Market valuations for tax purposes

Background

Market valuations are necessary to comply with several tax provisions including:

• The market value substitution rule, which may apply where parties have not dealt with one another at arm’s length when transferring assets between related parties;
• employees receiving shares or options under an employee share scheme;
• property developers applying the GST margin scheme; and
• businesses that consolidate for income tax purposes and need to obtain valuations to reset cost bases and to determine the rate of use of tax losses.

Your tax records need to contain details to support any valuation that were relied on. 

The ATO generally agrees that if you engage and properly instruct a professional valuer, you will not be liable for penalties if they disagree with the valuation.

What to note when engaging a valuer

When you engage a valuer, you must provide them with clear instructions and accurate information. Instructions to valuers should be documented in a written request or letter of engagement and should:

• set out the scope and purpose of the valuation
• acknowledge the valuer's independence to draw conclusions and write their report
• recognise that the valuer can refuse to provide an opinion or report if you do not provide the information and explanations they need
• provide the necessary access to records and help to complete the report

What is market value

The concept of “market value'' is not defined in tax law for most areas. 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 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”. 

What methods can be used

The three internationally defined valuation approaches are:

• The market approach - relies on applying market transactions for comparable valuation assets at the valuation date. This approach estimates market value by reference to market prices in actual transactions and asking prices of assets currently available for sale. The valuation process is essentially that of comparison and correlation between the asset to be valued and other similar assets.
  
  
• The income approach - refers to estimating the risk and return parameters of the valuation asset at the valuation date. This approach estimates the market value of an asset based on the income or cashflows that the asset can be expected to generate in the future.
  
  
• The cost approach - refers to estimating the market cost of replicating the valuation asset in a similar condition as at the valuation date as a suitable indicator of market value. It is often used when the plant and equipment is a component part of a larger transaction to allocate value to the plant and equipment as a proportion of the enterprise value.

The primary valuation methodology selected should be the most suitable approach for the valuation asset, with reference to the reliability and relevance of information available at the valuation date. The valuation report should include an explanation of why the chosen methodology is the most suitable. For tax purposes, it is highly recommended that a secondary or cross-check methodology is provided where possible to support the primary methodology estimate.

What about a premium based on value to specific parties?

This is controversial and the ATO views differ from some judicial guidance.

Generally, the ATO is of the view that market value should 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.

Advantages that relate to the physical, geographic, economic, or legal characteristics of an asset should not be factored in.

When undertaking a market valuation for tax purposes, it is only assumed that there is a willing buyer, not a ‘particular’ willing buyer.

However, there is strong judicial support for including special value. For example, in Brisbane City Council v Valuer-General (Qld)13, it was held that “all possible purchasers are to be taken into account, even a purchaser prepared for his own reasons to pay a fancy price”.

Specific consideration of this issue is required depending on the facts

What should the valuation report show

Valuation reports should contain all necessary information to ensure a clear understanding of the valuation analysis, and demonstrate how the conclusions were reached. The primary objective of a valuation report is to provide convincing and compelling support for the conclusions reached.

Is it appropriate to rely on assumptions or have exclusions?

It depends – unreasonable or incorrect assumptions and inputs and the use of proxies based on historical performance may be rejected. Omission of relevant information available on the valuation date and inconsistencies with evidence (for example, legal documentation) will not stack up.

Who can undertake a valuation

Briefing a qualified valuer properly and ensuring that the ATO’s acceptable valuation. methods are followed will provide penalty protection should the ATO disagree with the valuation.
 
Different tax laws have specific requirements regarding valuations and ATO approved valuation shortcuts can also be relied on  Care should be take to ensure that the valuation meets the applicable tax requirements.