Some exceptions allowed under s66 enable an SMSF to acquire assets from a related party, such as listed shares, business real property, r13.22C SISR entities, widely held trusts, insurance policies, in-house assets up to 5 per cent, acquiring an asset from another fund as a result of a relationship breakdown or a merger of super funds.
To ensure compliance with s66 and avoid the true impact of incorrect market valuations, related party assets must be acquired at market value, with an independent formal valuation undertaken as close to the transaction as possible where relevant.
Acquiring assets not at market value triggers the NALI provisions, whereas rectifying a breach of s66 SIS requires the trustees to sell the asset.
Case study 1:
Scott decides to transfer listed shares to his SMSF as an in-specie contribution. He transfers $100,000 worth of listed shares using the 15 June 2024 share price and fills in the off-market share transfer form.
Life gets in the way, and Scott finally signs the form on 25 August 2024. He sent it to the share registry that day. Does the transaction comply?
Suggested answer:
While Scott planned to transfer the shares on 15 June 2024, the form was dated and signed on 25 August 2024. Given that the share price is different on 25 August, the Fund has breached s66, which is reportable yearly until the shares are disposed of.
The NALI provisions are also triggered because the transfer form specified an incorrect purchase price, and the parties are not dealing with each other at arm’s length.
The market value substitution rules apply to modify the cost base but do not affect the application of the NALI provisions. Disposal of the shares will result in a CGT event taxed at the top marginal tax rate and any income incurred before the sale.
NALI
LCR 2021/2 discusses how purchasing an asset at less than market value incurs general expense NALI.
Where an asset is purchased under the terms of a contract in the Fund’s name and not through an in-specie contribution, any difference between the amount paid by the Fund and the market value is not an in-specie contribution.
As a result, the Fund will trigger the NALI provisions, and all income from the asset will be NALI and any capital gains on disposal.
Case study 2:
Scott decides to purchase business real property from an unrelated party. He personally pays the deposit of $60,000, which is correctly treated as a non-concessional contribution. The Fund paid the remaining $540,000 out of the bank account. Does this comply?
Suggested answer:
The purchase contract is in the Fund’s name, which paid for part of the asset ($540,000), and the member paid for the other part ($60,000).
Effectively, the Fund has paid for an asset “less than market value” by paying $540,000 for a $600,000 property.
The Fund has triggered the NALI provisions because the asset was acquired under the terms of a contractual agreement and not through an in-specie contribution. All income from the property will be NALI, as well as any capital gain from disposal.
If Scott, as trustee of the Fund, recorded the acceptance of the contribution in writing and reported the market value of the contribution in the SMSF’s account and to the ATO, the NALI provisions are not triggered (refer to Example 5, LCR 2021/2).
Collectable and personal use assets
There is no requirement for an annual independent valuation for collectable and personal use assets as long as the trustee provides objective and supportable evidence to show how they value the asset.
However, when an asset is transferred to a related party, the trustee must have the sale price at a market value determined by a qualified, independent valuer.
Each breach of r13.18AA, such as the asset being leased to a related party or stored in a related party’s private residence, is worth ten (10) penalty units per instance, or $3,130. In this example, the fine would amount to $6,260 per trustee, providing insight into the true impact of an incorrect market valuation.
Loans
Loans are considered high-risk within an SMSF primarily because of recoverability. The evidence required is the loan agreement and whether it is on commercial terms by reviewing factors such as the interest rate, whether it is secured or unsecured, and whether it is being repaid.
Where the terms of the loan agreement are not met, the question of recoverability and the market value of the loan is raised, which may result in a breach of r8.02B.
Complex assets
Complex assets, such as property and unlisted entities, do not require an annual independent market valuation.
Regarding property, the cost purchased during the audit year at arm’s length is acceptable audit evidence. Where the value remains the same in subsequent years, the trustees must be able to provide evidence each year to show how and why they have continued to rely on that valuation.
It dispels the industry myth that a property valuation is required every three (3) years.
Unlisted entities, on the other hand, require several factors to be considered, such as the most recent sale price between unrelated parties or a property valuation when a property is the only asset of the entity.
Issues arise when a different accountant prepares the financials. The reports are challenging to obtain, and there is no requirement for any entity other than an SMSF to value its assets at market value.
Apart from the penalty units that can apply for a breach of r802B, all parties waste significant time, never to be recouped, trying to obtain objective and supportable data.
Conclusion
The complexities surrounding market valuations will mean more onerous obligations and responsibilities for all SMSF professionals.
With market valuations now one of the emerging risk areas, SMSF advisers should be aware that SMSF auditors will be vigilant when reviewing documentation and valuations.
The true impact of incorrect market valuations can quickly impact SMSF compliance with far-reaching implications for SMSF trustees.
