ATO flags common issues relating to SMSF market valuations

Last updated March 2023

With the COVID-19 travel and movement restrictions now in the rearview mirror, so too are the temporary concessions around valuations. This article looks at the evidence now required to support market valuations).

What you need to know

The ATO has identified that SMSF trustees are failing to obtain sufficient audit evidence to support the market valuation of property/fund assets and transactions with related parties. This is a common issue that continues to arise when the ATO conducts its reviews of SMSF audits.

The ATO also regularly finds audits lack documentation to support the conclusions reached which is needed to enable the ATO to determine that the audit has been conducted appropriately. This is the case even if there was no contravention.

Role of the auditor

As a starting point, the ATO has reminded SMSF trustees that it is not the role of the auditor to value fund assets, or to determine their market value. As part of the annual SMSF audit, the role of the auditor is to:

• Check that assets have been reported at market value by the trustees, and

• Assess and document whether the basis for that valuation is appropriate given the nature of the asset.

In accordance with the Australian Auditing Standard (ASA) 500, an auditor must obtain sufficient appropriate evidence, either from the SMSF trustee or external sources, to form an opinion about whether the SMSF has complied with regulation 8.02B of the SIS Regs, which states assets must be valued at market value. The auditor must also document that evidence and any judgments made in their audit file.

As a reminder, the ATO has issued recent guidance on market valuations and have stated it is an area that it will continue to focus on going forward.

Why assets need to be valued – SIS requirements

Asset valuation is a key component in preparing meaningful SMSF financial reports. It has an impact on the returns for members and ultimately, the SMSF sector performance as a whole.

A valuation of assets is also required to confirm an SMSF has complied with all of the relevant superannuation laws, such as:

• Preparing the financial accounts and statements of the fund (r8.02B SIS Regs)
• Acquiring assets between SMSFs and related parties (s66 SIS Act)
• Investments are made and maintained on an arm’s-length basis (s109 SIS Act), and
• Commencing a pension (including under r6.17A SIS Regs: payment of benefit on or after death of a member).

Although the ATO expects trustees to review the value of assets each year, it does not mean that an external valuation is required annually.

SMSF trustees must be able to demonstrate that the valuation has been arrived at using a “fair and reasonable process” by:

• Taking into account all the factors that affect the value
• Being undertaken in good faith
• Using a rational and reasoned process, and
• Being capable of explaining to a third party.

Summary of valuation requirements

The following table is a summary of the key valuation requirements:

Although it may be easier to obtain a valuation through an independent professional valuer, this will come at a cost to SMSF trustees.

SMSF trustees are only required to engage a qualified independent valuer for events 2 and 3 in the table above. However, SMSF trustees should also consider using a qualified independent valuer if:

• The value of the asset represents a significant proportion of the fund’s value, or
• The nature of the asset indicates that the valuation is likely to be complex or difficult.

Specific requirements for asset classes

The ATO states that certain assets should be valued in a particular way. For assets such as listed securities, using the closing price on each listed security’s approved stock exchange or licensed market at 30 June as the market value of the security can be easily achieved. However other assets can be harder to value, such as:

a. Real property, and
b. Unlisted securities/shares in a private company, or units in an unlisted unit trust.

a. Real property
The ATO’s view is that a new valuation will be required if the latest property valuation has become materially inaccurate or a significant event has affected the value. A significant event could be an extensive capital improvement, renovations, a natural disaster, pandemic, or a change in market conditions like we are currently seeing with interest rate increases.

If the property was purchased during the audit year, the cost of property is acceptable audit evidence only in that year and may also be permitted the year after if no changes exist. When valuing real property, relevant factors and considerations may include:

• The value of similar properties and recent comparable sales results
• The amount that was paid for the property in an arm’s length market transaction (if the purchase was recent and no events have materially affected its value since the purchase)
• Independent appraisals from a real estate agent (kerbside valuation)
• Whether the property has undergone improvements since it was last valued
• The rates notice (if consistent with other valuation evidence)
• For commercial properties, net income yields (not sufficient evidence on their own and only appropriate where tenants are unrelated).

SMSF trustees must not base their valuations on only one item of evidence from the above list. Trustees should consider a variety of sources to substantiate the market value of real property.

The valuation may be undertaken by anyone provided it is based on objective and supportable data. This includes valuations undertaken by a property valuation service provider, including online property services or a real estate agent.

Where a real estate agent appraisal or online report is obtained, the valuation should list the comparable sales it relied on.

Using a minimum of three comparable sales is considered best practice by referencing them in a trustee minute that includes the property’s value. Simply stating that the trustees have looked on the internet is unacceptable. SMSF auditors will ensure that the trustee valuation aligns with the recent sales included in the minute.

What if there is no comparable sales data?

SMSF auditors will ask for more information if there are no comparable sales included in a kerbside valuation.

This is where trustees may wish to undertake research and provide at least three examples of comparable sales to confirm the valuation.

Alternatively, the kerbside valuation and another form of evidence may be sufficient, such as a market yield calculation. However, further analysis will be required to determine whether the yield is acceptable, factoring in the property’s age, use, location, and whether there was a change in tenancy.

This methodology is acceptable where the property is leased to an unrelated party but may also be sufficient for a related party tenant where additional evidence confirms the rent is at market value.

b. Unlisted securities and unit trusts

Where SMSFs are considering purchasing shares in a private company or a unit in an unlisted unit trust, valuations are going to be an important consideration due to the ATO taking a tougher stance on valuations.

The ATO expects trustees to take into account a number of factors that may affect value in this space, including both the:

• Value of the assets in the entity, and
• Consideration paid on acquisition of the unlisted securities or units.

Evidence to support the trustees’ valuation of an unlisted security may include:

• An independent expert valuation of assets held in the company or unit trust
• A property valuation where property is the only asset of the company or unit trust, and
• The date and price of the most recent sale and purchase of a share or unit between unrelated parties.

Where there is no independent valuation, trustees will need to provide evidence of what method has been used to conduct the valuation and how that market valuation has been substantiated by the trustees. This includes any objective data that the trustees relied on to come to that valuation.

In many cases, simply looking at the financial statements of a private company or unit trust is not going to be sufficient evidence on its own to be relied on for market valuation.

Thus, in situations where it may be difficult or complex to determine a value for the shares in a private company or unlisted unit trust, obtaining an independent valuation from a qualified independent valuer will minimise the risk of getting things wrong.

Action items for SMSF trustees

SMSF trustees must understand their responsibilities in running a fund, including the importance of market valuations. SMSF trustees must remember to provide objective and supportable evidence to their auditor to support the valuation of a fund asset.

Where an expert valuation is not obtained, trustees should provide the auditor with the type of evidence listed by the ATO. This should involve a range of these items, not just one.

If SMSF trustees find it hard to obtain a valuation on specific types of investments, then trustees must consider whether that investment is appropriate for their SMSF. The sole purpose test is another factor to consider in deciding whether to hold the asset within their SMSF. For example, from a sole purpose test point of view, if the asset is too hard to value, could this mean the asset will also be hard to liquidate?
Thus, before acquiring assets, trustees must consider whether any issues associated with that asset may cause problems in the future for the fund.

Action items for SMSF auditors

Auditors face significant potential exposure where they sign-off without sufficient valuation evidence.

Where an auditor is not satisfied or unable to obtain sufficient and appropriate evidence verifying the market value of a fund asset, they need to consider whether to modify the SMSF independent audit report (IAR) and lodge an auditor/actuary contravention report (ACR). If an ACR is lodged, it should include the reasons why the trustee was unable to obtain the appropriate evidence.

It is also important that the auditor documents any evidence and any judgments they have made in their audit file.

SMSF auditors must also be aware that the ATO can audit SMSF auditors to ensure audits are undertaken thoroughly and efficiently. The ATO has recently released a detailed checklist of the main issues they look for when auditing or reviewing a SMSF auditor.

SMSF auditors may wish to review this checklist to ensure they are aware of their obligations and that their audit processes and documentation are compliant with superannuation law and the Australian auditing standards.

Source: ATO website QC 69927, 24 June 2022