Valuations –
when do you need one for your business?
Sally Preston
Maybe you have been told by your accountant, lawyer, or even banker, that you need to obtain a valuation for a particular transaction or event?
This may be where you are planning your business for succession, planning a restructure, or thinking about selling, market valuations are an important consideration.
For tax purposes, the ATO expects that you have obtained a valuation in certain circumstances. In fact, some parts of the tax law mandate that an external valuation is obtained.
The guidance the ATO has put out on this makes it clear that it is the taxpayer’s responsibility to give an accurate answer as to the market valuation -with steep penalties and unwanted tax bills for those who get it wrong. The guidance also tells us how we can get it right by setting out the evidence and processes the ATO generally expects to see as support for a valuation.
In this article, we'll explore the critical aspects of valuations, answering four key questions:
What transactions may need a valuation?
When do you engage an external valuer, and is a management valuation sufficient?
How to select the right valuer?
What happens if you don't meet ATO valuation expectations?
Question 1: What transactions may need a valuation?
The answer is - lots! It is more than just for tax purposes though. You made need a valuation:
When you want to sell your shares or part of your business – the valuation can be used as a guidance to set a selling price. If you are negotiating with a third party they may also have their own valuation. These will often differ based on the risks etc. that they use when conducting the valuation.
When you want to approach the bank for finance – it may be useful to understand what the existing business is worth so that you can make strategic decisions about the amount of borrowing.
When you are planning for your demise/death and you want to split the assets you own in your will. Maybe you want to make sure children or grandchildren are provided for per what you intend.
When you are looking for improvement in the business and want to measure the business growth or increase in value year on year.
For tax purposes, there are often more times when the market value is required to be known:
Capital gains tax:
o Transactions that are not undertaken at arm's length may require the market value to be substituted for the actual transfer price.
o Small business CGT - $6m net asset test.
o Certain transactions on the death.
o Restructures under the tax law when these involve rollovers.
Tax consolidation – there are calculations required that depend on knowing the market value of individual assets. This valuation can impact future deductions and the tax cost base of these assets should they ever be sold.
Depreciating assets and trading stock - where the parties are not dealing with each other at arm’s length a market value deeming may occur. This calculation can affect the amount of tax you pay on a transaction.
Employee share schemes – It is important to understand the value that shares or options are issued at, compared with the market value.
Certain international transactions.
GST margin scheme - Under this scheme the GST payable is calculated on the “margin” for the supply, rather than on the amount paid (consideration). The margin is calculated as the excess of the consideration over the acquisition consideration. However, where property is sold that was held at the commencement of the GST, 1 July 2000, the margin is worked out by reference to the market value of the property at that date (subject to two qualifications).
Question 2: When do you engage an external valuer?
The ATO has stated that, for tax purposes, the acceptability of a valuation usually depends on the valuation process undertaken, rather than who conducted it. So. this means a business owner or your accountant, could conduct the valuation, barring a few exceptions where a person with a specific qualification will need to be engaged. These exceptions include:
Real property valuations.
Plant and machinery valuations.
Market valuations for GST margin scheme purposes.
Market valuations for the Cultural Gifts Program.
Otherwise, the valuation could be undertaken by internal management. The ATO has summarised its expectations in its publication "8 key fundamentals of a valuation". Keep in mind as we go through them, that whoever does the valuation should meet these criteria. This may, therefore, help you decide as to whether you have the capability to perform the valuation or whether you should seek external assistance.
A valuation should be specific to the tax and superannuation provision that it is being applied to and consider any requirements of the relevant provisions, having 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.
5. International valuation standards recommend that valuers consider using more than one approach. For tax purposes, we recommend that (where possible) a secondary or cross-check methodology should be applied to provide additional support for an estimated value from the primary methodology.
6. 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 promote transparency (for example, state the inputs and any assumptions made) and minimise the influence of any subjective factors on the process.
7. 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.
8. 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 has published a list of issues it commonly sees when conducting reviews of market value estimates. These issues include:
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.
Question
3: How to select the right valuer?
Some would say this is easy – based on the cost! Yes, there can be very large differences in the cost of a valuation but the main thing is you select a fit for purpose option.
As a tax professional who needs to engage a professional valuer for a client, there are several factors that you can consider when determining if a valuer is good or not.
These include:
Communication and Service: A good valuer should be responsive to your questions and concerns and provide clear and concise information in a timely manner. They should also be able to explain the valuation in simple terms that you and your clients can understand.
Cost: While cost should not be the only factor in determining the quality of a valuer, it is important to consider if their fees are reasonable and competitive with other valuers in the industry.
Reputation: You can also consider the valuer’s reputation in the industry. This can be assessed through online reviews, testimonials, and referrals from other professionals in the industry.
Qualifications and Experience: A good valuer should have the appropriate qualifications and experience in valuing companies and assets similar to the one you need to value. You can ask for the valuer’s qualifications and experience in the field and if they have any relevant accreditations or memberships with professional associations.
Methodology: A good valuer should be able to explain the methodology they will use to value the company or asset, and it should be consistent with industry standards. They should be able to provide detailed information on the process and assumptions made in their valuation.
What can you expect them to give you as the deliverable? Not a one pager! You should receive a report that outlines:
Purpose and scope.
Details on the asset being valued.
Assumptions relied upon.
The definition of “value”.
The relevant standards of valuation being applied.
The work performed – valuation method etc.
The conclusions reached
Risks, disclaimers and indemnities.
Terms of the engagement including the valuer's independence.
Date of the valuation and the date the report was issued.
Question 4: What happens if you don’t have a valuation that meets the ATO expectations?
So, we outlined above where a valuation became relevant for tax purposes. Where the amount you have used varies a tax outcome, the ATO may review the valuation.
They have advised that when they do review it, they consider:
the value of the asset.
the type of asset involved (intangible assets are more likely to increase risk).
materiality of any potential tax adjustment.
complexity of the valuation process.
documentary evidence supporting the valuation.
They generally use a valuer to confirm whether the market value is acceptable and to assess whether the valuation process complies with accepted valuation industry practice. Broadly, the review involves examining:
how adequately the process was documented.
the market value definition used.
the appropriateness of the chosen method.
the underlying assumptions and information.
So, what happens if they disagree with the valuation? Where this results in underpaid tax, there may be interest, penalties as well as the actual amount of tax paid.
In many cases, it is safer to seek assistance from your accountant or an experienced valuer to assist you with the process.