of choosing, briefing and leading the evidence of experts extremely carefully. It is not enough to leave a Court with a choice of opinions. If there is enough to allow the issue to go either way, it will be extremely difficult to unseat the decision on appeal if the Judge at first instance chooses an opinion that is contrary to your client’s interests.
5.15 The choice of expert may be all-important. A bad choice may be worse than having no expert evidence at all. The qualifications of an expert must be investigated and can, in some cases, be misleading. The experience of an expert must be balanced with his or her ability to communicate and to withstand cross-examination. New Zealand has a comparatively small market of available expert witnesses and there are benefits and disadvantages from that. A benefit is that it is possible to readily ascertain the views and “track record” of particular experts on various issues and to plan the use or rebuttal of such testimony accordingly. By contrast, it is possible in such a small market that alternative available views are not aired and opinions of limited scope become the norm.
5.16 Stepping outside the New Zealand market to import experts from other jurisdictions has its own advantages and disadvantages. It is necessary to ensure that such experts are familiar with any nuance that the New Zealand environment might involve and to ensure that their expert experience and testimony is generally “translatable” into this environment. In various fields where efforts are being made to harmonise standards and internationally these issues can be fairly readily managed, but there are still some instances in which the expert testimony of a person from outside New Zealand may be considered skeptically or at least subject to some considerable scrutiny before necessarily being accepted.
5.17 The preparation of expert testimony requires that privilege issues be considered. All expert witnesses are compellable and privilege does not normally extend to communications or documents on which the expert’s opinion has been developed or is based . Unused material may be relevant and compellable and may affect the credibility of an expert opinion. The example cited earlier in this paper of Anglo Group is on point. The disclosure that the expert’s first report had been prepared as a negotiating tool occurred as a result of discovery of documents relating to the preparation of his opinion. Those documents were available to the other side and led to the disqualifying concession that the expert’s first report had been prepared for a purpose inconsistent with the generally accepted object of expert testimony.
6 TOPICAL VALUATION ISSUES
6.1 In New Zealand and overseas valuation contests in taxation disputes are a “hot topic”. In the United States and Canada valuation matters have been involved in contests concerning software tax shelters, the treatment of non-cash wages (an FBT equivalent), estate valuations and transfer pricing. In New Zealand valuation issues are involved in most tax avoidance cases, those involving the repair/renewal dichotomy, land subdivision cases and those involving the disposition of interests in timber to name but a few.
6.2 At the time of writing the High Court’s consideration of the Trinity forestry investment has involved both parties leading the evidence of legion experts on valuation and forestry matters. It is routine for Inland Revenue now, in cases where avoidance is alleged, to obtain valuation evidence at the point where a notice of proposed adjustment is issued, something which inevitably requires a response from taxpayers wishing to dispute the position taken by the Commissioner. The preparation of such evidence needs to be undertaken with a weather eye on the reality that the evidence will be rigorously tested in the course of any subsequent litigation. The extent of that examination is illustrated by the approach adopted by the High Court in the ACTONZ case , decided in November 2003.
7 THE ACTONZ CASE
7.1 Until the High Court deals with the considerable body of evidence led in the Trinity case, the ACTONZ decision represents the most recent and comprehensive examination by the High Court of valuation issues in a tax avoidance context. The High Court reached quite damning findings regarding the valuation of software for which depreciation claims had been made. The factual background to the treatment of at least some of the software in question was crucial. The Court found in the case of one element of the software (Baccis) that it was little more than small-scale software which had involved only a modest cost to develop, despite valuation opinions to the contrary.
7.2 The valuations in question before the Court in the ACTONZ case had been undertaken for the purposes of striking values for investors, ie, for the purposes of a commercial transaction. They were not valuations undertaken for the purposes of the litigation that ensued. Indeed it seems the Plaintiffs’ case proceeded on the basis that no additional or new expert evidence was required. The criticisms leveled by the Court at some of the valuation opinions that had been obtained for the purposes of the commercial transaction make it clear that the disciplines required to establish a sustainable expert opinion ought to be exercised whenever such an opinion is advanced and not only in the context of a dispute or litigation. In other words, expert valuations ought to be prepared on the assumption that they will be litigated and subjected to rigorous scrutiny.
7.3 In the ACTONZ case there was common ground on the available valuation methodologies that could be employed when striking a value for the software in question. Broadly speaking, they were income, market and cost methodologies. The Court began its consideration of these by noting that one of the relevant valuations could be set aside peremptorily. A proponent of the valuation had resiled from it in Court and that person’s evidence was undermined by a clear lack of knowledge about the relevant circumstances so that the valuation was inherently suspect. The Court expected that any valuation purporting to represent the expert opinion of the valuer, whether or not prepared for the purposes of the litigation in hand, should be exposed to reasoning, background material, research and factual analysis. Without any of these the first valuation which the Court was able to set aside was considered to be “hopelessly inadequate”.
7.4 The Court set about considering the available competing methodologies and looked essentially at those based upon income and cost. The expert valuation opinion obtained for the purposes of the investment used an income method based upon assumed facts. Clearly, the valuation could not be considered to be reliable unless the assumptions on which it was based were validated. In short, the “facts” upon which the valuation was proffered were not necessarily facts at all. A unique combination of factors were considered to lie at the heart of the valuation but a number of important features were found not to be present. For example, the Court found that contrary to the assumptions adopted by the valuation experts, the software in question had not reached the stage where “convergence” was possible, it was not scaleable beyond 50,000 subscribers, and it was not easily installed outside GSM networks. While not exhaustive of the features on which the valuation had been advanced, the fact that three such key elements could not be sustained meant that the valuation advanced on the basis of them could not be relied upon.
7.5 It is clear from the approach taken in this, and indeed in a number of other cases such as those referred to above, that one can never expect a valuation simply to be accepted on its face. The essence of expertise is that it must withstand testing. It is necessary, therefore, that a valuation should be prepared in anticipation of it being challenged and with a view to ensuring that the assumptions on which it has been prepared are either manifest or have been tested themselves so that the valuation can be relied upon. Often a valuation is proffered on the basis that it is sufficient in and of itself, without looking beyond the opinion that is offered to test the basis on which it has been prepared. This is not to say that lay people need second-guess valuation opinions that are offered to them. It does mean, however, that those who, for example, advance a valuation in support of a promoted investment, should do so making it absolutely clear to investors, what information underpins the valuation, what has been tested and what is assumed, so that investors may then judge the worth of the valuation opinion.
7.6 In addition to the criticisms referred to above, the Judge noted that the experts providing a valuation made no independent assessment of the functionality of the software in question. Expert valuation testimony based upon assessments of functionality made by others, or which are simply assumed, are open to attack if functionality is at all in question. Too often expert opinion can refer to and simply adopt “facts” advised by a client as assumptions underpinning a valuation so that if any of those “facts” or assumptions prove not to be valid, the valuation is immediately undermined.
7.7 The rigour with which valuation opinions will be tested is illustrated by the several factors which the Judge in the ACTONZ case went on to consider.
7.8 First, he considered reliance on what were called “reference sites”, ie, sites in relation to which the software was supposedly being used. He also considered the reliance that was placed on supposedly exclusive contracts, the extent to which competitors might affect market access of the software, the appropriate discount rates that ought to be applied to likely income streams in the valuation exercise, key agreements affecting the development and distribution of the software and the timing of exploitation and likely returns.
7.9 He concluded that the reliance on reference sites was considerably overstated and that they did not relate to key issues of value, especially the “scalability” of the software, ie, the ease with which it could be upscaled to serve larger businesses. In other words, the reference sites used in the valuation were of inherently limited scale and gave no indication of the extent to which larger scale exploitation of the software in question could be contemplated, yet they were used to buttress a valuation as if they did.
7.10 Moreover, the Judge found that negative material that had come to hand in the valuation process was not included in the report. That material was disclosed on discovery (a reminder of the Anglo Group lesson referred to above). It undermined the valuation evidence proffered by the plaintiffs because it appeared that the valuation opinion was selective in the material to which it referred.
7.11 As a result the report was considered to lack balance and the Judge criticised it as failing to test the unique qualities of the software that were supposedly important. Had those qualities been tested, he concluded, the performance of the software would have been seen to be short of the mark and considerable concern should have been raised in the mind of any expert properly applying him or herself to the process of arriving at a tested and considered opinion of its value.
7.12 The valuation advanced for the software had been prepared having regard to certain exclusive contracts said to support the commerciality and worth of the software. However, the Judge concluded that important information on the status of some of these contracts had not been given to the valuer, an example of an expert being asked to produce an opinion on assumptions or client assertion. The withheld information affected the picture of the likely success of the software. The absence of that information combined with the fact that the expert made no independent inquiries about the existence, strength and likely capacity of competitors, meant that the assumptions about market penetration on which the valuation opinion had been arrived at were adversely affected and the opinion undermined as a result.
7.13 The discount rates applied to projected income streams which the software was thought to be able to generate were undermined by factual inaccuracies. The stage of development of the software had an affect on the appropriate discount rate and rather than arriving at a fixed valuation, the Judge concluded that a proper expert opinion would have subjected the various assumptions that were relied upon to a sensitivity analysis and arrived at a range of possible results. As it was, the valuation based upon discounted cashflow failed properly to consider the series of relevant factors referred to above, with the result that it could no longer be relied upon as an accurate or truly expert opinion.
8 WHAT LESSONS ARISE FROM ACTONZ?
8.1 Valuations at the time of promoting an investment will be tested in subsequent litigation. The independence and strength of expert valuation opinion may not be the same as opinions obtained for the particular purpose of litigation, yet if those opinions are relied upon as expert, in the sense of being defended in a subsequent dispute, they will be tested against the very same expectations as apply to expert testimony prepared for the purposes of the litigation itself.
8.2 If one ignores any facts, fails to test assumptions, is seduced by client assertions and fails to apply available tests to validate the basis upon which an expert opinion has been procured, one does so at one’s peril. A door will be opened that allows a challenge to the expert testimony upon which one’s case relies.
8.3 Tax advisors and counsel must provide discipline in the process leading to the expression of an expert valuation opinion. They must be alert to the relevant facts and must pay attention to competing methodologies and views. They must test the acceptability of the expert opinion without forming it.
8.4 Our Courts will not look at valuation as an exercise in “averaging”. In all spheres Courts will strive to accept one or another of competing valuations or expert opinions that are placed before it. This process is well established in matrimonial and in other cases and it is manifest in the way in which the High Court approached the ACTONZ case and in other tax cases such as Bay of Plenty Electric Power Board, referred to above.
8.5 Judges therefore set about to choose a valuation. As an issue of fact valuation is a matter on which the taxpayer carries the burden of proof in tax cases and the burden starts whenever a tax position is based on a valuation opinion. If it is to be sustained, that opinion should be obtained with the same discipline as if the expert is being briefed for trial. The fundamental lesson, therefore, is to ensure that whenever an expert opinion is sought, the expert in question approaches the task in hand by reference to the hierarchy of duties inherent in the Code applicable to the giving of expert testimony, so that the process by which the opinion is formed is such that the opportunities for it to be second-guessed, gainsaid or otherwise attacked, are reduced to the absolute minimum.
8.6 The ACTONZ case is obviously particular to its facts but it nevertheless offers a checklist of the factors likely to be considered relevant and the approach likely to be taken when a Court or tribunal considers a tax case in which expert valuation evidence is advanced. It is a “guidebook” to tax advisers of the tests to which any expert valuation opinion should be subject and a timely reminder to all tax advisers to be sure that their clients, and valuation experts engaged for any purpose in relation to their client’s cause, are aware of and meet the expected standards of performance.