HOW TO VALUE YOUR SMSFS UNLISTED ASSETS (AND AVOID A QUALIFIED AUDIT)

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If your SMSF has invested in unlisted trusts and companies then your fund’s auditor could be after more information to avoid giving the fund a qualified audit. Recent court decisions have held auditors liable for not investigating the recoverability of investments and determining the appropriate market value. Unlisted investments are now considered high-risk from an audit point of view and the Australian Taxation Office (ATO) is expecting an increase in breaches being reported.

As a trustee of your SMSF, don’t think you’re off the hook either as you have a legal obligation to provide information requested by the auditor, otherwise you could face penalties. In some instances, information gathering can be difficult as the underlying investments of the trust or company may not be valued on the same basis as required by the Superannuation Industry (Supervision) (SIS) Act and regulations. This may result in an audit qualification as well as an Audit Contravention Report (ACR) being sent to the ATO.

What’s the issue?

Each year your SMSF is required to be audited by a registered SMSF auditor for purposes of the SIS Act. As part of the audit, accounts must be prepared for the fund using the market value of assets. The ATO has published guidelines on how assets are to be valued for purposes of the super and tax laws.

For each fund investment the fund’s auditor will risk assess the evidence available and whether it is appropriate and reliable. This may include obtaining independent third-party verification directly from the company, trust or individual in which the fund has made the investment or loan.

The level of evidence required to substantiate the investment may depend on the proportion of the fund that has been allocated to make the investment or loan. For example, the auditor may require a greater level of confidence to confirm whether a loan or investment of $500,000 is recoverable compared to a similar loan with an outstanding balance of $20,000.

Who does the valuation?

As a trustee of your SMSF it is your responsibility to make sure the assets of the fund are valued correctly. The role of the auditor is not to do the valuation but to review the evidence available that the value recorded in fund accounts is reasonable.

A guide to help value unlisted assets:

If your SMSF has investments in unlisted companies or trusts here is a guide to help you meet audit requirements where market value of assets is not readily available, which is often the case.

1. Unlisted trusts and companies

From an audit perspective the value of assets recorded in the fund accounts of unlisted trusts and companies can be unreliable. There may be no requirement to have the assets valued at market value or that the financial statements are independently audited.

When risk assessing the evidence concerning the fund’s investment or loan, your fund’s auditor would look for:

Audited financial statements of the unlisted trust or company;
Financial statements including evidence that underlying assets are valued at market value;
Independent valuations of the underlying assets of the trust or company;
A share/unit price based on recent sales or purchases between unrelated parties; and
Written verification from a director or trustee of the trust or company who is not a related party of the SMSF.
On the other end of the spectrum an auditor would usually seek further information from you to substantiate the investment where:

The trust or company provided unaudited financial statements with no evidence of the underlying assets being at market value;
The fund trustees have provided their assessment of the underlying asset of the unlisted investment; or
Written verification has been provided from the trustee or director of the trust or company who is a related party of the fund.

2. Loans to an unrelated trust or company

If your SMSF makes a loan to an unrelated trust or company or even to an unrelated individual there are things to be aware of. The loan agreement needs to specify the terms and conditions of the loan including how the interest rate is determined, whether the loan is secured or unsecured and the term of the loan. The fund’s auditor will be interested in the purpose of the loan and the business of the borrower.

Recoverability of the loan will have an influence of its market value. Evidence could include:

Whether repayments have been made as required by the loan agreement;
Details on the financial position of the borrower confirming the ability to repay the loan (e.g. net asset position, sources of cash); and/or
Details and value of security held as collateral for the loan (if applicable).
At the other end, unsatisfactory evidence where the auditor would usually seek additional information would include statements made by the fund trustees or the borrower that provides an assessment of the recoverability of the loan. The evidence needs to go further than that. A copy of the loan agreement and evidence that interest has been paid on the loan merely establishes that the loan exists. But it doesn’t provide enough evidence of the loan’s value, whether it is recoverable and the borrower’s financial position concerning future repayments.

What does a qualified audit report mean?

Just because your SMSF has received a qualified audit report is not necessarily a reason to panic. An auditor may qualify the financial and compliance sections of the audit report where they have not been able to obtain enough and appropriate evidence concerning the investment. The auditor will notify you as trustee of your SMSF and may also be required to notify the ATO if a reportable breach has occurred.

A qualified audit report does not necessarily mean your SMSF is non-complying and that you’re up for penalties. The auditor is required to lodge an ACR where a breach has occurred, may have occurred or where they cannot confirm with enough certainty if your fund has met an audit standard.

Both the auditor and ATO will consider the circumstances case-by-case. The ATO may ask you to supply further information where the investment is material and there is an indication that the value used may not be an appropriate reflection of the market value.

Future-proofing your SMSFs unlisted investments and loans

It’s always sensible to ensure that any investments undertaken by your SMSF are correctly documented, especially if the trust or company is unlisted or there is a loan to an unrelated party. As you can see, the auditor will be after adequate evidence to establish the existence of the investment and whether it is recoverable. If this information is not available your SMSF may end up with a qualified opinion and an ACR sent to the ATO.

What to expect

Valuations of unlisted SMSF assets are now considered a higher risk area for auditors. Therefore, your auditor will be more cautious than in the past when reviewing documentation and valuations.

SOURCE, All rights reserved to – AMP Capital, Graeme Colley,19 Mar, 2019,How to value your SMSFs unlisted assets (and avoid a qualified audit),  https://www.ampcapital.com/au/en/insights-hub/articles/2019/march/how-to-value-your-smsfs-unlisted-assets-and-avoid-a-qualified-audit

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