If you plan a succession, restructure, or think about selling your business, the ATO will require a valuation of your business. As a result of the updated ATO guidelines, you are responsible for providing an accurate valuation. Failure to respond to the ATO correctly could result in steep penalties and unexpected tax bills.
It is, fortunately, possible to do this right by following the updated guide on ‘Market valuation for tax purposes’ (‘the Guide’).
The ATO’s Guide to Market Valuations explains what the Commissioner expects to see regarding valuations for tax purposes. It also describes the evidence and processes it generally expects to see that support a valuation. The guide is an in-depth look at what can be a complex area – valuation.
Tax valuations: when are they needed?
Let’s clarify when you might need to determine your business’s market value for tax. Several tax provisions in Australia require the determination of “unrealised values of assets and liabilities, or alternative values to a realised asset or liability”. According to the Inspector General of Taxation, there are at least 206 different tax provisions affected.
There are several examples of these provisions, including:
- If parties have not dealt with each other at arm’s length, the market value substitution rule may apply. CGT may be calculated based on market value rather than sale price when a family member transfers an asset for minimal or no consideration.
- Small businesses valued at less than $6 million may qualify for CGT concessions under the $6 million net market value asset test; or
- Business sale proceeds are allocated to various tangible and intangible assets, affecting the Capital Gains Tax calculation.
When it comes to valuing my business, what should I do?
You need to figure out what your business’s market value actually is. How do you do that? There’s no easy answer to this one: it depends. Several businesses are permitted to estimate their market value on their own, but this is not always recommended since a reasonable estimate requires knowledge, skill, and experience. A valuation prepared by a professional valuer is generally more favourable to the ATO.
Defining market value can be a tricky task, one that is more influenced by processes than outcomes. Market value cannot generally be defined since it depends on the asset, business, entity, environment, market, and other relevant factors affecting the asset, business, or entity.
As indicated in the guide, ‘market value’ should be determined by cases and by the International Valuation Standards Council (IVSC). Comprehensive guidelines or instructions on how to reach market value cannot be found in case law, legislation or regulations. Instead, case law focuses on a variety of available approaches, with different approaches being appropriate for different scenarios. A valuation is ultimately an expert-driven process that requires considerable experience.
As a result, the ATO has listed eight fundamental valuation principles:
1. In addition to considering the relevant provisions of the tax and superannuation provisions, a valuation should also consider any case law and relevant ATO guidance at the time of valuation.
2. There is a conceptual difference between market value and historical cost (the original price an entity paid or the cost incurred by that entity for producing the goods or services).
3. Based on the valuation purpose (tax or superannuation provision), the type and source of inputs must be consistent.
4. Valuers are required to follow industry standards and practices in choosing the most appropriate and relevant valuation methodology. Several factors can play a role in this:
- The data available
- The circumstances relating to the market, and
- An asset’s value should be determined according to industry practices and standards.
5. Multiple approaches are recommended in international valuation standards. In order to provide additional support for an estimated value derived from a primary methodology, we recommend (where possible) applying a secondary or cross-check methodology
6. Inputs and assumptions are inspected impartially by the valuer during the valuation process. In order to ensure credibility, judgments made during the valuation process must promote transparency (i.e., state the inputs and assumptions) and minimise the impact of subjective factors
7. To ensure that the valuation is adequately supported, the valuer should conduct inspections, inquiries, computations, and analyses.
8. When a project is in the planning or construction stages or is being converted to a redesigned use, a future estimate (prospective value) is often sought. Tax legislation specifies an assessment date for the market value.
The key to valuing your business is adopting the right approach and methodology, applying it correctly in accordance with professional standards, aligning it with the relevant tax laws, and ensuring that the assumptions and information and inputs you have used are accurate and complete. It is also important that the ATO’s professional valuers can test and replicate them.
We’ve included a full list of documents the ATO’s professional valuers can test and replicate so that you know what’s required. Business owners who attempt to complete this process themselves often make mistakes as a result of its complex nature.
It is, therefore, not surprising that the Commissioner considers valuation reports to be more reliable than those prepared by an untrained professional adhering to common industry standards and professional codes of conduct. However, the acceptability of a valuation is mostly determined by the method used rather than who conducted it.
A professional may provide a valuation, but you, the taxpayer, remain responsible for providing a replicable and defensible valuation.
In the event that the ATO thinks my valuation is incorrect, what should I do?
The ATO may conduct a market value review of your business or asset as part of its ordinary operations. To support your valuation position, you’re expected to provide more details and explanations. Using your own valuation or relying on a non-qualified valuation could lead to incorrect tax reporting and interest and penalties. See the ATO guide for more information.
Interest charges will apply if you underpay tax. An asset or liability may be overvalued or undervalued. Furthermore, if the ATO determines that your business valuation was reckless, it may apply administrative penalties. Depending on how much documentation is provided and how much care is taken, a variety of penalties can be imposed. Some can be up to 75% of the tax that has been underpaid (in addition to the amount that has been underpaid) and can cost much more than had you arranged an independent valuation performed by a qualified person.
Reports on tax valuations require the following documents.
In the guide, the ATO specifies what information a valuation report must include, at a minimum:
- Any relevant legislation, case law, and ATO guidelines, as well as the purpose of the valuation, including tax and superannuation provisions and other relevant factors.
- Instructions and limitations on the scope of the valuation
- Detailed information about the asset being valued
- The source and extent of the information (including subject matter particulars and industry data), the facts, inputs, and assumptions used to generate this report.
- Regulatory standards governing valuation engagements; for example, the IVS, APES 225 and RICS
- Date of the valuation assessment; for example, 1 July 2022 as the date of the valuation assessment
- If applicable, the date on which the valuer inspected the asset in order to determine its value.
- The definition of value
- A description of the valuation methodologies and approaches selected, along with the reasons for selection and any cross-checks available. e.g. Market Value v future cashflow present value.
- The market value of the property is based on adequate records. A valuation record should include sufficient detail to allow replication of the valuation process, as well as confirm that a valuation was undertaken. The credibility of the valuation may be affected if detailed reports and working papers are not maintained, and statutory records are not maintained. The report and associated records may be brief when the value of an asset can be readily determined objectively.
- A report from an expert (that contains information similar to that in a valuation report) and the use of experts. If you use an expert for your valuation, be sure to include sufficient details to confirm his or her:
- Professional competence
- Methods, assumptions, and data sources are used in a reasonable manner.
- The independence of the provider (or, if not independent, the justification for the dependency)
- Previous valuations may be used if applicable. Valuations prepared for a different purpose may pose difficulties if the valuer attempts to rely on a previous valuation. Current valuations should:
- Examine how the previous valuation relates to the current valuation, focusing particularly on the purpose of the previous valuation versus the current one
- The previous valuation should be reviewed to ensure the information and assumptions are still valid.
- The valuation must conform to any statutory requirements, so explain how any adjustments and changes have been made.
- Provide an explanation and quantification of any material differences between valuations and values, such as known historical costs, previous valuations, and valuations from the same time period
- Market value must be determined for a valuation conclusion. An explanation of why a particular market value was chosen is needed when the selected method produces a range of possible values.
- All risks, indemnities, and disclaimers. An assessment of a business’s value can depend on the success of a commercial initiative launched by it. It is imperative to describe these risks in enough detail to demonstrate that they were taken into account and weighed accordingly.
- Detailed instructions on the valuation are included in a written or verbal agreement that governs the engagement of the valuer. Any instructions that have affected the valuation process, or are likely to affect it, should be disclosed in the report.
- Identification, qualifications, and status of the valuer
- The valuer’s declaration of independence is sufficiently detailed to allow us to assess the valuer’s independence, and any conflicts of interest are detailed as well.
- The date on which the report was issued.
If you have any questions about business valuations, please contact our office.
