The SMSF Experts with Shelley Banton

Looking for Market Value with Mark Ellem

Episode Summary

Shelley is joined by Mark Ellem, Head of Education at Accurium, to discuss the murky area of market valuations, share issues they see in practice, tell a few war stories and shed light on the key problems when valuing assets at market value in SMSFs.

Episode Notes

Episode Transcription

Voice Over (00:01):

This is an ASF Audits podcast.

Shelley Banton (00:10):

Welcome to the SMSF experts, the podcast that turns complex SMSF issues and legislation into everyday language. I'm your host, Shelley Banton, head of education at ASF Audits. And in episode two of the SMSF experts, we are looking for market value, which continues to be problematic when valuing the more complex investments in a fund. Market value is a CIS issue. It's important for when a pension starts, it determines what a member's total super balance is, and the list goes on. So today we're going to demystify market valuations, discuss issues we see in practise, tell a few war stories, and try to shed some light on the key problems we see with valuing assets at market value in SMSFs. And to help us make sense of it all. I'm very happy to be speaking with one of the industry's most highly respected experts, Mark Ellem. Mark is a well-known and sought after presenter, who is passionate about educating accountants and SMSF practitioners on strategy to make smsf a successful part of their business. Mark's currently the head of education at Aurum and is responsible for their online education. He regularly presents that webinars, provides in-house training, and frequently provides content for media. Welcome to the SMSF Experts, Mark and thanks for joining me.

Mark Ellem (01:31):

Pleasure, Shelley. Lovely to be here.

Shelley Banton (01:33):

Well, I think you might be a little bit disappointed we're not discussing legacy pensions today, , but I'll try. Let's

Mark Ellem (01:40):

Get down to, I'll try and bring it in you. I'll give a challenge.

Shelley Banton (01:43):

Well, let's get down to the nitty gritty and start with market valuation basics. reg a 0.02, BF CS requires SMSFS to value assets at their market value each year. And while there's a ready market for some assets such as listed shares, which are obviously easy to value, the more complex assets are the one that continue to provide us with headaches, especially at audit. So what's so important about valuing assets at market value and why do they need to be valued every year instead of say every three years?

Mark Ellem (02:12):

Well, I think you, you, you touched on the point there, Shelley, you know, it's a regulatory requirement. 802B you know, says we've got to value assets in the annual financial statements at market value each year, not every three years. You know, it's, it's, it's each and every year. So the trustees need to turn their mind to valuing assets at market value in the annual financial statements. But that's not just where market values require. There's a lot of other areas or regulatory requirements where market value needs to be considered and determined. You know, for example, take the section 66 prohibition on acquiring assets from a related party. The, or there's, we focus on the category of accepted assets and we know that those, the main ones, business real property listed shares, widely held trusts. But in relation to all those exceptions, there is also the added end.

(03:12):

It's a quieted market value. So, yeah, yeah, we, we tick off that we've got an accepted category, my business rule, property listed chairs, but then we've also gotta make sure it's acquired at market value as well. So this has two requirements. you've got the in-house asset rule, you know, the concept of, well, we can have in-house assets c that's not a bad thing. The bad thing is we exceed the 5% limit, and that's based on market value, both, both of the in-house asset and of the total assets. Cause you know, numerator over denominator that gives us our percentage and they're both based on market value. section 1 0 9, you know, doesn't specifically talk about market value, but it says investments must be made on an arm's length basis. So that brings in the concept of market value. we've got market value you know, underpin market value of assets underpins the value of member interests, and particularly for member pension interests, that's going to determine what the minimum pension's going to be in the next year, or depending on the type of pension, the maximum pen, maximum pension amount.

(04:14):

So market value's going to affect how much pension needs to be paid each year. Likewise, you know, on the topic of pensions, when a new pension is commenced, again, the market value of assets is gonna underpin that commencement value and that commencement value is then gonna give rise to a credit in the member's transfer balance account and how much that credit's going to be. So that's underpinned by market value of assets. Also, if I can bring in Shelley E C P I exempt current pension income, , you knew I I was gonna bring it in, but you know what market value does have an effect on E C P I, of course, cuz if you are looking at the proportionate method during the year, we are basing it on how much of the fund is in retirement phase pensions during the year, and even at the start of the year, that's opening balance based on market value, where the fund has a period of deem segregation and the fund where the fund comes out of that period of deem segregation. We're gonna wanna know what the value of asset of the members intra sale, which is again, is underpinned by market market value. And lastly, I'll finish off on one that we can't forget good old gnarly, you know, market value and gnarly. So it's not just all about CIS requirements, there's the tax, you know, and market values a concept with gnarly, you know, we know we buy assets from a related party at less than market value. We are creating non arms length expenditure.

Shelley Banton (05:37):

Yeah. And just on that E C P I point, it's really interesting because while auditors get the bad end of the stick in terms of having to confirm market value and verify market value actuaries don't have to do that when they're calculating that percentage. So it really is an interesting difference between the professions, whereas that E C P I percentage comes before the audit effectively, and those values haven't been confirmed at that point in time. Whereas it, we, we get to the audit and that's when it has to be confirmed. So just interesting between the two professions as to what the obligations are there too. Yes,

Mark Ellem (06:15):

Exactly. I mean, we need to determine a market value. We take it that it is at market value. Obviously if then when the audit's done there's an issue with market value of assets, which then changes balances, then it would be up to the accountant to come back to us and say, I need to amend that certificate because values have changed. We'll provide the amended V C P I percentage and certificate accordingly.

Shelley Banton (06:38):

And so obviously there's going to be even more influence on market value or or determination of market value when we are looking at this proposed supertax, which is important in terms of determining what from pensions, transfer balance caps are and what the total super balance are is. So we are going to have a lot more, I guess not so much differences in, in the approaches, but obviously there's gonna be a little bit more pressure on auditors to accept valuations potentially that's trying to get the value up around about the June 30th, 2025 and then a lower value the following year. I mean, obviously we've got to adhere to those auditing standards and make sure that we are confirming and substantiating that the methodology's correct. But at the end of the day, it makes it a little bit more pressure that we don't otherwise need with this new proposed supertax.

Mark Ellem (07:31):

Yeah, I mean, on one, as you sort of alluded to of one aspect, it's the same requirements. There's not, there's no change in the requirements. Assets must be at market value, but of course there's gonna be probably that focus on market value and that extra scrutiny on market value. You know, the same thing as there was the scrutiny on single asset investment strategies. You know, there was no change to the actual re requirements. There was just a extra scrutiny on that. It's probably gonna be extra scrutiny, you know, assuming this proposal comes in. But again, that even now, if you look at the different thresholds for bring forward rule access to catch up concession or contributions, they're all based on total super balance. Total super balances based on member balances. Member balances are underpinned by asset values. So it's comes back to market value, but yeah, it, it's probably going to be extra, you know, putting under the microscope of market value of assets if we have this $3 million measure coming in. Yeah.

Shelley Banton (08:34):

And if the government didn't try and mandate how much we can retire on, we'd probably just be moving that bouncing ball along Yes. The next day without any issues. Let's move on. If we look at the atos website for market valuations, and the reference there if anybody wants to do that, is QC 2 6 3 4 3. There is a checklist for how assets have to be valued. Now, apart from collectable and personal use assets that have to be valued using a qualified independent valuer, the other assets listed in the guidance must have a fair and reasonable valuation based on objective and supportable data. So does that mean in real terms, apart from the fact that the auditor shouldn't be valuing the assets themselves? How does that work?

Mark Ellem (09:18):

Firstly, that's a great point that you make that, yeah, it's not up to the auditor to value the assets. It's up to the trustees to value the assets and then provide that, what do you call it? Sufficient appropriate audit appropriate evidence,

Shelley Banton (09:31):

Evidence to

Mark Ellem (09:32):

The auditor to not, you know, not convince them, but to show that, well, yes, this is the market value of that asset. And so you know, what's considered fair and reasonable. And again, you can refer to the market value guidelines. on the ATO's website, it talks about taking into account all the relevant factors and considerations likely to affect the value of the asset. So if it's a property, what condition is it? Is, is it in what area is it in? Is it an area that's going up in value? Is it an area that no one's buying in? You know, all those relevant factors. It's been undertaken in good faith that uses a rational and reasoned process. And I think this last point's input important. It's capable of being explained to a third party. So, you know, does the approach make sense? Does the valuation process make sense? And again, the ATO says, you know, it's all about the process, not about who actually performs the valuation or conducts the valuation. It's about the process. So is it easily explained and does it make sense? Does that approach make sense? And that, oh yeah, we've taken into account all the relevant factors surrounding what, what would affect that assets market value and the approach we've taken. Yeah, that's reasonable. It make, as I said, it makes sense.

Shelley Banton (10:48):

So does it pass the pub test at the end of the day? Does it c as you say, can it be explained to or the independent third party? And is it something that if could you enter into that transaction or into that transaction at market value at that you're going to put on that asset with yourself and, and not feel uncomfortable about that? And if the answer is probably yes, well then there probably is something, you know, a little bit untoward about that valuation, and you need to think about getting further methodology to support the valuation that's in the financial statements. At the end of the day, I guess this may also be a little bit of the tip of the iceberg in relation to the comparable sales that will, were required to be included in the real estate's agent's curbside valuation. Now, the problem here is, I've often said it's not the requirement that set down by the ato.

(11:38):

It's actually a requirement of the auditing standards that the valuation is, as we've said, based on objective and supportable data, because the auditor doesn't have that methodology when they don't have that meth methodology by which the valuation's placed on, they can't determine the value and and determine whether it's fair and reasonable. So it's interesting that the atos now updated their guidelines. It states that if a curbside appraisal is based on the comparable sales, then they should be included in the appraisal. And in fact, the ATO also considers that a variety of sources should also be looked at to substantiate that value. So what are the, some of the other factors or methodologies that could be used to value property?

Mark Ellem (12:21):

Firstly, you know, trustees may wish to use a qualified independent valuer. Now, as the ATO points out on their website, this might be the prudent approach where the value of the property represents a significant proportion of the fund's value. Now, if you consider SMSFs holding property, it would not be uncommon for that property to be a significant value of the fund's assets. So from my perspective, you're thinking, well, why wouldn't you be using an independent valuation of the property? Because if it's con, if it's comprising 70, 80 plus percent of the funds overall investment portfolio, then it's important that that market value can be substantiated and a qualified independent valuer is going to be able to meet that requirement. So I think auditor would be satisfied with yep, qualified independent value. That's underpinning a majority of the value of the fund because the majority of the fund is in that one asset.

(13:22):

Now, if they get that qualified independent valuation, you know, they use it in one year, they can consider then getting that updated from year to year. You know, so they could contact the valuer and say, well, do you think there's been a change in market value, significant change in value of the property? If yes a new valuation, if not, then just an update to it saying, no, everything's fine. We can continue to use that same, same value. It's still the value in the, at the following 30th of June. But if they decide not to use an independent valuation, again, it goes back to that valuation needs to be based in objective and supportable doc data. And the, again, the ATA lists out those factors that you've covered off on, on Shelley, you know, it could be based on other value of comparable sales in the area.

(14:05):

So in the, in the area, similar properties, what are they actually being sold for to unrelated parties? And that can use that data as a basis for valuing the property that is owned by the SMSF. You know, if the property was recently purchased in the year, it might have been purchased in March, April, may of the year. Now if it's purchased from an arms length vendor, then it's, that's going to be a great indication of that is the market value of the property. And you wouldn't expect market value to have moved too much in a short period of time at the 30th of June, as you said, the independent appraisal from a curb from a real estate agent, the curbside valuation rates, notice why you'd be gi be giving us indication of, of the value of the property depending on type of property.

(14:51):

If it's va, if it's vacant land, for example, you know, the land is what underpins the value of most property. It's the increase in the value of the land, you know, buildings depreciate. It's the land that appreciates. So it underpins the, underpins the value. And if it's a commercial property, it might be capitalization of yields, you know, what is the rental income producing and what's the appropriate cap rate to get back to? Well, that's the market value of the property. but you know, if we are not relying on an independent valuation of the property, we'd want to be using a variety as they, as the a t s says, a variety of those factors that I've just talked about in, again, coming up with that sensible approach that's easily explainable to a third party. Oh, well I've used, I've got the rates notice, it's showing the increase in the value of the land. I've got some comparable sales. I may have got a curbside valuation as well. I'm using all those different sources to then calculate and determine the market value of that property.

Shelley Banton (15:56):

And that's a really good point too, in terms of when you spoke about before with the ATO talking about if it's a significant value, but also if it's a more complex property, such as it could be a purpose-built property such as a, a medical centre, or it could be a hotel, then you would need to get an independent valuation compared to if you use comparable sales. Well then it's not simply enough for the trustees just to put a minute together saying, I've looked at comparable sales on the website, on the internet, and I've come up with this is evaluation. They actually have to put that, those comparable sales within that minute and document it to show that that valuation is fair and reasonable. So you've probably seen examples where you've had the minutes from trustees saying, yep, I've had a look at last year's valuation, it seems okay, and it seems within the market, but we do need more information under those circumstances. Don't you agree?

Mark Ellem (16:52):

Ye yes. And, and, and with regard to comparable sales, well, are they comparable sales , you know? Yeah. If, if it's a special built property, that might be the difficult finding those comparable sales. The other one is, it might be a regional property where there are no comparable sales. There hasn't been a that's right sale for a a long time. So it might be a scenario where, or in that scenario that the trustee has no choice but to get an independent valuation. Because how else, I mean, again, you might be able to use rate notices, you might be able, there might be other indications what's happened to properties in the area with regard to any sales. It might be a comparable sale, but now you're wanting to get a, a lot of different sources to be able to help substantiate that market value that the trustees determine. And again, that point, you know, it's the trustees that are determining market value.

Shelley Banton (17:43):

That's right. And if there are no comparable sales, because as you said, it's in a regional area, it's important to document that as well so that the auditor understands that they do have to look at other methodologies and other areas to be able to come up and agree and confirm with the confirma with the valuation that's been included in the financials. So what about online valuations? Markhere, the, we've got the range of the value is really critical because we can't have a valuation that says the property's worth between 200,000 and 800,000 and we pick the midpoint of five. So what needs to be done in that situation and and how reliable are they?

Mark Ellem (18:22):

Well, just as an exercise, I just went on and put in my home that's treat dress . And a couple of things I noticed, firstly, as you noted out, it was a wide range. It was a wide range. You know, I was, I was happy at the top of the range and I wasn't so happy at the bottom of the range . And, and your point about, you know, everyone takes a midpoint. Well, why? You know, yes, why take a midpoint? it could, you could argue to the low end or you could argue to the high end. And that probably gets back to that issue of as we approach 25, 26, if a $3 million cap comes in, then justifying why you think you're at the low end rather than the high end. The other thing I noticed was the photo of my place, obviously taken by the Google car going Google going by was at least 20 years old.

(19:07):

Oh, right. Yeah. The hedge out the front was looked like a hedgie up the front, which looked like had just been planted. Where now it is really, really high. Cause it hasn't been pruned for a while, . But yeah, so it was quite an old photo before, and importantly it was before a whole heap of renovations we had done. So you know, one of those factors that we need to take into account is whether renovations have been happening on the property. So online know, and, and what type of online, is it a paid online or is one of the free online valuations? And then we look at the substance of the online valuation. What's it based on? Like if it just says, Hey, we've looked at your property and based on comparable sales, it's worth between X and Y. Well, again, as you said, well, what are those comparable sales?

(19:46):

Where are they listed? How recent are those comparable sales? Like they, were they 20 years ago or 10 years ago, or five years ago? Or are they in within the last 12 months? So we need to just, you know, online's okay, but it needs to have within it those comparable sales so that we can ascertain all the third party i e the order deck and look at it and go, okay, again, that makes sense. Passes the pub test, it's got those comparable sales in there and, and they support this valuation that the trustees determination of market value the trustees have come up with.

Shelley Banton (20:19):

And that's where it's important too, to look at those comparable sales to make sure that within those online valuations, that they are comparing apples and apples and not apples and oranges. So, and when you do get that variation, it is just a database that's spitting out two variables that take an average of the best and the worst that's happened over a period of time. So like any database, if the data hasn't been updated, if there's been not so many sales, you're gonna have some issues at the end of the day, which is gonna give you a variation valuation that may not be as reliable as certainly an independent valuation. So you need to actually look at how wide, what's the, what's the forecast, standard deviation of that variance, and then look to other factors as what we've spoken about in other methodologies to be able to value, all right?

(21:11):

We've got a qualified independent valuation that we get for commercial property and it's obviously comes with a higher cost than a curbside valuation for resi property property, but sometimes we have no alternative but to go down that path. And I guess what's the interesting from them about an audit perspective is the level of detail that provides you with a lot more information, such as the property may be on one or more titles, which we may not have known about. And also it's been leased a related party, which we may not have known about. Now, as we know, the ATO O says that an independent valuation isn't required every year. But if relying on this in the future, the trustees need to assess whether it's still appropriate and a new requirement. And even more importantly on what the A t O says is that they need to document how they came to this conclusion. So what's the best way that trustees can do this? And what types of situations would result in evaluation no longer being appropriate?

Mark Ellem (22:07):

So I think the best way to document that the previous independent valuation is still appropriate is by trustee minute or or resolution. So again, yeah, the trustees need to turn their mind to market value of assets at the end of each and every year. So what a better way than have a meeting. Yep. Make that point. Hey, we've, we, we've gotta value the assets at the at market value each in every year in relation to this current year's financial statements when the accountant administrators prepare them. And importantly, we've gotta substantiate that to our friend, the SMSF auditor, you know, let's think about what the value of assets are. Now, they can't simply hold a meeting and say, look, we've previously got this independent valuation, it's less than three years old, so we're just gonna continue to value the asset at that value.

(22:57):

You know, basically use the value from last year's financial statements cuz it's supported by this independent valuation that's not more than three mi three years old. That's not gonna work as we know, because there needs to be evidence of why the trustees believe that the market value of that asset property is still the same as what the independent valuation said. Six 12 months ago, 18 months ago, two years ago. So why do they think it has not changed? Now it can't simply be the vibe, you know, , right? Right. So one way is could be with the trustees to contact the, the valuer, a person who did the valuation and just have a chat to them about whether they feel there's been a material change in the value of the property since they did the valuation. And if not, no, there hasn't been a material change.

(23:48):

Ask them to provide maybe just a, a letter, a simple letter saying we've reviewed the valuation, we've considered the en environment, the real estate environment of the area of the property, maybe considered comparative sales, and there's no material change to the valuation. So again, the trustees say, well, we've used got the previous independent valuation. It's, it's not that old, it's less than three years old. We've spoken to the valuer, we've got a letter from the valuers are saying, you know, there has not been any material change. So in our view, the market value is still the same as what it is per the previous independent valuation.

Shelley Banton (24:24):

And so when, for example, the ATO says that the valuation should be refreshed or reviewed if there's been a significant event, if there hasn't been a significant event that should be documented, or is there been a significant event such as a change in interest rates, which which may not have affected the valuation for whatever reason, should that be documented as well? Is is more the merrier or is less better? What, what sort of, how, how should be the approach here I guess?

Mark Ellem (24:53):

Well, again, we need to take into account all those factors. So with the recent interest rate environment, and we've seen a downward pressure on, on prices, you know, that how, how old is that independent valuation? Like if it is 18 months old when prices were skyrocketing and, and going up quite highly, then if we've got indication that interest rates have had this effect on property, then you're most likely going to get the value of say, well, yeah, they have, they have come off, you know, and you may not need to speak to the value. If you've got access to comparable sales looking at sales over the last few months in the lead up to 30 June, 2023 for example, then it might be indication, well actually property like properties in the area have dropped down. So rather than, you might not even need to contact the valuer. We say, well, I've got the valuation, but looking at, I've got data of comparable sales now using both the independent valuation, the comparable sales, we see that there's been a drop off in value of 5% of 10% of 15%, then we're going to apply that to our in previous independent valuation and therefore we are determining that the market value of the property at 32 this year has dropped off by this amount. And again, is that easily explainable? Does that make sense? It's all about the process.

Shelley Banton (26:13):

Yeah. And the devil's in the detail. Yeah. And making sure that you are following the bouncing ball and that logic within whatever documentation you're providing at order to be able to substantiate it.

Mark Ellem (26:24):

Yeah, and I think just at, at this point in time before I forget the point Shelley is, you know, this is real estate, you know, we were mainly talking about real estate, you know, which you think is not that difficult to value, but it's not like listed shares where you just look up the stock market at 30 june and, and there's the price. This also comes back to educating the trustees that if they're going yeah, if they've come to you and said, I'm gonna buy some property, you know, with I'm, I'm selling the share portfolio, or we've, we've just set up the fund and we've got this all this cash, we're gonna go buy a property, educate and go, well that's great. That's, that's wonderful, but just let you know what are going to be your ongoing compliance and particularly audit requirements for this property. You know, you are going to have to turn your mind to determining and importantly substantiating market value of this asset each and every financial year. So, you know, you don't get the question asked of the trustee and then it coming back from the trustee. Why is the auditor asking about market value again this year? We did that last year. So, you know, e e accept that expectation at the right level. You are buying this type of asset, it comes with some additional work that you're gonna need to do each and every year.

Shelley Banton (27:42):

Yeah. And we love it when the you know, the property comes in for the very first year because it's, it's a cost price. We've got the purchase contract we know that if it's between unrelated parties, it, it's armless length and we have no problems and we can just tick that off and move on. So that's where cost price in the first year is, is, you know, acceptable. But moving forward, that's where we need to do a little bit more work. And as we know, the more complex the asset, the more expensive it's gonna be in terms of being able to meet compliance and regulatory obligations within the fund.

Mark Ellem (28:18):

Yeah. And that's also important to set for the expectation of the client expectations is not just, I've got to supply this extra gar but actually might cost me. That's it might, yes, that's might be a additional cost to the fund for holding that particular asset category vis-a-vis. Yeah. Real property.

Shelley Banton (28:34):

you made an interesting point about listed assets being easy to value, which is a hundred percent correct. But what are some of the difficulties you've seen with valuing assets such as unlisted entities at the end of the financial year and what are some of the approaches to determining market value is around for this particular asset class?

Mark Ellem (28:52):

Well, you know, if you've hit the nail on the head, the difficult is is that they're unlisted . There's, there's no easy reference for the year end of market value or at any time for market value. You know, mentioned that it's not just 30 June, that market value is important. Let's, let's consider two types of unlisted entities here, Shelley. one where the underlying asset, the main asset is real property. And so typical er, it might be an unlisted unit trust, either unrelated or related, but accepted under the non-GE unit trust rules. Now, and you probably the SMSF or the client probably has some influence control over that trust that owns the property. Particularly if it's the non geared unit trust. You know, normally it's either the fund or the fund in a related party that is either unit holders of that non-ed unit trust.

(29:42):

So you know, the trustees normally very aimable to a request to get evaluation of the underlying property cuz they're probably the same person. Yep. So you, you can generally sort of re configure the statement of financial position for that trust, the balance sheet for those of us who have been around long enough and still refer to it as balance sheet. you know, you can reformat, reconfigure the statement of financial position so that it's stated at market value. So it's treated like an SMSF, the assets are stated at market value. And so you make those adjustments, you can see what the net assets is, which will be the difference between market value of assets being the property market value, the other assets generally just cash at bank. That's the market value. That's easy. Yep. And then you've got your net assets and then you abide by the number of units and that gets you your market value of the units because that's the asset of the SMSF being the units in the unit trust.

(30:37):

Yep. So that one's can be fairly straightforward. It might be an unrelated trust because you might have two parties that are not related or you know, at least two parties, obviously 50 50 cause can't hold more than 50. And as we know, mathematical mathematically 50 is not more than 50 or either more units unit holders that are unrelated in there. So, but again, generally the unit trust will be receptive to a request or can we get a evaluation of that property? Yeah. So that we can determine market value of the units. And a lot of the times, if it's an unrelated unit, trust, the unit holders, all the unit holders will be smsf anyway. So I've all got the same That's right. Requirement. That's right. Now we turn to the second is an unlisted entity then, you know, trades, you know, it might be a public company but it's not listed for example, you know, but it's actually conducting a business and the Superfund has a minority interest in that company I only own, so, you know, small percentage of the shares.

(31:36):

So that makes it a little bit more difficult because you can't, it's not the underlying asset's, not real estate. We can't just go get independent valuation. Even if it was, the entity might not be receptive to a request, oh look, I've got this obligation to provide my auditor with the substantiation of market value of these shares in your, in this company. We need to go get those assets valued. So there is, you know, there is the option that the, the SMSFs as a shareholder could request an independent valuation of, of the company probably cost prohibitive for that. Yeah. You know, that's gonna cost a a a lot of money to do that. It could be you look at if, if, if you've got access to it, particularly if it's a a public company, there might be, you might have access to a list of recent share sales.

(32:21):

But again, that'll depend on whether, how frequent those share sales are. They might be too infrequent to be able to give an indication or might be too far in the past to give indication of what the market value is. If there is a history of dividends being paid, then we look at a capitalization of dividend yield or distributions from that entity capitalising those dividends. Or if it reports, I had an example of a public, a public unlisted company where they actually reported EBIT earnings before interest in tax. And I had a colleague who, who worked in the area of valuations and our discussions with that colleague were able to determine what a EBIT multiple was for that industry. Industry wasn't the acceptable industry. So, you know, we used a combination of EBIT multiples, dividend capitalization of dividend yields. We had a history of of share sales, even though they're infrequent using all those sources of data for then the trustees to come apply a process to say, well here's what the market value is at the end it was, I think, we'll think what was adopted was the capitalization of dividends being paid, but also looked at the EBIT multiple, which came out relatively the same.

(33:38):

And that's the evidence that the trustees presented to the auditor to underpin the market value that they determined of those shares. So, and again, as we noted before, telling the client when they say, ah, I'm gonna abide these shares in this public company, it's unlisted. Yeah. And with the internet trustees are, you know, fairly o fai with a lot of these rules going, it's okay, I can do that. Yeah, you can do that. There's nothing in the law that says you can't do that. That's fine. You know, make sure you tick off investment strategy sole purpose, but there's going to be this ongoing requirement for you to address market value. It's substantiate that with, for the auditor. So you're gonna go through this process each year. Are you happy to do that?

Shelley Banton (34:19):

Yeah. And it makes it very hard when the accountant who's preparing the financials for the superfund isn't preparing the financials for the unlisted entity. Firstly, because obviously we need signed financials as part of the audit to make sure that the entity is a going concern. But it also means there's a lack of information because we've got third parties trying to get, you know, director's valuations or whatever it might be. And obviously with director's valuations, we all an independent director valuation. We also need to make sure that the methodology of how they've come up with that valuations is included within that valuation as well. And part of the biggest issue of this is that while the requirement to value market to value assets, that market value is assist requirement, it's not of any other entity that has to value at market value. They can continue to value a cost. And I guess this is where the problem comes in. Yeah,

Mark Ellem (35:16):

Yeah. It is. Because you said you, if you're a minority shareholder, you just can't, you know, bring up the company or, or the trustees of the, of the, of the unit trust that you're a minority interest holder in and say, look, I'm a super fund. I've got to value my assets at market value. You know, the only entity that has to do that. Yep. And importantly, I've gotta provide evidence to my auditor that backs up that market value calculation. I want you to do this, this, and this, you know? Yeah.

Shelley Banton (35:44):

Care factor zero.

Mark Ellem (35:45):

Yeah. Yeah. They're gonna go, , thank you. Goodbye. Click.

Shelley Banton (35:48):

That's right

Mark Ellem (35:49):

. So it, it, it again comes back to this educating the client. Do you wanna go into this asset fine under the super law, but then how are you going to meet this ongoing compliance requirement of valuing assets at market value on the compliance obligation and the ongoing audit requirement to substantiate the market value? Where are you gonna get the data from? I mean, in, in, in this scenario I was talking about, it was a publicly listed company that was audited every year. So we had audited financials we had a lot of data that we could get hold of dividends and ebit, recent share sales. I think there might have been a director's valuation of shares as well. So there's a lot of data there. So that was good. But if it's a unrelated company, but a private company and the accounts aren't audited, that just makes it even more difficult to come up with that data, that information that's gonna underpin that valuation.

Shelley Banton (36:48):

Yeah, agreed. From the ATO's point of view, they also weigh in on investments without a ready market. And some of these shares can be very illiquid, as we know, and some of them lose, lose their value entirely. So what the ATO says, and they do differentiate between assets that have gone belly up versus assets that have no ready market, but what they say is that where the asset has no value or potential for capital growth, and they then question is that a prudent investment to support members' retirement goals? And I guess that brings into question section 62 assist the sole purpose test regarding those compliance aspects of having these types of assets in a fund. So what are your thoughts on this and do you have a different perspective to the ATO

Mark Ellem (37:34):

no, I'm, I'm in lockstep with, in lockstep with the ATO on this one. I mean, again, think of it, I'm, I'm, if I was in arms length, if I was the trustee Shelley and you were the member, I'm, I'm looking after your money, you know, yeah. Shelley, I'm gonna go buy this asset. What, what do you think, mark? Is it, what, what do you think is, are you paying market value? What's his potential for growth? Got no idea. I can't determine what market value is. It's a good vibe. I it's gonna be a good investment, right? I've got a good feeling about it.

Shelley Banton (38:05):

It's the next big

Mark Ellem (38:05):

Thing. It's the next big, big, big thing , you know, so that's right. You know, firstly, you know, from sole purpose test point of view, you know, I'm the provision of retirement benefits for members. I'm maximising, I'm acting prudently. How is that in line with sole purpose? How am I gonna show it's in line with my fund's investment strategy or I've got my objective where, you know, for example, I want to beat inflation by 3% on a rolling five year basis. You know, how am I going to show that from when I purchase the asset? And importantly because my accountants come to me first and go, Mark how are you going to determine market value each and every year and satisfy regulation 8 0 2, capital B of the cires, and then provide the relevant evidence to the auditor that that's the market? Good question. Value. Good. You know, how are you going to do that? But even before we get there, you know, I I I am questioning sole purpose, why are you buying an asset that you can't determine market value at the time you're buying it. Okay, you are agreeing on a price, but why are you agreeing on the price? Why do you think that is the value of that investment that you're acquiring or the investment that you are making? And then how are you going to assess that going forward?

Shelley Banton (39:21):

Good points. Okay. So the last question I wanna ask you Mark is about, there's a misunderstanding in the industry about when a shared transfer becomes effective. So because there's a difference between beneficial ownership and legal ownership, which is recognised by the commissioner, what problems can happen if an off market share transfer form is signed and dated the wrong date and then obviously has the incorrect valuation of those shares in that off market transfer form?

Mark Ellem (39:49):

Well, I think the answer is all of the above. What, what, what we've been talking about. I mean, as you alluded to, yeah. Everyone can refer to the tax officer's contribution ruling TR twenty ten one. As you said, it recognises that ownership of an asset can be either when legal ownership or beneficial ownership transfers and beneficial ownership can be before legal ownership. If we're talking about shares, there's a registration of the transfer of shares that happen, the other share registry. and that would generally occur after the beneficial ownership is transferred. Now for beneficial ownership to transfer earlier. And where it is argued, well it's the earlier date of beneficial ownership, then you need to again substantiate why it's prior to the legal ownership being transferred, which is when the registry's been updated to say, yes, these shares are now moved from party A to party B, party B normally being the SMSF, the purchaser, the SMSF needs to be in possession of all the relevant forms that it would need to register that transfer.

(40:54):

Right? So the off market transfer forms be in possession of that. Now if it's being purported that the off market transfer happened on generally, well I don't know Shelley, say the 25th of June, that's when it's argued that the acquisition occurred. And this might be a contribution in spec of those listed shares. As I was saying, we, we've done it on the 20th of June. Are we in possession of all the reasonable forms the off market transfer forms? Generally that would be fairly straightforward, but also what prices we use. Well, if we're saying it's happening on the 20th of June, then it's the market price of those shares on the 20th of June. Now if they're listed shares, which they would have to be from a share perspective, an exception to the section 66 prohibition, then we are just gonna be easily be able to tell whether that price is market value. You can look it up, that's it, you know, and you can look at it open and close and you, you want that share price to be somewhere between that open and closed to substantiate it was acquired at market value. Now I, I don't know of late, but I, you know, it's not two in the recent past where there was still base argument I can use a share price at any time in the probably 30 days.

Shelley Banton (42:08):

Oh that old chestnut

Mark Ellem (42:09):

That, yeah, that old chestnut. Yeah. Yeah. I mean that, that was a stamp duty issue as I understood it to be. And of course there's no stamp duty on the transfer of listed share hasn't been for a long time. So, but it's gotta be that value at that time. So you've got a couple issues here. What's the date on the transfer form? You know, what date are we saying that the transfer has taken place, the date that the SMSF has acquired ownership of those shares? Was the trustees in possession of all the registerable forms at that time? And is the value used, the value of that date? Have we got the tick, tick and tick? If we've missed on one of those, then we are going to maybe either have a section 66 issue, we haven't acquired market value, we've got an nine alarms length and now have a non arms length expenditure issue. Or we might have it that everything's fine, but it's actually not happened on the 20th of June. It's now not happened until the legal ownership has transferred when the shares have been registered, which wasn't until the 2nd of July. So now we are moving that transaction into the next financial year, which then may have contribution cap consequences cuz we wanted it in the previous year. Yeah,

Shelley Banton (43:17):

And you make a good point about the delay between filling in the forms and sending them off to the share registry because we wanna make sure that there's no mischief between that part. So we would not expect to see any more than, you know, a few weeks difference between when that form had been signed and dated with the correct market value of the shares on there and when it hit the share registry any longer than that. And you might think that there'd be some manipulating of the data within the form. So we don't wanna see that and we need to be able to justify why that is the case. So you know, once again, facts and circumstances and obviously it depends, but we wanna make sure that there's no mischief there at the end of the day and make sure that there's no compliance breaches as well.

Mark Ellem (44:03):

Yes, absolutely.

Shelley Banton (44:04):

Well, we've come to the end of our time today. Mark thank you so very much for being part of the SMSF experts. Always great to have a chat to you and I look forward to our next time together. Thank you.

Mark Ellem (44:16):

Thank you, Shelley. Pleasure.

Shelley Banton (44:19):

Well, that's all for this episode of the SMSF experts. We hope you enjoyed our discussion on looking for market value. It's been a pleasure talking to MarkEllem today, and I'd like to take the opportunity to thank him for his on a complex issue, which is about to get more complex. Thank you, mark. And just remember that what we've discussed today is for SMSF compliance and information purposes only and shouldn't be used as financial advice in any way. If you like this episode, be sure to subscribe to our podcast and head to the as f audits website where you can sign up to my monthly newsletter access fact sheets, check out our latest events and follow us on social media to stay up to date on all things SMSF.