31 October 2022
In Brief
The Australian Taxation Office (ATO) has released an updated guide on market valuations for tax purposes. Market valuations are relevant for a wide range of tax matters, including capital gains tax (CGT), employee share schemes, goods and services tax (GST), and tax consolidations, to name just a few. The ATO’s updated guide is intended to help taxpayers reduce the tax risks associated with valuations, as failing to engage an appropriately qualified valuer can lead to incorrect reporting of tax outcomes, and the potential for administrative penalties and interest.
In this Tax Alert, we summarise the ATO’s latest guidance on market valuations for tax purposes.
In Detail
In the updated guide, the ATO has outlined its views on the meaning of market value, who can determine market value, and the processes and evidence the ATO expects to see to support a valuation.
As highlighted on the ATO’s website, taxpayers may need a market valuation for tax purposes in a range of circumstances, including:
- individuals, where property or shares are transferred between related parties
- employees, where shares or options are received under an employee share scheme
- small businesses, in order to apply certain asset threshold tests for CGT concessions
- property developers who apply the GST margin scheme, and
- corporate groups which consolidate for income tax purposes.
What is market value?
The concept of “market value'' is not defined for all purposes in the tax law, although there are some provisions which provide for a specific meaning of market value. Where market value is not defined or otherwise qualified in a particular provision, it takes its ordinary meaning. The ATO guidance highlights the principles established in case law, and those set out by the International Valuation Standard Council (IVSC), are relevant in determining the ordinary meaning of market value.
The key judicial determination for determining the ordinary meaning of market value is the High Court decision in Spencer v Commonwealth of Australia [1907] HCA 82. In this case, the High Court held that in valuing an asset, a valuer is to assume a market with hypothetical buyers and sellers such that the "market value" is the price negotiated between the buyer and seller to achieve a notional sale in the hypothetical market. The notional sale is assumed to be made after voluntary bargaining between a willing but not anxious seller and purchaser, rather than a forced sale, and with both parties being fully informed about the advantages and disadvantages of the asset being valued and aware of the current market conditions.
The IVSC defines market value as “[t]he estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm's length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion”. The ATO considers the definition provided by the IVSC is consistent with the judicial definition.
The market value of an asset will generally reflect its “highest and best use”. This is the use that maximises its potential and that is possible, legally permissible and financially feasible. Market value does not reflect attributes of an asset that are of value to a specific owner or purchaser that are not available to other buyers in the market.
Who can determine market value?
For tax purposes, the acceptability of a valuation usually depends on the process undertaken to obtain the valuation, rather than who conducted it, although there are some exceptions where the law requires a professional valuer to provide valuation (for example, for the GST margin scheme).
A reasonable estimate of market value requires skill, knowledge and experience, and as such, a valuation carried out by a suitably qualified professional following commonly accepted industry standards and codes of conduct is generally considered more reliable by the ATO.
Valuation fundamentals
The ATO has outlined the following eight fundamental principles for valuations for tax purposes:
- A valuation should be specific to the tax and superannuation provision to which it is being applied and consider any requirements of the relevant provisions, considered case law and relevant ATO guidance.
- Market value is conceptually distinct from historical cost (the original price that is paid for goods or a service, or the amount paid to produce the goods or services by the relevant entity).
- The nature and source of the valuation inputs must be consistent with the bases of value (relevant facts and assumptions) and the valuation purpose (tax or superannuation provision).
- The valuer should adopt the most relevant and appropriate valuation methodology based on industry standards and practice. This may be influenced by:
- the data available
- the circumstances relating to the market, and
- industry practice and standards for the asset being valued.
- the data available
- International valuation standards recommend that valuers consider using more than one approach. For tax purposes, the ATO recommends that (where possible) a secondary or cross-check methodology should be applied to provide additional support for an estimated value from the primary methodology.
- The process of valuation requires the valuer to make impartial judgments as to the reliability of inputs and assumptions. For a valuation to be credible, it is important that those judgments are made in a way that promotes transparency (for example, state the inputs and any assumptions made) and minimise the influence of any subjective factors on the process.
- The valuer should assemble and record evidence by means such as inspection (as required), enquiry, computation and analysis to ensure that the valuation is properly supported.
- An estimate provided for a future date (prospective value) is frequently sought in connection with projects that are proposed, under construction or under conversion to a new use. Market value for tax purposes requires valuation for a date specified by the legislation and a prospective assessment will not be considered reasonable or acceptable.
The ATO guide notes that there are three internationally-defined valuation approaches:
- The market approach - this approach relies on applying market transactions for comparable assets at the valuation date. An estimate of market value is determined with reference to market prices in actual transactions and the advertised price of assets currently for sale. This process compares the asset to be valued with similar assets available on the market.
- The income approach - this method estimates the risks and returns of the asset at the date of the valuation by estimating the expected income and cashflows that the asset is expected to generate in the future.
- The cost approach - this approach involves estimating the market cost of replicating the asset in a similar condition at the valuation date. This method is often used when plant and equipment is a part of a larger transaction to allocate a proportion of the enterprise value to the plant and equipment.
The valuation approach utilised in any given scenario must be reasonable based on the asset and information available, supported by evidence, is suitable for tax purposes, replicable and well documented. Greater credibility is placed on valuations undertaken by valuers following professional standards.
Obtaining valuation reports
When obtaining a valuation report, it is a taxpayer’s responsibility to ensure the valuer is suitably knowledgeable and experienced, receives appropriate instructions, remains reasonable and objective, is not presented with obstacles or limitations that may inhibit their work, and provides a reasonable market value that is supported by credible evidence using an appropriately recognised valuation method (as listed above). The onus for providing a replicable and defensible valuation remains with the taxpayer even if a professional is engaged to provide a valuation.
The ATO’s guide outlines the minimum information it expects to be contained in a valuation report, including, amongst other things:
- the scope and purpose of the valuation
- details of the asset being valued, and any information, facts, inputs and assumptions relied upon
- the standards governing the engagement
- the valuation assessment date, and the date the valuer inspected the asset (if applicable)
- valuation approaches and methodologies used, including reasons for selection, and
- the valuer’s identity, status and qualifications, and a declaration of the valuer’s independence.
Common issues with valuations
The ATO has noted the following issues that commonly arise when it conducts reviews of market value estimates:
- inappropriate choice of methodology given the circumstances and information available
- incorrect application of methodology according to industry and professional standards
- the valuation approach, including the bases of a valuation, does not align with the relevant tax and superannuation provision, case law or ATO guidance
- unreasonable or incorrect assumptions and inputs and the use of proxies based on historical performance
- omission of relevant information available on the valuation date
- inconsistencies with evidence (for example, legal documentation)
- reliance on post-valuation date information and future events that cannot be reasonably foreseeable at the valuation date
- inappropriate apportionment of value across assets (bases, evidence, calculation)
- inappropriate choice of comparable assets on which to base valuation (chosen entity, assets)
- lack of support for size, risk and other adjustments to the chosen discount rate or capitalisation multiple
- lack of appropriate analysis and scrutiny of base information
- inappropriate use of averaging
- insufficient market evidence for inputs and assumptions
- failure to verify inputs (subjective and unqualified)
- insufficient or incorrect documentation, and
- omission of assumptions from the valuation report.
Other issues raised in the guidance
Taxpayers are able to request the ATO to provide a private ruling on an asset's market value where it is relevant to a question about the tax law. Where a private ruling is requested relating to market valuation, the ATO may engage a professional valuer to conduct a valuation of the asset or to review a valuation provided by the taxpayer, in which case, the fee for the valuer is passed onto the taxpayer. For further information, refer to Private rulings and valuations.
The ATO’s updated guide also outlines the process for ATO reviews of valuations, noting that the likelihood of a review is greater where the asset’s value is high or the methodology used is contentious. It sets out the supporting documents a taxpayer may be asked to provide during a valuation review.
In addition, the guide contains signposts to other ATO guidance on market valuations that is currently available, including, for example, the tax consolidation valuation shortcuts, which are available to determine the market value of certain assets for consolidation purposes.
The Takeaway
There are a range of circumstances where the market value of an asset is required for tax purposes. The ATO recommends that valuations be conducted by suitably qualified valuers using one of the ATO’s accepted valuation methods to ensure that the tax position adopted for the relevant tax years provide sufficient penalty protection and are reasonably arguable. This is particularly important for high value assets, or where an asset’s valuation is likely to be contentious.
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