There have been several key updates to the rules and regulations affecting SMSFs in the upcoming 2014 financial year. One of the most significant changes is the introduction of the market valuation requirement for all assets held under a superannuation fund. Following these changes, a particular SMSF is likely to be affected in myriad ways, depending on the nature of the investment assets, the current valuation practices on the investments and the phase that the super fund itself is currently in. This article aims to clarify the reasons behind the upcoming changes, while presenting their impacts on SMSF investors.
Current valuation guidelines
The Australian Taxation Office (ATO) has so far regarded market valuation of SMSF assets as a good practice. These recommendations resulted in most SMSF trustees, either on their own or with the help of their accountants, making it best practice to determine the real value of their asset holdings within the fund. This practice, in the financial year starting 1 July 2013, has been changed to a mandatory requirement by the ATO following legislation that was recently passed.
Reasons for mandatory valuations
With the ATO increasingly structuring SMSF management practices over the past years, the lack of compulsory market valuations of assets has been a cause for concern. Several key rules and regulations recently introduced have been based on the value of the SMSF itself, and this has resulted in a greater incentive for SMSF trustees to fail to record accurate and current valuations of their assets.
There have been several issues resulting from a failure to record accurate market values of all assets held in the SMSF. The most basic problem for investors has been in learning about significant discrepancies during the process of realising their return in the pension-transition or the pension phase of their superannuation fund. In cases where trustees have overstated fund balances, members have been left to realise returns considerably lower than expectations during the later stages of their accumulation phase.
There has also been concern regarding the SMSF withdrawal bounds and taxation laws. Inaccurate valuations of net assets have led to situations in which the SMSF has become non-complying with the ATO legislative and regulatory requirements. For instance, a member in the transition-to-retirement phase has the potential to be withdrawing more than the allowable limit of 10 per cent of their superannuation balance, when the market value of the superannuation itself has been overstated in records.
Conversely, for a member in the retirement phase of their superannuation, an understatement of the market value of their superannuation net worth would result in them withdrawing less than the minimum 4 per cent regulation set in place. This would subsequently produce unfair tax benefits over time, seeing as the returns on a pension fund are tax free, and could therefore make the member liable for strict non-compliance penalties by the ATO once the SMSF’s true market value is realised.
There have also been other complex situations resulting in an inadvertent violation of legislative regulations. Without careful management of market value, especially of the more illiquid assets, the fund may attract compliance action by the ATO. For example, in the scenario where the SMSF’s external investments fall in value substantially over a period of time less than one year, the fund’s in-house assets (assets invested in a related party or related trust of the fund) may become worth more than the allowable maximum of 5 per cent of the fund’s total assets.
This would lead to a situation where the fund’s auditor would be required to present to the ATO a document outlining the plan and process to reduce the in-house asset ratio to below 5 per cent. An inflated market valuation of the investments, however, could allow a circumvention of these regulations. It was therefore evident that there was a requirement for a standardised regulation on the current market valuation of SMSFs.
The valuation process
In light of these issues, the ATO now requires all SMSF market valuations to be conducted as required for all assets invested into by the fund. These valuations are in most instances a relatively simple process that has already been conducted by prudent investors, trustees and members. Valuing shares, managed funds and cash investments can be done with ease, due mainly to the relatively easy access to the live market prices. However, the more illiquid investments, such as property, private equity, trusts, personal use assets and collectibles, would need specialist understanding and advice to value.
The property market is one asset class that can be especially difficult to accurately gauge for most common investors, given the large size, dynamic nature and inherent information-gathering difficulties in this market. Acquiring in-depth, quantitative and unbiased private equities and trusts is another grey area, where it can be unclear as to what the particular exposure is valued at. Several private companies and trusts legally disclaim any legal responsibility on the accuracy of the valuations published in their investor updates.
The valuation frequency has been set by the ATO on a particular need basis. Therefore, valuations need to be conducted when there has been a significant event whereby the value of the asset may be affected. These include natural disasters, macroeconomic events, market volatility, changes to the character of the asset or changes in market speculation and perception of the asset. Following these changes, it is mandatory for a valuation to be conducted by a trustee at the end of a financial year, starting next year.
People who can value assets
The ATO has provided a set of guidelines to regulate how assets within an SMSF can be valued. The guidelines particularly focus on the method of valuation, rather than the person valuing the assets. In fact, according to the ATO, a valuation can be conducted by:
- a registered valuer,
- a professional valuations service provider,
- a member of a recognised professional valuation body, and
- a person without a formal valuation qualification, but who has specific experience or knowledge in a particular area.
Therefore, for most valuations, it is possible for trustees to independently value the assets, provided they disclose the method of the valuation in appropriate relevant documents.
Valuation issues – a property example
In the case of property valuation, a number of market factors need to be considered and analysed to gain an accurate understanding of the asset. These factors can be looked at in three independent levels, each with its own level of detail:
1. The macroeconomic factors, such as:
- the world and Australian gross domestic product growth rates,
- national and state median property values and growth rates,
- the cash and inflation rate set by the Reserve Bank of Australia, and
- the national housing and labour market statistics.
2. Suburb analysis factors:
- median house and unit values and growth rates,
- median household incomes and mortgage and rent payments,
- demographic factors and dwelling preference, and
- property market factors such as auction clearance rates.
3. Locality analysis factors:
- comparable properties analysis,
- local crime, education and health facilities and statistics,
- transport infrastructure, and
- restaurants, cafes, entertainment areas and shopping amenities.
Therefore, there are several factors that need to be taken into account to present a reasonably fair valuation of a property asset. We recommend, given the complexity of the analysis at each level in the process, specialist due diligence reports need to be consulted for appropriate advice on this matter.