Expert SMSF insights

15 May, 2019

Unlisted SMSF assets could mean a qualified audit

By Marjon Muizer

Marjon Murizer

No SMSF wants a qualified audit at tax time. Yet the chance is higher if you hold unlisted assets, particularly unlisted trusts and companies, plus any loans you’ve made.

These assets will invite more scrutiny, and don’t be surprised if your auditor seeks more information about them. 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 ATO is expecting an increase in breaches being reported. So you need to be prepared.

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. Sometimes however, information gathering can be difficult. For example, you may be invested in a trust/company whose underlying investments are not valued in accordance with superannuation law. This scenario would likely trigger an audit qualification and 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. As part of the audit, accounts must be prepared for the fund using the market value of assets. Valuation guidelines are published by the ATO.

For each investment, the fund’s auditor will risk-assess the evidence available and whether it is appropriate and reliable. This may include obtaining independent verification.

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

Who does the valuation?

It is your responsibility, as fund trustee, 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 that the recorded value is reasonable.

A guide for valuing unlisted assets

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

Unlisted trusts and companies

In assessing the valuation of these assets, the types of supporting evidence your fund’s auditor would look for include:

  • 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
  • Written verification from a director or trustee of the trust or company who is not a related party of the SMSF

On the flipside, an auditor would usually seek further information from you 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
  • Written verification has been provided from the trustee or director of the trust or company who is a related party of the fund
Example 1

Preet and Olivia have an SMSF with a balance of $300,000. They have invested $240,000 in the “Hope street investment trust”, which was established two years ago and has 18 different unit holders. The trust acquired a vacant block of land and after obtaining council approval, organised construction of an apartment building which is expected to be complete in 6-8 months.

The trust has provided financial statements which show the land valued at the original purchase price two years ago.

The SMSF auditor will need to assess if the SMSF financials show the units at market value. There is no record of recent sales of the units available and there is no evidence as to what the building could be sold for if it was placed on the market. In addition, the auditor is not able to determine if the unit trust has enough cash to complete construction of the building.

Based on the circumstances, the auditor is not able to confirm the market value of the units with adequate certainty. The auditor would be required to issue a qualified opinion in relation to the market value of the units. 

Two years later the building is completed and an independent valuation is obtained confirming the apartment block is worth $16m. The financials of the unit trust show that the only other asset besides the building is $2m in cash. 

The trustees revalue the units from the original purchase price. They calculate the market value by dividing the total assets of the unit trust by the total number of units issued by the trust. They supply the auditor with a copy of the financials of unit trust and valuation. This would normally be sufficient for the auditor to verify the market value of the units.

Example 2

Frank works at a renewable energy start-up and uses his SMSF to buy $50,000 worth of shares as part of an employee share plan. He makes the purchase in April.

The company issued a prospectus as part of the share plan which was available to all employees. As the shares were purchased by the SMSF at market value in April, the auditor is likely to consider this as adequate evidence to support the 30 June market value for that financial year. 

One year later, the value of the shares within Frank’s SMSF remain at $50,000. Although Frank obtained a copy of the company’s financial statements, it is a small business and does not require its financials to be independently audited. No recent share sales or purchases have occurred.

Even though the auditor did not qualify the prior year audit, the auditor will likely qualify the audit for the subsequent year as there is insufficient information to confirm the market value of the shares. 

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)
  • Details and value of security held as collateral for the loan (if applicable)

On the other hand, unsatisfactory evidence, likely to invite greater audit scrutiny, 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.

Example

Liz’s SMSF has made a $300k loan to Anthony, a friend and property developer. Two-year loan term. Interest rate of 8% p.a. Monthly payments which Anthony always meets. The loan agreement lists Anthony’s home, worth $1.5m, as security. The SMSF financials show the loan at $300k on the balance sheet. The auditor obtains a title search for Anthony’s property which confirms there is a registered charge against the property by Liz’s SMSF. 

In this scenario the fund auditor would normally accept the loan is valued correctly. If Anthony was to default on the loan, Liz would be able to take possession of his home and recoup her loan investment. If on the other hand, Liz’s SMSF hadn’t registered a charge over the property, the auditor would probably qualify the audit unless Anthony could demonstrate his assets less any liabilities exceed the loan value.

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 that 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 unlisted assets

It’s always sensible to ensure that any investment undertaken by your SMSF is 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.

 


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