SMSFs flagged on arising pitfalls from complex valuations approaching EOFY
As the end of the financial year approaches, SMSFs owning more complex assets will require greater care to ensure accurate market valuations and smoothly navigate across various compliance issues that can affect the fund.
Approaching 30 June, it is a legal requirement that all SMSFs record and report all assets at market value. Failure to report assets at market value or misrepresenting the value of assets can have compliance consequences for SMSF trustees.
Importantly, the SIS Regulations make it an operating standard that end-of-year financial statements must be prepared using market value, meaning funds that don’t comply can be reported by their auditor.
In a recent technical bulletin update, SuperGuardian education manager Tim Miller said that using market value means an SMSF can provide an accurate representation of the fund’s value and, importantly, each member’s interest in the fund. This ensures that financial reports are meaningful and can be relied upon for decision-making, including receipt of contributions and calculations of pensions.
It is also important to account for arm’s length transactions and maintain all investments on an arm’s length basis, particularly given many SMSF transactions are conducted with related parties.
Mr Miller said it is important to remember the ATO has indicated that the process of determining a valuation is generally of more importance than who conducted the valuation in assessing its validity. The key basis is that there must be objective and supportable data.
“A qualified and independent valuer is only required in certain situations, but they must be used where collectable and personal use assets are disposed of to a related party,” he said.
“Additional situations where it may be appropriate to obtain an independent valuation include where the asset represents a significant proportion of the fund’s value and/or the nature of the valuation is expected to be complex.
“As part of the annual SMSF audit, a trustee may need to provide an updated valuation, for review, including evidence or documentation of the valuation method used. The valuation needs to be based on objective and supportable data, using a fair and reasonable process.”
Cash accounts, listed securities, widely held unit trusts/managed funds and cryptocurrencies all have values readily available to use for reporting purposes at 30 June each financial year, according to Mr Miller.
However, real property, unlisted shares/units, collectables and personal use assets and in-house assets are classes where care must be taken to ensure that a fair and reasonable valuation is used to ensure accurate and meaningful financial statements each financial year.
Real property valuations
According to the ATO’s guidelines on valuations, an external valuation of real property is not required each financial year. Mr Miller noted most SMSF auditors will request an updated external valuation be performed every three years unless the trustees expect the previous valuation to be materially inaccurate.
“If you expect the value has significantly changed since the last valuation due to changing market conditions or other factors, then it would be considered necessary to arrange a new valuation,” he said.
“Examples of significant events that would affect the value of real property include natural disasters, macro-economic events, market volatility and changes to the character of the asset such as renovations.”
Mr Miller said the factors that need to be taken into consideration when determining the value of real property include the value of similar properties and the amount paid for the property in an arm’s length transaction.
This also includes the independent appraisal and whether there have been any improvements undertaken since the last valuation.
For commercial properties, net income yields are also an important consideration in determining real property value.
As a rule, Mr Miller reminded council rates notices are not sufficient for property valuations unless supported by documentation above.
“Valuations prepared by suitably qualified and independent valuers are less likely to be questioned by auditors and the ATO,” he said.
“However, for financial reporting purposes, the valuation can be undertaken by anyone as long as it’s based on objective and supportable data. Therefore, as stated earlier, it must be capable of explanation to a third party.”
Unlisted investments and private unit trusts
Market valuations for unlisted investments can also be complex and this includes shares in private companies, shares in unlisted public companies, units in private unit trusts and units in unlisted widely held unit trusts, according to Mr Miller.
For these types of investments, there are generally not readily available market prices that can easily be used for financial reporting valuation purposes.
“The value of the underlying investments of the entity and the asset value at acquisition are important factors in determining the valuation to use for financial reporting purposes,” Mr Miller explained.
“Where a valuation may be complex, an external valuation may be required. Cost price and net tangible assets (NTA) which are readily available are generally not sufficient valuation methodologies for companies or trusts.
“For example, NTA cannot be relied upon where a private company or trust prepares special purpose financial statements and assets are shown at cost price or their written down value.”
To satisfy valuation requirements, Mr Miller noted it may be helpful to consider the share price of any share issues or sales within the last 12 months. SMSFs can also look for correspondence from the company’s CFO with the share price, explanation and evaluation of company assets and liabilities with evidence along with calculations to support NTA of a company where market or fair value is used in reporting.
Meanwhile, to satisfy valuation requirements for private unit trusts, Mr Miller said it may be helpful to consider the unit price of any unit issues or sales within the last 12 months.
“This includes the valuation of unit trust assets and liabilities with evidence and calculations to support along with the NTA of trust where market or fair value is used in reporting and cost price of units for the first year acquired,” he continued.
“On an annual basis, the trustees need to be able to provide signed unit trust financial statements, current market value of units. If a related trust has a controlling interest, copies of bank statements and loan statements may be required for significant accounts and any title searches where relevant.”