The Challenge of Assessing the Market Value of Private Companies Using a Standardized Combination Method for Tax Purposes – Lessons to Be Learned from Past Experience

When taxes on capital or wealth are levied, in most countries companies have to be assessed in terms of their market value. Estimating the market value of private companies for tax purposes is a challenging task for tax authorities as market values are not available. In this study I analyze empirically to what extent an accounting-based tax valuation method for private companies, a simplified residual income model, succeeds in matching the market value. I refer to the mandatory Standardized Combination Model that is a special case of methods commonly used in several countries. In the absence of market prices for private companies I use a sample of small German public companies as a proxy. I validate this approach using a sensitivity analysis that involves matching the sample of public companies with private companies. The results imply that the mandatory Standardized Combination leads to a severe unequal treatment not only between public and private companies but also among private companies across and within industries. Furthermore, I simulate the effects of variation in the key parameters and highlight their impact on the approximation quality of the Standardized Combination Method. The findings are relevant to tax reform discussions as well as to tax policy makers and practitioners in many countries