Valuations are required for a number of tax reasons. For example, to set a cost base for an asset for capital gains tax purposes, or to establish asset values for SMEs to qualify for the CGT small business concessions, or for GST land valuation purposes.
But not just any valuation will do.
The Australian Tax Office has warned taxpayers who undertake their own valuations – or use valuations from people without adequate qualifications – risk incorrectly reporting their tax and may be liable to administrative penalties.
The majority of taxpayers who use a qualified valuer or equivalent professional for taxation purposes will generally not be liable to a penalty if they have provided the valuer with accurate information where the valuation ultimately proves to be deficient.
For example, a real property valuation prepared by a qualified valuer or an estimate of historical building cost made by a quantity surveyor are matters that are likely to be outside the range of professional expertise of a tax agent or taxpayer. The ATO considers that relying in good faith on advice of this nature is consistent with the taking of reasonable care even if the advice later proves to be deficient.
When using a valuer or qualified professional, the ATO warns there may be the potential for administrative penalties for making a false or misleading statement or for treating the income tax law in a manner that is not reasonably arguable if:
- the taxpayer has not given correct information to the valuer to allow them to correctly assess the value of the item for the period required;
- the taxpayer or their agent should reasonably have known the information provided by the valuer was incorrect;
- the methodology or valuation hypothesis used by a qualified valuer may be based on an unsettled interpretation of a tax law provision or unclear facts.
The ATO gives three examples – concerning the margin scheme, the CGT maximum net asset value test, and the market value substitution rule – that provide guidance about the application of penalties in cases where the false and misleading statement arises from a valuation issue.
1. GST margin scheme
Bob the builder engaged a professional valuer to determine the value of land held before July 1, 2000. The valuation was used to calculate the GST payable on the sale of the developed land.
The valuation was invalid because it did not comply with the requirements of the Goods and Services Tax Act. The ATO has set out approved valuation methods in a GST Determination.
After commissioning a new valuation, the Tax Commissioner assessed Bob on additional GST.
Although the valuation was invalid, Bob had taken reasonable care. He engaged a professional valuer and was unaware of the flaws in the valuation.
If correcting a valuation or using a different valuation results in more GST being payable, administrative penalties and/or the general interest charge may apply. However, where a genuine mistake is made, no administrative penalties will apply.
2. CGT maximum net asset value test
Frost Pty Ltd disposed of a property it owned and claimed small business relief from capital gains tax on the basis that it satisfied the maximum net asset value (MNAV) test. Frost Pty Ltd had valued its assets itself before lodging its return.
The ATO contacted the company about the valuation of three properties held by Frost Pty Ltd immediately before the CGT event. The ATO engaged a professional valuer and determined that the value of the three properties was understated by 25% and that Frost Pty Ltd did not satisfy the MNAV test.
Frost Pty Ltd valued its properties based on comparison with other properties that had few characteristics in common with the properties owned and was unable to explain satisfactorily how some of the valuation assumptions were made.
A reasonable person would have recognised the real risk that the MNAV test was not satisfied and that the tax return lodged was incorrect. A penalty for recklessness was applicable.
3. Market value substitution – non-arm’s length
Helen Green obtains a valuation from Tom Green & Associates (Real Estate Agents) for her property. Tom Green is Helen’s husband. Tom Green & Associates value Helen’s property at $1.8 million.
Helen sells the property for $1.8 million to a related party, Property Trading Pty Ltd. Tom Green is the director and major shareholder.
On transfer, the State Revenue Office determines the market value of the property to be $2.3 million and assesses stamp duty payable accordingly. Property Trading Pty Ltd does not seek a review of the assessment for the additional stamp duty.
Helen’s tax agent, when told about the additional stamp duty, pointed out to her that income tax is levied based on the market value of assets transferred to related parties, not necessarily the contract price. Helen instructs her tax agent to complete her income tax return based on the $1.8m valuation, as she has the valuation.
Helen knows that the property is undervalued and the gain on disposal is understated by $500,000. In this case, a penalty for making a false or misleading statement and intentionally disregarding applies.
Valuations are important for tax purposes. Taxpayers, including SMEs, need to be sure they use a qualified valuer or equivalent professional for taxation purposes.
Terry Hayes is the editor-in-chief of tax news reporting at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions.