The Tax Court's Position on the Russian Doll: Tiered Valuation Discounts

Copyright (c) 2011 Sean Saari

As children many of us had an opportunity to play with a "matryoshka" doll - also known as a Russian nesting figurine. These were the statuettes which, upon opening the outer shell, revealed smaller figurines with even smaller figurines nested inside of them. I know that every time I spent the day at my grandparents' house, I was always intrigued by the statuettes and their many layers. What I did not know, however, was how similar the structure of many family limited partnerships and holding entities are to these dolls. Not only is it difficult to estimate how many "layers" of statuettes are within a single Russian nesting figurine simply by looking at it, it is also difficult to determine how valuation discounts should be applied to tiered ownership structures in which one company has an ownership in another entity, which has an ownership in another entity, which... you get the picture.

Tiered discounting is something that occurs when control and marketability discounts are taken at the subsidiary level (the small doll) as well as the parent level (the big doll). Many valuation practitioners agree that in most cases in which the parent entity (the big doll) has a controlling ownership interest in the subsidiary entity (the small doll), control and marketability discounts are not appropriate in determining the value of the subsidiary on the parent's books. Any marketability or control discounts related to the parent ownership interest being valued would be taken at the parent level.

There was less agreement, however, related to the application of control and marketability discounts when the parent (the big doll) had a non-controlling ownership interest in the subsidiary (the small doll). The question is should marketability and control discounts be taken at the subsidiary level (to determine the value of the parent's investment in the entity) and then again at the parent level?

In Astleford v. Commissioner, a 2008 Tax Court case, the Court provided guidance to practitioners regarding this conundrum. In the case, tiered discounting was permitted for an investment that represented 16% of the overall net asset value of the entity being valued. The Court stated that tiered discounts would be rejected. However, when the lower-level interest constitutes a significant portion of the parent entity's assets or when the lower-level interest is the parent entity's principal operating subsidiary. Hence, the Tax Court has indicated that applying tiered marketability and control discounts to investments that make up a small portion of an entity's total asset value is permissible, but that such adjustments should not be taken when an investment comprises a significant portion of the entity's total assets.

The debate as to the appropriateness of the Tax Court's decision will continue, but valuation practitioners now have another piece of information to rely upon when valuing holding companies with complex subsidiary ownership structures.


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Sean Saari, CPA/ABV, CVA, MBA is a manager in the Valuation and Litigation Advisory Services Group at Skoda Minotti, a CPA, business and financial advisory firm with offices located in Cleveland and Akron, Ohio. View more of Sean's business valuation articles here.