In sharp focus

Asset valuations present a potential pitfall for both practitioners and trustees, with the process now falling under the new superannuation regime, writes Krystine Lumanta.

Asset valuations will undergo close scrutiny in the current environment, not because the ATO has identified issues of concern in this space per se, but because it now underpins a person’s transfer balance cap (TBC) and total super balance (TSB). Valuations will also be required for those funds applying for transitional capital gains tax (CGT) relief, so SMSFs will need to be wary of the tax office’s warning and approach this area appropriately.

At the Tax Institute National Superannuation Conference in Sydney in August last year, the ATO first put the industry on notice and began flagging asset valuations for SMSFs as one of its key areas of surveillance to ensure trustees were exercising due diligence and complying with the super rules.

Madgwicks Lawyers special counsel Rebecca James says she’s reluctant to describe a valuation as “accurate” given the valuing of an asset is not an exact science. Rather, it’s an opinion based on a consideration of all the relevant factors.

“What’s really important are the instructions given to the valuer, which should be recorded in writing and consistent with the ATO valuation guidelines,” James tells selfmanagedsuper.

“The cost and time involved in obtaining a formal valuation as opposed to a kerbside valuation from a real estate agent can make some SMSF trustees reluctant to go down that path, particularly where the value of the property is comparatively low or there hasn’t been an event, such as the death of a member or the commencement of a pension, where the market value of the asset carries more weight.”

For SMSFs teetering on the edges of the $1.6 million TBC and TSB, there is a temptation to use valuations to prevent members from breaching these limits. But with the ATO’s close surveillance over this area to ensure the new super rules are being met, the likelihood of getting caught is high.

James believes any deliberate manipulation would be limited to a very small number of SMSF trustees who are unaware of their obligations and the accompanying risks.

“In my experience, SMSF trustees want to comply with super and tax laws, but given the complexity, wrongdoing is generally a result of an honest mistake or misunderstanding – the TBC and CGT relief rules are certainly complex and could easily give rise to errors and confusion,” she says.

The TBC versus CGT contradiction

The TBC and CGT relief provide an interesting conundrum because they are opposing forces, Miller Super Solutions founder Tim Miller says.

The TBC suggests lower valuations are preferred, whereas CGT relief may bring about a higher valuation to provide a growth buffer moving forward.

“Without evidence, I would suggest that the TBC decision-making process would take precedence because a) it’s compulsory and b) it’s pretty straightforward what your obligations are,” Miller explains.

“As far as risks are concerned I think the TSB provides the greatest risk. I’ve seen examples where the ATO have not accepted the valuations provided for in-specie transfers as they weren’t at market value and so they deemed a higher valuation on the transaction.

“If we take that one step further and the valuation used for a property, or some other asset that doesn’t have an accepted and easily obtainable 30 June valuation, and the valuation is brought to the attention of the ATO via the funds audit, what consequence might that have on the member’s ability to make non-concessional contributions?”

He says given the TSB must be below $1.6 million at the previous 30 June, if the trustees attribute a value to an asset and make a contribution based on that assumption and it is later determined the value should have been higher, then the member is exposed to the excess contribution regime.

Penalties and tax consequences

Evolv managing director Ron Phipps-Ellis says failure to correctly record assets at market value in the fund’s financial statements would result in a contravention of Superannuation Industry Supervision (SIS) Regulation 8.02B.

Phipps-Ellis warns a material breach would result in an auditor qualifying part B of the SMSF audit report and would require the auditor to report the matter to the ATO via lodgement of an auditor contravention report.

“This would breach section 35B of the Superannuation Industry (Supervision) (SIS) Act. Subsection 35B(5) provides that a person commits an offence if the person contravenes section 35B and carries a penalty of 100 penalty units. Subsection 35B(6) provides that this is also an offence of strict liability and carries a penalty of 50 penalty units,” he says.

“An offence of strict liability is an offence for which there are no fault elements for any of the physical elements of the offence and the defence of mistake of fact is available.”

Potential tax penalties could further apply for manipulation of taxable income within the fund.

Expected outcome

Whether the ATO will later find and report a large number of SMSFs with inaccurate asset valuations will be determined by the SMSF audit, according to Miller.

“If the SMSF auditor doesn’t see fault with the valuation, then the ATO are unlikely to be any the wiser that something is out of place, therefore I put far more emphasis on how the audit process deals with it as to how much the ATO responds,” he explains.

“I expect the majority of auditors will be pretty vigilant, particularly given they will be referencing valuations with commutation requests, so hopefully this impacts the decision of those that think it’s worth trying to manipulate valuations.”

From speaking to many SMSF trustees who are fully invested in their role, for many of them it is absolutely about the valuation they are selecting, he reveals.

“They have gone to the effort to obtain a valuation and have then made a judgment call about what they accept to be the appropriate valuation but then they raise concerns about whether it will be accepted by the auditor or the ATO. More often than not, I suggest that the trustees speak with the auditor about their concerns,” he says.

While there will be reluctance from some service providers to encourage that conversation, Miller is a strong believer that given the auditor is the only provider every trustee needs to engage, engagement should be more than a signed letter.

The regulator’s say

The industry has provided valuations based on the ATO’s asset valuation guidelines in line with super and tax law requirements over many years, including financial accounts, determining and managing the acquisition of assets between SMSFs and related parties, in-house asset rules, and the commencement of a pension, to name a few.

The tax office has confirmed that, in the post-reform environment, the guidelines remain applicable.

ATO SMSF segment assistant commissioner Kasey Macfarlane says before the new super rules were introduced, there were no systemic concerns around SMSF asset valuations.

“Of course, every year SMSF trustees have to turn their minds to the value of the assets in their fund and they need to be satisfied regardless of whether they’re getting a new valuation that year – they need to be satisfied that the value of the assets in their fund appropriately reflect that market value,” Macfarlane stresses.

“But the guidelines haven’t changed and there isn’t anything new or onerous, like additional documentation requirements, under the super changes – the same principles apply as they have always applied.”

However, it will be inconsistencies and unexplained significant fluctuations between one year and another that will be monitored closely here, she warns.

“We’ve been saying people must use their asset valuations clearly and consistently, so don’t try to pick a value at the high end of the range for CGT relief and another value at the low end of the range for the same asset for balance cap purposes,” she says.

“We will have in place a monitoring of the data for SMSF returns, particularly for 2015/16 and 2016/17, to pick up any out-of-pattern issues in relation to fluctuations or inconsistencies.”

She says the ATO is not expecting to change its guidelines.

“But as with anything, we will continue to evaluate, so if we get feedback that perhaps there needs to be further clarity provided, we’ll look at that and we will also consult with the SMSF industry prior,” she says.

James underscores that ultimately the risks are that excess transfer balance tax may apply, or the tax commissioner will deny the exempt income exemption for the relevant years.

“In this circumstance I would expect advisers to strongly recommend that their clients stay on the bright side of the road, to borrow a phrase from Van Morrison,” she says.