Market valuation for tax purposes

Introduction

Many provisions of the laws administered by the Commissioner of Taxation require a market value to be determined. This guide is intended to provide assistance to taxpayers and their advisers (including valuers) on the processes to establish a market value for taxation purposes.

While the process of valuing a thing can range from being simple to complex, the principles remain constant. These accepted principles of valuation are outlined in this guide.

This guide is not intended to be a comprehensive handbook for undertaking valuations, or to provide guidance in the process of valuing all things. It provides guidance on the more commonly valued things and supplements other advice and guidance we have provided on matters dealing with valuations (refer to the Appendix).

More comprehensive material, prepared by those experienced in the valuation process, already exists in the public domain.

We expect most readers of this guide to be those who are required to value things for taxation purposes. Taxpayers and their advisers, including valuers, may variously find the guide useful when drafting instructions and understanding the actions of valuers and the expectations of the ATO.

Part A: Market value for tax purposes

This part provides information about determining the market value for tax purposes, including:

Market value

Many of the laws we administer require ascertainment of market value. Some common instances are:

for individuals - transfers of real estate or shares between related parties, such as husband and wife, or family members
for employees - non-cash benefit transactions, such as gifts, or other benefits, such as car parking
for small businesses - transfers of assets to related parties, passing the asset threshold tests for the small business capital gains tax concession
for property developers - the GST margin scheme
for businesses - consolidation events, and
for all taxpayers - many anti-avoidance provisions.

What 'market value' means

Although the law frequently refers to market value, the meaning of that term will depend on its statutory context. In each instance you need to take into account the context in which the term is used, and pay particular attention to its definition and any specific requirements in that context. Where a statutory definition is provided for a particular context, it must be used.

The current tax law does not define market value in any general provision. It is defined in the 'Definitions' part at the end of the Income Tax Assessment Act 1997 (ITAA 1997), but not in a way that fixes its meaning in all contexts (section 995-1). As a result, 'market value' usually takes the ordinary meanings given below, unless specially defined or qualified in a particular provision.

Valuers of real property adopt the definition used by the International Valuation Standards Council (IVSC):

... the estimated amount for which an asset should exchange on the date of valuation between a willing buyer and a willing seller in an arm's length transaction, after proper marketing, wherein the parties had each acted knowledgeably, prudently and without compulsion.

Business valuers in Australia typically define market value as:

the price that would be negotiated in an open and unrestricted market between a knowledgeable, willing but not anxious buyer and a knowledgeable, willing but not anxious seller acting at arm's length.

Market value is not to be taken to mean simply any value. The term 'value' is used in a number of contexts, for example, community values, scientific value, heritage value and cultural value. Such terms tend to be intangible and thus difficult to measure.

Market value can be more readily measured. It reflects a market's measure of the benefits enjoyed by someone that uses an item or receives a service, at a nominated date.

'Value' is described in the International Valuation Standards as:

… an economic concept referring to the monetary relationship between goods and services available for purchase and those who buy and sell them (General valuation concepts and principles 4.5).

Conceptually, market value is quite distinct from 'price' and 'cost'.

'Price' is defined in the International Valuation Standards as:

… the amount asked, or offered, for goods or services.

and 'cost' as:

… the price that is paid for goods or a service, or the amount paid to produce the goods or services (General valuation concepts and principles 4.2 and 4.3).

Cost refers to the result of a historic transaction, set in time and amount, whereas market value varies through time and circumstances. Further, although the cost of an item might be consistent with its market value at the time of purchase, there are a number of situations where this may not be the case. For example, the cost of constructing a building in a remote Australian community may be greater than the building's market value on the limited local market.

Depending on the financial strengths, special needs or the interests of the parties, the cost or price of goods and services may or may not be the same as their market value.

Judicial interpretation

The High Court cast light on the ordinary meaning of 'market value' in Spencer v. The Commonwealth of Australia (1907) 5 CLR 418. In this case, the Commonwealth had compulsorily acquired land for a fort at North Fremantle in Western Australia.

In discussing the concept of market value, Griffith CJ commented (page 432) that:

… the test of value of land is to be determined, not by inquiring what price a man desiring to sell could have obtained for it on a given day, i.e. whether there was, in fact, on that day a willing buyer, but by inquiring: What would a man desiring to buy the land have had to pay for it on that day to a vendor willing to sell it for a fair price but not desirous to sell?

Isaacs J subsequently expanded on the concept (page 441):

… to arrive at the value of the land at that date, we have … to suppose it sold then, not by means of a forced sale, but by voluntary bargaining between the plaintiff and a purchaser willing to trade, but neither of them so anxious to do so that he would overlook any ordinary business consideration. We must further suppose both to be perfectly acquainted with the land and cognisant of all circumstances which might affect its value, either advantageously or prejudicially, including its situation, character, quality, proximity to conveniences or inconveniences, its surrounding features, the then present demand for land, and the likelihood as then appearing to persons best capable of forming an opinion, of a rise or fall for what reasons so ever in the amount which one would otherwise be willing to fix as to the value of the property.

In this case, the High Court recognised the principles of:

the willing but not anxious vendor and purchaser
a hypothetical market
the parties being fully informed of the advantages and disadvantages associated with the asset being valued (in the specific case, land), and
both parties being aware of current market conditions.

Statutory adjustments to market value

More recent tax law qualifies the ordinary meaning established by the High Court. For instance under Subdivision 960-S of the ITAA 1997 you are to:

reduce the market value of an asset by the amount of GST credits, to the extent that such credits relate to a taxable supply, and
disregard anything restricting or preventing the conversion of non-cash benefits (that is, property or services in any form except money), into money if you are determining the market value of non-cash benefits.

The law specifically defines 'market value', in the context of:

shares and rights for employee share schemes (ESS) - Subdivision F of Division 13A of the Income Tax Assessment Act 1936, and
superannuation - subsection 10(1) of the Superannuation Industry (Supervision) Act 1993.

Where a statutory definition is provided for a particular context, it must be used.

Highest and best use

You should assess market value at the 'highest and best use' of the asset as recognised in the market. The concept of 'highest and best use' takes into account any potential for a use that is higher than the current use.

The current use of an asset may not reflect its optimal value. Optimal value is defined by the IVSC as:

…the most probable use of a property which is physically possible, appropriately justified, legally permissible, financially feasible, and which results in the highest value of the property being valued.

You should value all inter-related assets on the same use. You should not value some assets on an alternative use and others on their existing use if the assets are inter-related.

Other standards of value

Valuers are sometimes required to assess value using different standards of value in specific circumstances. Typically, these may reflect the 'value to the user' or the utility of an asset in its current use. The use of accounting concepts inclusive of 'value-in-use' and 'investment value' may be inconsistent with the measure of market value and we may not accept these as substitutes for market value.

Arm's length value for transfer pricing purposes

Market value is not always the same as the arm's length consideration that the transfer pricing rules require for income tax purposes, where a taxpayer buys or sells property under an agreement with a foreign related party.

In such cases, the transfer pricing rules call for use of the consideration that would be expected if the property had been bought or sold under an agreement between independent parties, dealing at arm's length with each other, in comparable circumstances. A market value or price is, therefore, only used for this purpose where this makes business or commercial sense in all of the taxpayer's circumstances.

Refer to Taxation Ruling TR 97/20: Income tax: arm's length transfer pricing methodologies for international dealings for further information.

Fair value

Fair value is an accounting concept specifically used for financial reporting purposes. It is not always an identical concept to market value, although it is generally defined in a similar way to market value.

International accounting and valuation standards bodies have adopted 'fair value' for financial reporting purposes as a means of relating financial statements to market-based values.

…the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm's length transaction (Australian Accounting Standards Board, 116 - Property, plant and equipment).

Fair value can be measured in reference to the:

quoted market price in an active and liquid market, if available
current or recent market prices for the same asset or similar assets
net present value (if an established cash flow can be identified), and
depreciated replacement cost (DRC) - for specialised assets that are not traded in an active and liquid market.

Where an asset has been declared surplus to requirements, fair value will be represented by its 'market selling price' or 'market value at the highest and best use'.

V aluation methods

You should assess market value on the basis of the highest and best use of the asset as recognised in the market.

The valuation industry and courts have recognised that particular valuation methods are more appropriate for some valuations than others, although each instance needs to be considered in light of the information available to support the valuation method. In practice, it is common to use one or more secondary methods to cross-check or confirm the value derived from the primary method.

To determine the market value, you should use the most appropriate valuation method. Where comparable arm's length sales data is available (for example, in a market for a commodity product), this is generally considered the most appropriate method.

Where a market exists for an asset, that market is widely considered to be the best evidence of market value of the asset.

Part B sets out the valuation methods generally used for valuations of real property, plant and equipment.

The valuation of a business is usually based on a number of established valuation methods built around the market-based, income-based and asset-based approaches.

These methods include:

comparable transactions
comparable trading
capitalisation of earnings
discounted cash flow, and
calculation of net assets on a 'going concern' basis.

A significant amount of published material is available regarding these (and other) methods. Accordingly, we will not cover the mechanics of these methods in this guide, but we do provide a general description of them in part C.

Hypothetical market

If there is no market for the asset being valued, the courts have held that the valuer is to assume a market. This involves developing a 'hypothetical market', consisting of all hypothetical buyers and sellers who could reasonably be expected to be interested in buying or selling the asset. The market value is the price that such hypothetical buyers and sellers would negotiate to achieve a notional sale.

The hypothetical market approach was confirmed in a majority decision of the High Court. In Commissioner of State Revenue (Vic) v. Pioneer Concrete (Vic) Pty Ltd [2002] - HCA 43, paragraph 44 states:

In determining the value there is no warrant, either in the language of the statute or in principle, for departing from the hypothetical inquiry as to the point at which a desirous purchaser and a not unwilling vendor would come together. The purpose of making the inquiry hypothetical is to isolate the value of the estate or interest to be transferred from factors that are extraneous to the purpose for which such a value is to be ascertained. To introduce into the exercise a special condition for which, on a particular occasion, a particular vendor chose to stipulate, and to which a particular purchaser chose to agree, is to depart from the statutory requirement, which is to determine the value of that which was transferred. It is rather, to value the net benefit which the transaction conferred upon the purchaser.

Special value

It is sometimes argued that an asset has special value to a particular buyer. Usually this is not relevant in deriving a market value. Where there is clear evidence that the special value is known or available to the wider market, this would be reflected in an objective valuation of the asset.

However, even where the seller knows that you value the item in a special way, this usually only means that the item will sell (and the market value will be) at the higher end of the usual market value range. On the other hand, if two or more hypothetical purchasers were assumed to exist, both having a special use for the item, the special value may be reflected in the market value.

If a special value is known and available only to one potential buyer and not known or available to the wider market, it will not be reflected in market value.

Prospective market value

A market value determined in advance may not be reliable because subsequent events may change the appropriate valuation. For example, key personnel in smaller businesses may leave or die, or there may be major fluctuations in equity markets or the economy.

Where the valuer's method takes these unknown future events into account, we may be prepared to accept that method. For example, we will accept a valuation based on the closing price of widely held shares listed on the Australian Securities Exchange (ASX) to derive the market value for a non-arm's length transfer of such shares between a husband and wife, provided the price had not fluctuated materially on the day.

For unlisted shares, there is no reliable method for approximating a market value at a future time.

We generally will not rule prospectively on market value if there is no reliable method for approximating the market value at the future time. We will rule after the event giving rise to the market value has occurred.

Other valuations

Market value is generally the most appropriate basis of value for a wide range of applications and should be applied in all instances where the market value of the asset can be established.

Concepts of special value, synergistic value, liquidation value and salvage value will not be acceptable in the absence of market value, as they do not necessarily involve the exposure of the asset in the market place at large.

Some valuation processes are not intended to result in a market value, for example, an indicative assessment or appraisal. An indicative valuation may occur where the valuer has not been engaged to provide a definitive opinion on market value, or where the valuer does not make reasonable enquiries as to the veracity of information, relevant to providing a definitive opinion on market value. As such, the valuation process may not be accepted as arriving at market value for taxation purposes.

Director valuations are those undertaken by a director. Whether the valuation is acceptable as market value will depend on the valuation process used.

Who may undertake a market valuation?

For tax purposes, it is usually the valuation process undertaken rather than who conducted it, that governs the acceptability of the valuation. However, some exceptions do exist; for example, only a professional valuer may undertake a market valuation for GST margin scheme purposes or for determining non-monetary consideration for GST purposes.

Depending on the situation, a market valuation may be undertaken by a:

registered valuer
member of a recognised professional valuation body (see Qualifications and experience)
director, for balance sheet purposes, or
person without formal valuation qualifications whose assessment is based on reasonably objective and supportable data.

Except for the most straightforward valuation processes, valuations undertaken by persons experienced in their field of valuation would be expected to provide more reliable values than those provided by non-experts.

According to legal precedent, experts who assess market value should have specific knowledge, experience and judgment in that particular field. While professional qualifications may add weight to the valuer's opinion, he or she should also display personal integrity and competence. To ensure the objectivity of the report, the valuer should be independent of the interests of the party commissioning the report.

Documentation

The valuation process should be adequately documented; if it isn't, we may not accept the resulting value as a market value. See Valuation reports for more on documentation.

Qualifications and experience

Formal qualifications and membership of appropriate industry and professional bodies are prima facie evidence of a valuer's expertise.

Valuers may have the qualifications, registrations, memberships and experience detailed in the following sections.

Property valuers

Property valuers operating in New South Wales, Queensland and Western Australia are registered with a state board established by legislation and responsible to a minister. The boards register and discipline people who conduct land valuations.

They usually examine the character, experience and qualifications of applicants before they give them full or conditional registration as practising valuers.

In other states and territories the professional bodies have the dual role of advancing the profession and maintaining the practice standards of their members.

Valuers of real property and equipment may seek membership of bodies such as the Australian Property Institute and the Royal Institution of Chartered Surveyors. The main role of these bodies is to set and maintain high standards of professional practice, education, ethics and discipline.

Business valuers

There is no formal admissions board in Australia for business valuers (encompassing the valuation of businesses, securities and intangible assets). Business valuers traditionally have significant experience in areas such as financial markets, investment banking, corporate finance, corporate management, and academic qualifications in areas such as accounting, finance or economics.

Valuers of cultural or heritage material

Valuers of cultural or heritage material may seek 'approved valuer' status within their area of expertise under the Cultural Gifts Program .

Instructing the valuer

We expect that a person commissioning a valuation for tax purposes will be able to demonstrate that they provided the valuer with instructions that clearly:

set out the scope and purpose of the valuation
ensured the valuer's independence in writing the report and in drawing conclusions
recognised the valuer's right to refuse to provide an opinion or report if not provided with the information and explanations they needed
granted the valuer access to the taxpayer's premises and the necessary records
ensured the valuer would be provided with all necessary help needed to complete the report, and
established that any fee, where levied, did not depend on the outcome of the report.

Instructions to valuers will usually be in the form of a written request or could be documented in the engagement letter.

Other ATO guidance on market value

The Appendix sets out the advice and guidance products we have provided on market valuations in tabular form, covering:

Products based on the nature of the transaction or event (table 1).
Products and methodologies based on asset class (table 2).
Commonly used valuation methods for selected securities (table 3).

Part B: Real property and plant and equipment

This part provides guidance on valuation processes for real property and plant and equipment. It includes:

valuation methods - property, and
general comments on plant and equipment valuations.

Valuers of real property (residential, commercial, industrial, retail and rural) generally adopt the IVSC definition of market value and base their valuation on the property's highest and best use.

Valuers should be familiar with current market trends and conditions for the type of assets they are valuing. They should also refer to current market transactions to establish the basic data on which the valuation may be assessed.

Valuation methods - property

After inspecting an asset and researching all the factors likely to affect its market value, you should then determine which method is most appropriate for assessing its value.

The three basic valuation methods described below are:

a direct, sales or market comparison approach
depreciated replacement cost approach , and
income-based approaches .

You should check the valuation you arrive at using the primary approach, by applying another valuation approach.

The first two methods listed above require you to analyse sales.

Comparison approach

In deciding whether other sales are comparable, you should consider a range of factors, including:

the parties to the sales
the dates of the sales, and
any special terms and conditions that applied to the sales.

In the case of real property, you should also consider:

location
topography
environmental factors
accessibility
utility services
town planning zoning and restrictions
site area
improvements
potential for an alternative use, and
any other factors likely to affect the property's desirability.

Property markets are diverse. In some instances, there will be sufficient comparable sales to enable a simple valuation. However, generally it will be necessary to analyse recent comparable sales and adjust your initial valuation based on your judgment and expertise.

Analysing a sale

To analyse a sale, you should start by considering the evidence relating to the underlying land value. You may establish the market value of the land component by referring to sales of land with similar characteristics (for example, location, site area, accessibility, services, topography, zoning and potential).

You usually have to reduce the sales evidence to units of value for comparison purposes - for example, dollars per square metre, hectare, square kilometre, unit site or potential block.

Valuers also refer to the 'added value' of improvements. Once you have established the value of the land component, the balance of the sale represents the total value added by the various improvements (such as a house, garage, sheds, paving, fencing and gardens), regardless of the actual cost of each of these improvements.

In some instances, the existing improvements may be redundant because of a potential higher and better use. For example, when existing improvements add little value to the land, and may actually detract from it, because achieving the better potential use may involve costly demolitions.

Depreciated replacement cost approach

'Replacement cost' is also known as the 'summation method'.

After analysing sales to establish land values, you should determine the replacement cost of the existing improvements and allow for any depreciation by age or obsolescence. For instance, you could establish the size of the building (in square metres of floor space), and then calculate a replacement cost in the light of current costs in the area for that type of building. You would then need to deduct a proportion for depreciation, based on local data for the differences between the prices of new and old buildings.

This technique is known as 'depreciated replacement (or reproduction) cost' (DRC), and will result in a market-based assessment.

If you apply the DRC method, the assumptions and depreciation rates you adopt should reflect market rates representative of open market conditions. These rates should not be based on prescribed or arbitrary depreciation rates and asset lives sourced from legislation or guidelines. The DRC should be representative of the market value of the asset, otherwise the valuation would be inconsistent with IVSC and Australian Accounting Standards Board (AASB) standards.

Income-based approaches

Many properties are valued on the basis of their ability to produce an income stream. This includes commercial, retail, industrial and multi-unit residential properties, and other assets that are purchased for their income-producing capacity and as an investment.

These assets are valued using either the 'capitalisation of net income' or the 'discounted cash flow' (also known as 'net present value') approach.

Capitalisation of net income

Capitalisation of net income is an approach that involves converting the property's income stream into a capital value estimate through a capitalisation process. It uses a single year's income as the basis of the calculation.

Example

A light industrial manufacturer is making a profit or return on capital, after expenses, of $400,000 a year in an industry where the typical rate of return on capital is 23% a year.

To calculate the capitalised value, you invert the rate of return and multiply the profit by that figure:

100/23 x $400,000 = $1,739,130

The multiplier (100/23 in this example) is called the 'year's purchase factor'.

You can vary the final capitalised figure if there are other relevant factors. For example, if a building is vacant at the date of valuation, you could deduct the rental income lost while the property is not leased.

Discounted cash flow or net present value

The 'discounted cash flow' approach involves applying a discount rate to future cash flows (over many years of income) generated from a property in order to produce a 'net present value'.

If, for instance, you were valuing a business that is likely to produce a profit of $400,000 in each of the next ten years, you would not value the income stream at $4 million. Rather, you would discount the future earnings in order to arrive at the lower 'net present value' of the income stream.

Money you will receive in the future is usually worth less than money you have today. The discount approximates what it would cost you to borrow the money during the period before you actually receive the profit, and it compounds as the future time gets greater.

The net present value of the asset as a whole, represents the amount a hypothetical purchaser would be prepared to pay for the property, based on the discount rate used and the other assumptions adopted in the discounted cash flow assessment.

You need to make appropriate financial allowances, throughout the cash flow period, to account for factors such as capital expenditure, loss of rental income due to expired leases, and acquisition and selling costs.

Valuations of plant and equipment

The process for valuing plant and equipment can be summarised as:

identification
description
determination of the price (from sales information or market-derived depreciation allowances), and
establishment of value.

Similar to real property valuations, the direct sales or market comparison, depreciated replacement cost or income-based approaches are relevant for plant and equipment.

In accordance with AASB 116 - Property, Plant and Equipment, the definitions of 'market value' and 'fair value', and the valuation methodologies employed, are essentially the same as those for financial reporting purposes.

Specialised assets that can be freely traded in an open market are treated in a similar way to real property valuations.

Plant and equipment is an asset class with particular characteristics that distinguish it from real property. These characteristics affect the selection of the approach adopted in determining market value. Plant and equipment can normally be moved or relocated and will often depreciate faster than real property. The market value may also differ depending on whether an individual item is valued alone or in combination with other items within an operational unit. Influencing factors include whether the item is valued individually for exchange, is considered as in situ, or is to be relocated or removed. These considerations affect the resultant market value.

If you use the DRC approach, the depreciation rate should take into account the remaining life of the asset, relative to its total or effective life. The total or effective and remaining life of a plant or equipment asset may be limited by the broader business context within which it is used. For example, there may be contractual, statutory or other legal limitations to an asset's ongoing use in a particular business. Similarly, the length of a lease, or the effective life of, say, a mine or quarry might affect the total or effective and remaining life of a plant or equipment asset. The market value of the asset would reflect such circumstances.

Valuation by sample

In some instances, it may be impractical for you to value each asset individually because of the extent and diversity of the assets. In these cases, you may need to arrive at a valuation on the basis of a sample.

Sampling is less appropriate for a group of diverse assets than it is for a large number of very similar assets.

Where a group of assets have greater variability or diversity, sampling becomes more intense and more complex. For example, a collection of fictional novels involving a recurring theme could be valued on the basis of a sample of four or five items, whereas for a collection of rare books, the sampling would need to be far more intense.

Where weakness in an asset register is suspected, it can be tested and verified by sampling before valuation actually occurs.

Where you know all the relevant characteristics of the asset population, valuation may be simply the product of the calculation:

Assessed value per unit
(derived from sample)

population (number) of assets

If the assets are more variable, the size and composition of the samples need to be demonstrably random, and stratified if appropriate, to ensure no bias. For comparatively large and relatively varied populations, you could engage a specialised consultant to assist in this process.

Assets identified as being inconsistent with the sample characteristics (for example, unusually high or low-value assets) can be classified as 'outliers'. You should value outliers individually, with the remaining generic material valued by reference to a sample. The values applied to the two sets of assets can then be added together to provide a total value of all assets.

Generally, when using sampling, the overall valuation amount determined for financial reporting purposes should be reliable to a level of accuracy consistent with a relative standard error of up to 10%. This is to ensure that the valuation can be regarded as 'materially' correct.

If we are concerned about your method of sampling, we may require you to provide verification by a qualified expert statistician that the methodology and the reliability of the valuation are appropriate.

Part C: Business valuations

This part provides guidance on valuation approaches and methods for deriving market value for a business, and for securities and intangible assets.

There are a number of occasions when you need to know the market value of a business, security or intangible asset for tax purposes, including:

changes in capital structure
changes of ownership
capital gains tax rollovers
company divestments
company acquisitions
formation of a tax-consolidated group
entry to a tax-consolidated group
exit from a tax-consolidated group, and
thin capitalisation.

Valuation approaches

There are several approaches you can take to valuing a business, security or intangible asset. These are usually categorised as:

market
income
asset
cost, and
probabilistic (this approach may be included within other valuation approaches, such as the income approach).

The approach you choose depends on the context and purpose of the valuation and the particular characteristics of the item being valued. Often, you will combine several valuation approaches to reach an opinion on the market value of an item.

Market

When using the market-based approach, you would analyse transactional or trading data based on information typically found in the public domain. This information may include licensing agreements, mergers and acquisitions, capital raisings, divestments and on-market transactions.

The comparable transaction and comparable trading methods are examples of the market-based approach and are often used to derive or assess a market value for securities.

Income

Using the income-based approach, you determine the market value of an item by estimating a set of economic benefits (such as cash flow or earnings) that will be derived from that item for either a finite or perpetual term. This approach often overlays evidentiary factors (such as price or earnings multiples available from the public markets) with more subjective factors (such as estimated earnings). The 'capitalisation of earnings' (often categorised as a market-based method) and 'discounted cash flow' methods are examples of the income-based approach.

Asset

The asset-based approach is typically used to derive the market value of a business, usually on a 'going-concern' or liquidation basis. This approach is commonly used (on a going-concern basis) for valuing holding and investment companies.

Cost

The cost-based approach can be used to derive market value where market or income factors are difficult to obtain or estimate with reliability (for example, for some intangible assets). The cost approach is normally categorised into two methods:

replacement cost (in basic terms, the cost of replicating functionality), or
reproduction cost (in basic terms, the cost of recreating the asset).

Probabilistic

The probabilistic approach is often used to derive a valuation based on a range of outcomes or discrete events. This approach is commonly used to value an item where several layers of uncertainty and co-dependability exist (for instance, from a budgetary, time or variables perspective).

Probabilistic approaches are often used to value items such as research and development, mining projects or the option-embedded elements of securities. Simulation analysis (for example, Monte Carlo) and lattice-based models (also known as decision-tree analysis) are examples of the probabilistic approach.

The approaches and methods described above comprise of only the first step in deriving the value of an item. When you are determining the market value of something for tax purposes, you need to identify a number of variables and incorporate them into the derivation of the market value. We discuss some examples of these below.

Valuation of a business

What is a business?

In this guide, we use 'business' in a way consistent with usual valuation industry descriptions and definitions, applied within the context of Australian federal tax law.

Business is defined in the International glossary of business valuation terms as meaning 'business enterprise' and is defined as: 'a commercial, industrial, service, or investment entity (or a combination thereof) pursuing an economic activity.'

Section 995-1 of the ITAA 1997 defines 'business' as including 'any profession, trade, employment, vocation or calling, but does not include an occupation as an employee'.

We have also provided some guidance in relation to the meaning of 'business'. Refer to Taxation Ruling TR 1999/16: Income tax: Capital gains: goodwill of a business.

Valuation methods

The valuation of a business is usually based on a number of established valuation methods built around the market-based, income-based and asset-based approaches.

These methods include:

comparable transactions
comparable trading
capitalisation of earnings
discounted cash flow, and
calculation of net assets on a going-concern basis.

A significant amount of published material is available regarding these (and other) methods. Accordingly, the mechanics of these methods are not covered in this guide other than to note their application within the context of existing legislation, our publications and established industry approaches (for instance, refer to the appendix, table 3).

In valuing a business, we would expect to see that you have considered a number of factors that may affect the market value and produced a reasonable and defensible view of the market value.

These factors may include:

valuation methods - you would need to explain your choices and demonstrate why they are appropriate
valuation metrics - you would need to explain your choice and demonstrate that you have applied them appropriately; for instance, you would need to show how you derived a company weighted average cost of capital (WACC)
valuation date
purpose of the valuation
basis or premise of your valuation - for example, valuation of the business on a going-concern basis
description of the business
a summary of the corporate structure and management of the business - including such details as the operating history, management and board, capital structure, company constitution, board minutes, shareholder agreements, business and strategic plans, marketing plans and operating plans
market information - including key customers and spread, customer lists, sales pipeline, barriers to entry, competitors, alternative products, market size and growth
operations - including information such as manufacturing and production, service delivery, research and development capability/plans, fixed asset details, key suppliers, intellectual property protection and utilisation, resourcing, risk identification and management and regulatory issues
products or services - including information such as product description, product pipeline, pricing and the basis of pricing (for example, market or cost-plus)
financial requirements and financial structure - including information such as current and historical financial statements, budgets, forecasts, key operating metrics, funding details and terms (equity, hybrid and debt funding - existing and planned), off-balance-sheet structures, capital expenditure requirements and operating cash flows
strategic and corporate development initiatives - including information such as previous and planned acquisitions, previous and planned divestments, corporate restructures, corporate actions, strategic alliances and joint ventures
sales and marketing strategies - including information such as target markets (existing and planned), direct or channel strategies, reseller or supplier agreements, compensation strategies and product and brand awareness strategies
adjustments for items such as non-operating assets (for example, investments) and excess cash, and
adjustments for factors such as control and liquidity or marketability (at the company or business level).

Valuation of securities

What is a security?

The term 'security' is defined in a range of legislative and industry applications. For the purpose of this guide, we discuss a number of securities (but not all) that fall within the definition of 'security' in subsection 159GP(1) of the ITAA 1936, namely:

stocks, bonds, debentures, certificates of entitlement, bills of exchange promissory notes or other securities
deposits with banks or other financial institutions
secured or unsecured loans, and
any other contracts, whether or not in writing, under which a person is liable to pay an amount or amounts, whether or not the liability is secured.

The Financial Services Reform Act 2001 (FSR Act) defines the term 'security' (section 761A and Part 7.11) to mean:

a share
a debenture
a legal or equitable right or interest in a share or debenture
an option to acquire, by way of issue, any of the above securities, or
a managed investment product.

Securities may be listed or unlisted and may be categorised generally into three types:

equity
debt, or
hybrids.

Examples of equity securities include:

ordinary shares, or
preference shares (depending on structure).

Examples of hybrid securities include:

some preference shares (depending on structure), or
convertible notes (not covered in this guide).

Examples of debt securities include:

discount securities
bonds, or
floating rate notes.

For the purpose of this section, we refer to ordinary shares, preference shares, floating rate notes and bonds in accordance with commonly accepted industry understanding, but applied within the context of Australian federal tax law.

Valuation approaches

The valuation methods that may be used to determine a market value for securities are based on established approaches that are market-based, income-based, cost-based or probabilistic.

These methods include:

business valuations adjusted for the relevant security or ownership interest
trading benchmarks, for example, volume weighted average price (VWAP) or closing price, and
security-based discounted cash flow.

Equity securities - ordinary shares

An ordinary share may be either:

listed - registered on a recognised exchange such as the Australian Securities Exchange (ASX), or
unlisted - held privately by an individual or group of shareholders.

Registration of an ordinary share on a recognised exchange provides for a daily market in the ordinary share, whereas an unlisted share is sold in either in a limited market or in a transaction between two or more parties.

Preference shares, convertible notes, bonds and floating rate notes may also be registered and traded on a recognised exchange.

Valuing listed shares

As listed ordinary shares are commonly traded on a daily basis, you may be able to rely on the appropriate share market as the source for valuing a listed ordinary share.

When you value a listed share, we would expect you to take into account a number of factors in addition to the listed price. These include:

liquidity
volatility
valuation changes resulting from company capital structural events or changes in retained earnings (for example, as a result of dividend payments), and
the period to which the valuation applied.

Where a stock is relatively liquid and does not exhibit significant price volatility, you may, in certain circumstances, refer to a point-in-time valuation (such as the closing price of a share). However, there are a number of tax contexts where this may not be applicable.

A common method of smoothing the effects of illiquidity (that is, thin trading) and volatility of a stock is for a person to adopt the volume weighted average price (VWAP) of the stock over a certain period. You may also adopt the VWAP method if the stock is liquid but does not exhibit excessive volatility. Within a tax context, this method is commonly applied to corporate events and actions.

In addition to the valuation of an individual listed share, the value of a block of listed shares in the hands of one owner will often be derived using the value of a listed share as a base. As an example, depending on the size of the shareholding (in absolute and percentage terms), a discount may need to be applied to take into account the difficulty of selling this block of shares into the market. This is known as the blockage discount.

The application of the blockage discount needs to be based on the particular facts relating to a case. For example, a significant holding of listed shares, in some circumstances, could require the application of a premium rather than a discount.

The value of a company's equity (or significant portion, where an individual legal or beneficial owner could exert significant influence) will often also be derived using the value of a listed share as a base. In such situations, a premium for control would often be added to the value of the company's shares. This would be necessary to account for factors such as the influence a particular shareholder may exert on the running of the company and synergies that may be gained through the acquisition of a controlling holding.

Valuing unlisted shares

Where an ordinary share is held privately by an individual or group of shareholders, applying the appropriate valuation method (or methods) may be more complex.

When you value an unlisted share, we would expect you to take into account a number of factors that may affect its market value, including:

many of the factors described in Valuation of a business (accounting for the specific interest)
adjustments - you need to adjust for factors such as liquidity (at the holdings level) and degree of control (actual or effective) and show that these adjustments are appropriate (for instance, you could benchmark a minority interest in an unlisted investment company against a listed investment company operating in a similar environment), and
the rights of other equity and debt holders (which may influence the market value of an ordinary share).

Where an ordinary share is held privately by an individual or group of shareholders, applying the appropriate valuation method (or methods) may be more complex.

Hybrid securities - preference shares

Preference shares may either be unlisted or listed, and may be classified as either equity (depending on the preference structure) or debt.

From the equity perspective, the preference share may be represented as an additional class of equity (despite the hybrid tag) differentiating itself from an ordinary share in its basic rights (for example, voting rights and liquidation preferences).

From the hybrid perspective, the preference share may be more akin to a debt instrument where a number of debt-like features comprise the elementary features of the preference share - for example, in the form of a reset preference share (RPS) that may include a conversion option, fixed dividend, step-up rights and redemption.

Valuing a preference share

In valuing a preference share, we would expect to see that you have taken into account relevant factors that may affect the characterisation (that is, equity or debt classification) and valuation of the preference share.

While a preference share may trade on a recognised exchange, you will need to consider certain factors concerning the preference share's structure (including attached rights) when assessing its market value, including:

issue date
issue rating
issue price
term/maturity
reset dates (if applicable)
dividend rate
dividend payment period
whether it is cumulative or non-cumulative
whether it is redeemable or non-redeemable
conversion details (if applicable)
conversion discount (if applicable)
voting rights
ranking, and
liquidation preferences.

Some of these factors may also apply to a number of hybrid structures more widely.

Where you use a traded preference share (such as an RPS) as a benchmark in assessing the market value of a debt instrument, we would expect you to exclude the equity factors embedded in the pricing of the preference share.

In deriving the value of an ordinary share by reference to preference shares issued by a company, we would expect to see the rights attached to the preference shares incorporated fully into any valuation.

We do not expect to see preference shares valued at their paid-up value unless warranted by industry standards. We would expect to see the rights of the preference shareholders fully incorporated and priced in the market value of the ordinary shares for the valuation of a start-up firm where a senior class of shares was subsequently issued.

Debt securities

In this section, we focus on the valuation of debt securities that are not listed on a recognised exchange or traded in the 'over-the-counter' (OTC) markets. Such debt securities should be priced using industry accepted practices.

In basic terms, any interest-bearing instrument is generally referred to as debt (such as discount securities, bonds and floating rate notes). This definition extends to cover zero-coupon notes and bonds, but excludes hybrid and derivative structures.

Valuing a debt security

In most circumstances, we would expect the yield or price adopted in a transaction to be appropriately benchmarked to the market (accounting for the arm's-length principle). When you value a debt security or derive a market yield we would expect you to take factors such as the following into account:

issue date
issue price
term/maturity
early redemption options
face value
coupon rate or interest rate
coupon payment period
coupon payment date
accrued interest
par yield curve (for instance, Government)
zero yield curve
forward curve
credit rating (actual or estimated, issuer or issue)
credit curve, and
liquidity.

Price may vary depending on the circumstances and structure of the debt. Where inter-group debt has been issued, we would expect to see the debt priced at market value. Our general expectations about certain debt structures and price are as follows:

coupon that is equal to the yield to maturity - we would expect to see the bond priced around par
coupon greater than the yield to maturity - we would expect to see the bond priced at a premium to par (the amount of principal owing on the bond at maturity; this value may include accrued interest, as in the case of a zero-coupon bond)
coupon that is lower than the yield to maturity - we would expect to see the bond priced at a discount to par, and
zero-coupon or discount structure - we would expect to see the issue price lower than the face value.

Where an Australian subsidiary issues debt to an offshore parent, we would expect you to price the issue with reference to factors such as those mentioned above.

Valuation of intangibles

What is an intangible asset?

The term 'intangible asset' has both legislative and industry definitions.

Intangible assets are typically categorised as follows:

identifiable intangible assets (excluding intellectual property and goodwill)
intellectual property, and
goodwill.

Accounting Standard AASB 138 Intangible assets provides a detailed definition of an intangible asset (refer paragraphs 8-17). For example, in Paragraph 8 an intangible asset is defined as:

an identifiable non-monetary asset without physical substance.

And Paragraph 12 states:

An asset meets the identifiability criterion in the definition of an intangible asset when it:

(a) is separable, that is, is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, asset or liability, or

(b) arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.

AASB 138 also contains detailed information relating to accounting recognition criteria for an intangible asset (refer Paragraphs 21-23):

An intangible asset shall be recognised if, and only if:

(a) it is probable that the expected future economic benefits that are attributable to the asset will flow to the entity…

Accounting Standard AASB 3 Business combinations provides a number of examples of intangible assets that meet the definition and recognition criteria (as outlined in AASB 138) within the context of a business combination.

Intellectual property

There are both legislative and industry definitions for Intellectual property.

From an industry perspective, the World Intellectual Property Organization (WIPO) defines intellectual property as follows:

Intellectual property refers to creations of the mind: inventions, literary and artistic works, and symbols, names, images, and designs used in commerce.

Intellectual property is divided into two categories: Industrial property, which includes inventions (patents), trademarks, industrial designs, and geographic indications of source; and Copyright, which includes literary and artistic works such as novels, poems and plays, films, musical works, artistic works such as drawings, paintings, photographs and sculptures, and architectural designs. Rights related to copyright include those of performing artists in their performances, producers of phonograms in their recordings, and those of broadcasters in their radio and television programs.

The World Trade Organization (WTO) defines intellectual property rights as follows:

…the rights given to persons over the creations of their minds. They usually give the creator an exclusive right over the use of his/her creation for a certain period of time.

These rights include patents, trademarks, copyright, industrial designs and trade secrets.

Within the context of the Australian federal income tax law, section 995-1 of the ITAA 1997 defines intellectual property as the rights (including equitable rights) an entity has under Commonwealth law (or equivalent rights under a foreign law) as the owner or licensee of a:

patent
registered design, or
copyright.

Goodwill

Tax law does not define 'goodwill'. However, the term is defined in a range of industry applications. AASB 3 Business Combinations defines goodwill as:

Future economic benefits arising from assets that are not capable of being individually identified and separately recognised.

AASB 3 also describes how goodwill is measured (refer Paragraph 51(b):

…the excess of the cost of the business combination over the acquirer's interest in the net fair value of the identifiable assets, liabilities and contingent liabilities…

In the wake of Commissioner of Taxation v. Murry (1998) HCA 42 (16 June 1998), we have published Taxation Ruling TR 1999/16: Income tax: capital gains: goodwill of a business. This ruling provides guidance regarding the meaning we assign to goodwill.

For guidance in relation to goodwill and consolidation, refer to TR 2005/17: Goodwill identification and tax cost setting for the purposes of Part 3-90 of the Income Tax Assessment Act 1997.

Valuing intangible assets and intellectual property

The valuation of intangible assets, including intellectual property but excluding goodwill, is based on a number of established valuation methods using market-based, income-based, cost-based and probabilistic approaches.

These methods include:

comparable transactions
incremental income
excess earnings
relief from royalty
replacement or reproduction cost, and
simulation analysis.

A significant amount of published material is available regarding these (and other) methods. Therefore, this guide focuses on how you apply these methods within the context of existing legislation, ATO practice (such as rulings) and established industry approaches.

When you value intangible assets (other than goodwill), we expect to see a number of factors taken into account. These factors include:

any relevant factor described in Valuation of a business (accounting for the specific interest)
a description of the specific intangible asset or item of intellectual property and substantiation that the intangible asset or item of intellectual property is adequately categorised (that is, under the separability and/or contractual/legal criteria)
a description of the complementary assets used in generating value for the intangible asset or item of intellectual property, and the calculation of any value allocation or charge needed to account for the use of those assets
an analysis of the useful or effective life of the intangible asset or item of intellectual property
an analysis of the obsolescence factors affecting the intangible asset or item of intellectual property (such as functional, economic, legal and technical factors)
the legal rights associated with the intangible asset or item of intellectual property
evidence that the intangible asset or item of intellectual property derives incremental value (for instance, establishing proof of the value generated by the aesthetic elements of an industrial design versus the utilitarian nature embedded within the design), and
expert reports, where relevant (for instance, the results of any prior art search from an intellectual property attorney).

Valuing goodwill

The valuation of goodwill is generally based on the calculation of a residual value. In basic terms, this approach requires the valuation of the net identifiable assets of the business (market-adjusted) and the valuation (market value) of the equity of the business.

A residual value may be derived by subtracting the value of the net identifiable assets of the business from the value of equity of the business. As a general rule, the calculation of a residual value will be the most appropriate method for deriving goodwill. However, other methods may be accepted if they are appropriate to the circumstances.

Further details on valuing goodwill can be found in part E: Allocating value to underlying assets.

Part D: Valuation reports

This part provides guidance on the content we require in a market valuation report.

Minimum requirements

A valuation should:

be replicable - in effect, this means the valuation should be documented and explained well enough that another person or valuer can understand how the value was determined, and
preferably be undertaken by a suitably qualified and experienced person in relation to the asset being valued.

A valuation report should:

be understandable, and
objectively demonstrate the valuation process undertaken in accordance with valuation industry practices.

If you do not adequately explain the process you undertook, we may not accept that the value reached by that process is the market value.

Elements of a good valuation

The following elements should be apparent in any properly conducted valuation process, in accordance with valuation industry practice:

We expect this information to be included in a valuation report or to appear clearly in the valuer's working papers.

Description of asset

When you value an asset, you should specify it with sufficient certainty that there can be no mistake about its identity. In particular, you need to be sure that you have not overlooked items such as separately identifiable intangibles and goodwill.

Purpose and context of valuation

You need to specify the reason for the valuation and the provisions of the law under which the market valuation is required.

Definition
A market valuation is a valuation that applies the definition of market value for tax purposes , as described in this guide.

Date of valuation

The valuation report and supporting documents should specify the valuation date (that is, the date to which the valuation relates) as well as the dates the valuation was started and completed. This will allow us to determine whether the valuation and valuation documents are contemporaneous.

If you value an item before or after the relevant date or event, you may be influenced by factors that should not have been taken into account. For this reason, we prefer valuations that are contemporaneous with the valuation date.

Method or methods used

A valuation is unique to the asset and the point in time. Valuations may vary in the component parts (information and assumptions) used in the valuation calculation. You should explain the method or methods you used in sufficient detail to enable another valuer to repeat and assess your valuation.

There are generally accepted valuation methods for different classes of assets. These are specified in the relevant standards, guidelines and text books, and are applied by valuers in making valuation determinations.

Reasons for methods used

You need to explain the reasons behind your choice of method so that we can determine whether it is the most appropriate for the asset concerned.

In every case, you should use the most appropriate methodology based on the facts and circumstances of the valuation, valuation principles and industry standards. If you use an inappropriate method, the valuation may be flawed and we may require a new valuation to ascertain the market value.

Your method needs to be aligned with the intent and framework of the legislation under which the valuation is required.

In most instances, where there is a market for the asset being valued, you should use the comparable sales method (see Comparison approach ). In this case, you should clearly define the market, including:

a description of the market
the market history
the breadth, depth and location of the market, and
an evaluation of the market, that is, supply and demand for the asset.

Discounted cash flow valuation reports

Where a valuation is based on the discounted cash flow approach the report should include the following information:

Income projections and growth rates.
The future income flows and market growth rates you have assumed. You should also outline the projected consumer price index rates for the same years.
Discount rate.
The rate you select for discounting projected future income streams and your reasons for your selection.
Leasing allowances/renewal probabilities.
The allowances you made for future vacancies and leasing costs.
Capital expenditure allowances.
The allowances you made for capital expenditure on the property throughout the cash flow period.
Outgoings/expenses.
Any other future outgoings or expenses you have allowed for, and your assumptions about the rate of growth in these outgoings.
Terminal value assumptions.
The method you used to determine the terminal value (or selling price) of the asset at the end of the cash flow period. You would usually include the terminal capitalisation rate adopted, and the net income figure adopted.
Transaction expenses.
The transaction expenses you allowed for in the cash flow period, such as acquisition costs and selling expenses. These items are usually expressed as a percentage of the purchase or selling prices.
Discounted cash flow valuation results.
The value you arrived at, following sensitivity analysis, using the discounted cash flow approach, based on the inputs outlined above.

Specific value

Tax legislation requires the specific market value to be ascertained. Where your method leads to a range of possible values, you need to explain why you have adopted the specific market value that you finally nominated.

Information relied on

You should clearly specify the information upon which you have relied, as well as its source.

Evaluation of information

You should confirm that any information used to arrive at the market value is reliable. This is particularly necessary where the client is the source of the information. You should make available any empirical evidence that you relied on.

Assumptions relied on

You should outline any assumptions you relied on in the valuation process, and the reasons for making them.

Evaluation of assumptions

You should evaluate each assumption for its reliability and reasonableness, particularly assumptions given by a third party.

Material risks

If you identify material risks underpinning the valuation, for instance, where a business valuation is dependent on the success of a commercial initiative by that business, you should describe these risks in sufficient detail to show that they have been given due consideration and weight.

Use of previous valuations

If you seek to rely on a previous valuation for current purposes, difficulties are likely to arise if the previous valuation was compiled for a different purpose. The current valuation should:

explain how the earlier valuation is relevant to the current valuation, with a particular focus on the purpose of the original valuation compared to the purpose of the current one
confirm that the information and assumptions pertaining to the original valuation are still relevant, and
declare how any adjustments and changes have been made to comply with any statutory requirements associated with the valuation.

Explanation of material differences

You should quantify and explain any material differences from previous relevant valuations or values. This includes known historical costs, earlier revaluations, and valuations with a similar or proximate valuation date.

Expert reports and the use of experts

When relying on an expert in the valuation process, you should include sufficient detail to confirm the expert's:

competency in the field
use of assumptions and methods seem reasonable and sources of data appear appropriate, and
independence or, if not independent, disclose the dependency and justification for it.

It would also be expected that that any expert's report would contain details similar to those required generally in valuation reports.

Terms of engagement

As part of your report we would expect you to specify the terms on which you have been engaged by your client. We also would expect you to include any special instructions relating to the valuation, and whether they were written or oral. In particular, the report should disclose any instructions that have affected, or are likely to affect, the valuation process.

Your client should be able to demonstrate that they provided you in advance with instructions, preferably in writing, that clearly:

set out the scope and purpose of the report
ensured your independence in writing the report and in drawing your own conclusions
recognised your right to refuse to provide an opinion or report if they did not provide you with the information and explanations you need
granted you access to their premises and the necessary records
ensured you would be provided with all the help needed to complete the report, and
established that any fee payable was independent of the outcome of the report.

Relationship between valuer and client

You should outline any relationship you have to the client or any conflict of interest, in sufficient detail to enable us to assess your independence.

Working papers

When your client relies on the market value for tax purposes, they need adequate records to explain the basis of the market value.

These records should not only confirm that a valuation was undertaken, but should also contain sufficient detail to enable the valuation process to be replicated. If the working papers are your property, you should ensure that you keep them, unless the valuation report contains sufficient detail to enable replication.

If you fail to maintain detailed reports and working papers, this may affect the credibility of your valuation. In addition, if your valuation report does not give sufficient information to allow another valuer to replicate the valuation, it may not meet the statutory record-keeping requirements. In such a case, your client will be unable to demonstrate that the market value has been ascertained in accordance with accepted valuation principles.

Where a valuation is straightforward, or the asset's value is relatively low or can be determined objectively, your report and associated records may be relatively brief.

Disclaimers and indemnities

If there are any disclaimers or indemnities that affect the valuation process or the market value you should identify them and explain their effect.

Valuer's details

Your report should contain your name and the following details about you:

qualifications
work experience, including specialisations
any licences or registrations, and
relevant professional memberships.

Part E: Allocating value to underlying assets

This part provides guidance on how to reasonably allocate value to underlying assets.

What is an allocation of value?

For some tax purposes, it may be necessary to determine the value of a whole asset as well as the component assets that form the whole. For example, this may occur in relation to a business in its entirety and the individual assets that make up the business.

An allocation of value occurs when you allocate values to underlying assets out of a single whole amount.

Some common examples are:

composite transactions - for example, a sale of a franchise operation involving the sale of the land, fixtures and fittings, stock on hand, right to operate the franchise, and goodwill
bundled asset transactions - a sale of several operational franchises where you may need to allocate a value to each operation, then to each underlying asset of each operation, and
consolidation events - here, the cost-setting process requires you to determine the allocable cost amount (ACA) that you then allocate to underlying assets on the basis of proportionate market values - using the method outlined in the legislation.

Under tax law, you need to allocate value to underlying assets on a reasonable basis. You can use the allocation process outlined below, which includes the residual value method where goodwill is involved.

Is there goodwill?

If you have paid more for a business than the market value of the tangible assets and the identifiable intangible assets, the excess or premium is the goodwill. This means that the market value of tangible and identified intangible assets will be less than the value of the enterprise. The Murry case and TR 1999/16 support the residual value approach in calculating goodwill, and that goodwill attaches to a relevant business. For further discussion about intangibles, including goodwill, see Valuation of intangibles.

Allocation process

You need to identify all assets before you allocate values to each one. You also need to consider whether there are any transactions related to the transaction giving rise to the allocation, such as related agreements. Related transactions may impact on the total transaction value to be allocated, and assets to be valued. We provide some guidance on compliance risks associated with the allocation of value to underlying assets. See table F2 in part F.

You should sort identified assets into the classes listed below:

Cash and cash equivalents - such as cash and bank deposits that are taken at face value.
Assets that are actively traded - such as foreign currency, bonds, debentures, derivatives and listed securities. These assets tend to have a transparent value due to the existence of a ready market.
Inventory (that is, trading stock or property held primarily for sale in the ordinary course of business). This asset class is identified separately due to its rate of turnover. Any allocated value is deductible in the ordinary course of business.
Other tangible assets - such as depreciating assets and realty (land and improvements). This will capture all other tangible assets.
Identifiable intangible assets except goodwill - such as patents, brand names and software.
Goodwill (or going-concern value). This is the residual value after all other asset values have been allocated.

If a business has been acquired as a going concern and is generally profitable, you should include a value for goodwill. If a valuation does not include a value for goodwill, you should consider whether the allocation process has been reasonable, and the reasons behind the absence of a goodwill valuation. The absence of goodwill in a value allocation may indicate that:

the business does not generate economic profit
the sale price was undervalued (and hence the purchaser did not pay a component for goodwill), or
excessive value has been allocated to other assets.

Step-by-step allocation of value

The following is a step-by-step process for allocating value.

Some assets have a statutory value other than market value for tax purposes. Each of these assets needs to be allocated its market value, not its statutory value, in both the residual value and apportionment methods.

For example, Division 43 of the ITAA 1997 sets out particular methods for establishing asset values for tax purposes in rental properties. Such assets would therefore have those values for tax purposes, but for allocation to other assets under the apportionment or residual value methods they still need to be valued at market value.

Step 1	Identify all assets transferred as part of the overall transaction.
Step 2	Group assets by the following classes in this order: cash and cash equivalents actively traded assets inventories all other tangible assets, and identifiable intangible assets (other than goodwill).
Step 3	Assign the market value to each asset in classes 1 and 2. The market values for these assets remain unadjusted regardless of whether goodwill exists.
Step 4	Add up the market values of all assets in classes 1 and 2 to get a total market value for all classes 1 and 2 assets.
Step 5	Assign the market value to each asset in classes 3 to 5.
Step 6	Add up the market values of all assets in classes 3 to 5 to get a total market value for these assets.
Step 7	Add your step 4 and step 6 answers together to get a total assigned market value of all assets for classes 1 to 5. If this amount: is less than the total transaction amount, the market value assigned to the class 3 to 5 assets is the allocated value and there is also goodwill - go to step 8(a) to calculate goodwill is equal to the total transaction amount, the market value assigned to the class 3 to 5 assets is the allocated value and there is no goodwill exceeds the total transaction amount, go to step 8(b) to determine the adjusted allocated values for each asset in classes 3 to 5.
Step 8(a)	Goodwill Where the result at step 7 is less than the total transaction amount, the residual amount represents goodwill. Establish the value of goodwill as follows: Overall transaction amount minus the total assigned market value of all assets (step 7 answer).
Step 8(b)	Apportionment Where the step 7 amount exceeds the total transaction amount, there is no goodwill and you need to establish the adjusted transaction value for each asset in classes 3 to 5. Use calculations (i) and (ii) to do this: (i) Overall transaction amount minus your step 4 answer (ie minus total market value of assets in classes 1 and 2), and (ii) Answer to (i) multiplied by the market value of each asset from classes 3 to 5 divided by your step 6 answer.

Part F: ATO processes

This part describes how the ATO approaches:

compliance activities and market valuations
compliance activities and allocations of value, and
ruling requests involving market value.

Compliance activities and market valuations

We may review a market value as part of our compliance processes. Generally, we do this by considering the tax risk associated with the market value, and the risk in the market valuation process itself.

Tax risk associated with market value

Generally speaking, we determine tax risk by considering the likelihood of non-compliance with a tax law and the consequences related to that non-compliance.

In assessing likelihood, consequence and tax risk associated with a valuation, we usually consider the following:

the value of the asset or assets
the type of asset or assets involved (intangible assets are more likely to increase risk)
the materiality of any potential tax adjustment
the complexity of the valuation process, and
the documentary evidence supporting the valuation.

Valuation process risk

We generally use valuers to confirm whether the market value is acceptable. They usually review the valuation process to see if it complies with accepted valuation industry practice. Broadly, the review involves looking at:

how adequately you documented your process
which market value definition you used
how appropriate your method was, and
what assumptions and information you relied on.

At the conclusion of the review, the valuers provide us with a report on the valuation which may include an estimate of the market value (or likely range) of the asset or assets, based on data available to them at that time. When we receive the report we use our standard risk assessment procedures to decide whether to take further action, such as an audit.

Table F1 below shows how we review the valuation process and documentation risk.

Table F1: Risk matrix for quality of the valuation process and documentation

	High	Medium	Low

Appropriateness of methodologies	Assuming continuation of existing use, the valuations do not sufficiently demonstrate that: methods are consistent over similar asset types methods are the most appropriate, and appropriate data was used.	Assuming continuation of existing use, the valuations demonstrate mostly that: methods are consistent over similar asset types methods are the most appropriate, and appropriate data was used.	Assuming continuation of existing use, the valuations demonstrate fully that: methods are consistent over similar asset types methods are the most appropriate, and appropriate data was used.
Qualifications of person undertaking valuation	Person undertaking the valuation can demonstrate few, if any, of the following attributes: appropriate knowledge and industry experience professional membership subject to external regulation retains specialist advice where appropriate, and holds appropriate licences or authorities.	Person undertaking the valuation can demonstrate most of the following attributes: appropriate knowledge and industry experience professional membership subject to external regulation retains specialist advice where appropriate, and holds appropriate licences or authorities.	Person undertaking the valuation can demonstrate all of the following attributes: appropriate knowledge and industry experience professional membership subject to external regulation retains specialist advice where appropriate, and holds appropriate licences or authorities.
Use of supporting methods	No cross-check of valuation where it would have been appropriate.	Single cross-check of valuation where appropriate.	Valuation cross-checked with other methods where appropriate.
Integrity of process	Person undertaking valuations cannot demonstrate: appropriate experience basis of engagement subject to external regulation professional relationship, and access to information.	Person undertaking valuation can demonstrate most of the following attributes: appropriate experience basis of engagement subject to external regulation, and professional relationship access to information.	Person undertaking valuation can demonstrate: appropriate experience documented basis of engagement subject to external regulation, and professional relationship access to information.
Information supplied in the market valuation report	Report does not include enough of the following information required by the ATO to understand the market valuation report: description of the assets valued to enable identification purpose and context of valuation specific market value date or period to which valuation relates date valuation was commenced and completed details of the methods used information the valuation is based on details of all assumptions used.	Report includes most, but not all, of the following information required by the ATO to understand the market valuation report: description of the assets valued to enable identification purpose and context of valuation specific market value date or period to which valuation relates date valuation was commenced and completed details of the methods used information the valuation is based on details of all assumptions used.	Report includes all of the following information required by the ATO to understand the market valuation report: description of the assets valued to enable identification purpose and context of valuation specific market value date or period to which valuation relates date valuation was commenced and completed details of the methods used information the valuation is based on details of all assumptions used.
Use of existing valuations	No documentation as to the relevance of earlier valuations or inadequate documentation of changes.	Adequate documentation as to the relevance of earlier valuations and/or adequate documentation of changes.	Complete documentation as to the relevance of earlier valuations and/or complete documentation of changes.

Compliance activities and allocations of value

When you allocate a total transaction amount (usually a sale or purchase price) to underlying assets, you need to do so on a reasonable basis. The most appropriate basis requires you to establish the market value for each underlying asset - the process for this is set out in Allocating value to underlying assets.

There are three broad areas of risk associated with the allocation of value. They are whether:

the total transaction value is accurate
you have recognised all assets to which value is to be allocated, and
you have allocated value correctly to each underlying asset.

If we doubt the integrity of the total transaction value you have used, we will examine that transaction and its basis. If the transaction amount:

is based on a valuation (for instance, in cases of consolidation, where there has been no actual sale), we will consider the risks associated with that valuation, and
is not based on a valuation or there is no statutory requirement for market value to be determined, we will examine the basis on which it has been determined in the context of the legislation and factual circumstances.

It is important that all assets are identified and that you have allocated amounts only to separately identifiable assets. We would confirm this by examining the transaction documentation and the vendor balance sheets prior to the transaction, and by comparing values in prior years.

We have found that the assets most likely not to be identified individually are intangibles and goodwill. For instance, a vendor may prefer to bulk allocate value to intangibles and goodwill (to reduce CGT and capital allowance balancing adjustments on other assets). However, a buyer may prefer to allocate value individually to assets that are deductible, depreciable or likely to be sold in the short term (giving them an increased cost base or higher adjustable value to reduce CGT and balancing adjustments).

We may use a valuer to ensure all the assets are recognised and to consider the integrity of the valuation process.

Where parties deal with each other at arm's length and agree, in a bona fide manner, on the value of underlying assets, we are likely to accept the values as reflecting market value. If an allocation of value does not exhibit particular characteristics (summarised in table F2 below), we are likely to consider the allocation of value to be a higher risk, and may subject it to greater scrutiny.

Table F2: Risk matrix for allocations of value

	High	Medium	Low

Integrity of the allocation values (overall transaction value). Value is transparent. Value has been determined or tested in the marketplace. The transaction was conducted in a bona fide manner between arm's length parties. There were no related transactions or side agreements. None of the parties was, effectively, tax-exempt.	Transaction not transparent Value has not been tested. Does not meet at least one of the other criteria.	Transaction somewhat transparent Value has been tested. Does not meet at least one of the other criteria.	Transaction likely to be transparent Value has been tested. Meets the other criteria.
Allocation-of-value process. Underlying assets were specifically identified, especially intangible assets and goodwill. Allocation of value was documented and agreed between the parties at the time of the allocation.	Underlying assets not identified. No agreed allocation of value.	Some underlying assets not identified, especially intangible assets and goodwill (if appropriate). No agreed allocation of value.	All underlying assets identified. Agreed allocation of value.
Integrity of allocation process. Allocation process fully documented. Basis of allocation appears to be reasonable. All values appear to be materially correct. Parties are not related. None of the parties is, effectively, tax-exempt. There is no suggestion that the values were at risk of manipulation.	No documentation. Does not meet at least one of the other criteria.	Allocation process is fully documented. Does not meet at least one of the other criteria.	Allocation process is fully documented. Meets all other criteria.
Report information We need the following information to understand the report: asset description that enables identification of the asset purpose and context of valuation specific market value date or period the valuation relates to commencement and completion dates of valuation details of the methods used information on which the valuation is based detail of all the assumptions used.	Report does not have sufficient information for us to understand it.	Report has most but not all of the information we need to understand it.	Report contains all of the information we need to understand it.

Other allocation and apportionment processes

Consolidation

Under the law, you align the tax cost of the assets of an entity joining a consolidated group with (broadly) the tax cost of the membership interest in that entity. When an entity leaves the group, the entry allocation process is reversed and the group's cost base of the leaving interest is derived from the net tax cost of the entity's assets taken out of the group.

This tax cost-setting process is basically an apportionment method, and requires you to allocate the ACA to the assets of the entity.

Construction expenditure for income-producing capital works

If you are entitled to a tax deduction for construction expenditure for income-producing capital works, refer to Taxation Ruling TR 97/25: Income tax: property development: deduction for capital expenditure on construction of income producing capital works, including buildings and structural improvements for an outline of how to establish and apportion the construction expenditure (or cost).

Ruling requests involving market value

We can provide private, class and product rulings on matters involving valuations. We generally will not rule on the market value for a future event (see Prospective market value in part A).

We do not usually rule on valuation methods. We can only rule on how a relevant provision applies to a particular taxpayer in relation to a particular scheme, and a question about whether or not a particular method is appropriate may not fall into this category. Moreover, we will often not have sufficient facts to determine the appropriate method to use. In some instances, we may comment on the appropriate method within our explanation of a ruling. This particularly occurs in class or product rulings, where a number of taxpayers are affected.

Class and product rulings

If a request for a class or product ruling requires a valuation, the taxpayer seeking the ruling should provide a valuation that is acceptable to us (based on the standards set out in this guide).

Private rulings

In seeking a private ruling, you can either provide your own valuation in support of the market value or ask us to determine the market value. In both instances we would expect to engage a valuer, either to confirm the valuation you have provided or to determine the value. Either way, we will pass on the costs charged by the valuer to you.

Part G: Specific statutory approaches and processes

Tax law requires particular approaches or processes in the following situations:

Employee share schemes for unlisted shares and rights

Tax law sets out how shares, stapled securities and rights to acquire them (ESS interests) are treated for tax purposes when acquired under employee share schemes - refer to the former Division 13A of the ITAA 1936 for ESS interests acquired before 1 July 2009 and Division 83A of the ITAA 1997 for ESS interested acquired after 30 June 2009.

The former Division 13A defines market value for unlisted shares acquired before 1 July 2009 as 'the arm's length value of the share' - paragraph 139FB(1)(b) of the ITAA 1936. This subsection allows us to approve, in writing, a reasonable method of calculating the arm's length value of unlisted shares. For example, an acceptable arm's length value might be one based on recent arm's length commercial transactions involving the unlisted shares.

For the purposes of the former Division 13A, the arm's length value of unlisted shares can be determined by a registered company auditor (in the relevant state or territory) who is not associated in certain capacities with the company - refer to the former section 139FG of the ITAA 1936. The auditor provides a written report in a form we approve. This report is given to the person from whom the taxpayer acquires the shares.

Division 83A of the ITAA 1997 uses the ordinary meaning of market value for determining the value of ESS interests acquired after 30 June 2009. However, where the expression 'market value' is used with its ordinary meaning, in some cases that meaning is affected by the rules in Subdivision 960-S of the ITAA 1997. Subdivision 960-S provides that any conditions and restrictions that prevent a taxpayer from converting the ESS interests into money are ignored in calculating market value - refer to section 960-410 of the ITAA 1997.

The method for calculating the value of an ESS interest acquired after 30 June 2009 can also be specified by regulation in the Income Tax Assessment Regulations 1997 (the Regulations) (see section 83A-315). Regulation 83A-5.01 says that for Division 83A of the ITAA 1997, the rules under the former Division 13A about valuing unlisted rights to acquire shares under an employee share scheme are preserved.

As a general rule, we accept that the market value of the unlisted shares is a reasonable basis for establishing arm's length value. However, we will not usually rule where the request applies to future employee share acquisitions, because the facts we need to establish the market value may not be certain until the future acquisition happens - see Prospective market value in part A.

Cultural and heritage gifts

Under the Cultural Gifts Program (the program), donors who make gifts of significant cultural items to public art galleries, museums and libraries may be eligible for a tax deduction for the market value of their gifts.

The Department of Broadband, Communications and the Digital Economy administers the program with advice from the Committee on Taxation Incentives for the Arts. The committee advises the secretary to the department on the approval of valuers to participate in the program and examines donations to make sure they conform to the program's requirements.

More information is available in relation to:

Cultural gifts
Heritage gifts
Department of Broadband, Communications and the Digital Economy
Gifts of property valued by the ATO at more than $5000 (Philanthropy program), and
Australian Valuation Office (AVO) at www.avo.gov.au which is part of the ATO.

Part H: Consolidation valuation shortcuts

Consolidation: Valuation shortcut options

The following valuation shortcut options are for consolidation purposes only. They enable businesses to avoid the need to obtain new valuations for certain assets and membership interests. These shortcuts, which are provided under the Commissioner's general administrative powers, provide a reasonable approximation of the true market value of the asset.

Use of these options may avoid the need for new valuations for the purpose of setting assets costs. However, the valuation shortcut options are not available for calculating a joining entity's market value for the purpose of determining the maximum use of transferred losses.

The use of valuation shortcut options reduces the risk of the ATO undertaking a market valuation review of the assets for which the shortcut options have been used.

Table H1: Consolidation: Valuation shortcut options

Valuation shortcut	Type of asset	Valuation option
1	Depreciating assets (not including intangible assets) that have not been depreciated on an accelerated basis, whose individual adjustable values are 1% or less of the joining subsidiary's allocable cost amount (ACA)	Adjustable value (which can be revised to ignore any balancing adjustment amount that reduced the adjustable value) can be used as market value
2	Depreciating assets (not including intangible assets) that have been depreciated on an accelerated basis, whose individual adjustable values are 1% or less of the joining subsidiary's allocable cost amount (ACA)	Adjustable value, revised to ignore the effect of accelerated depreciation (and which can be revised to ignore any balancing adjustment amount that reduced the adjustable value), can be used as market value
3	Trading stock (other than livestock and growing crops) that is not a retained cost base asset	Terminating value at the joining time may be used as market value except in certain circumstances
4	Employee share scheme shares	Existing market valuation updated if appropriate
5	Unlisted shares	Existing market valuation updated if appropriate

Constraints on use of valuation shortcuts - supporting documentation required

When choosing to use a valuation shortcut for a particular asset, the taxpayer must ensure they have adequate supporting documentation that demonstrates the asset satisfies the eligibility requirements of the particular shortcut.

One in, all in - with an exception

While use of the valuation shortcuts is optional, the decision to use a particular shortcut must generally apply to all of an entity's assets that are eligible for that particular shortcut.

For valuation shortcuts 1 and 2, there is one exception to this rule. A taxpayer can generally opt to use shortcuts 1 and 2 for a joining entity's eligible depreciating assets, while obtaining new market values for the assets (including those eligible for the shortcut) that make up a single large functioning unit of integrated plant. Such a unit includes integrated plant within an oil refinery, or a communications cable, and integrated plant within a factory production line.

The single large functioning unit of integrated plant must have a total adjustable value greater than 1% of the joining subsidiary's allocable cost amount to qualify for this exception. Without this exception, the 'one in, all in' rule precludes the taxpayer from obtaining new market values for those constituent assets that were otherwise eligible for the shortcut.

The exception works as follows:

A taxpayer opts to use the shortcut to value their eligible depreciating assets. Among these are a number of assets that constitute one or more items of integrated plant. A market value is determined for the integrated plant and the value is then allocated on a reasonable basis among the integrated plant's constituent assets. These values may then be adopted as the market values of the constituent assets instead of the values that would be adopted for these assets under the valuation shortcuts applying to depreciating assets.
In valuing an integrated functioning unit of plant, the market value must reflect the physical value of the plant and not comprise any embedded goodwill or any other intangible value. That is, care should be taken to ensure none of the value attributed to the asset is actually goodwill attached to the use of that asset or to any other intangible assets held by the entity.

Not available where there is an intention to sell

Valuation shortcuts, with the exception of valuation shortcut 3 (trading stock), are not available for use for assets if there is an intention at the joining time to sell any of the following after consolidation:

the joining entity in which the asset is held
the underlying business of the joining entity in which the asset is held
part of the underlying business of the joining entity in which the asset is held
the asset.

This provision only applies where both of the following apply:

at the joining time, an asset has been the subject of a fully determined specific intention to sell
the expectation is that the asset will be sold within two years of the joining time.

For example, it would apply where either of the following applies:

a decision had been taken to market an asset with the intention to sell if a suitable buyer could be found
a decision had been taken to accept an offer to buy an asset but the decision to sell had not yet been communicated to the buyer.

However, this provision would not apply where either of the following applies:

where an entity had a history of disposing of its assets on a strategic basis but had not taken a decision to sell in relation to any particular asset at the joining time
where an entity had merely fielded offers in respect of a specific asset or assets but had made no decision to sell at the joining time.

Where this provision applies to a particular asset, it will no longer be treated as an asset of that particular type for purposes of applying the 'one in, all in' rule. The intention to sell the asset prevents the use of the valuation shortcut in relation to that asset. However, it will not prevent the valuation shortcut from applying to other assets that qualify for that particular shortcut.

Not available for calculating the available fraction

The valuation shortcuts cannot be used to calculate the available fraction for the use of a joining entity's losses by the head company. For this purpose, market valuations of the loss entity and the consolidated group at the joining time will be required.

Use in determining goodwill

Where valuation shortcuts have been adopted for certain assets, the shortcut values for those assets should be used in determining the market value of the entity's goodwill. Goodwill is determined as the excess of the market value of the entity over the market value of its net identifiable assets at the joining time.

The net identifiable assets may have a mixture of market values and shortcut values. If a taxpayer market values all or any of the entity's net identifiable assets that qualify for one of the shortcut options in order to work out the value of goodwill, they should not adopt that valuation shortcut for qualifying assets that have been market valued.

Valuation shortcut 1

Depreciating assets that have not been depreciated on an accelerated basis

The adjustable value at the joining time, which may be revised to ignore any balancing adjustment amount, can be taken as the market value for all depreciating assets where all of the following apply:

they have not been depreciated on an accelerated basis
their individual adjustable values amount to 1% or less of the joining entity's ACA
they are eligible for a deduction under Division 40 of the ITAA 1997, except for the following intangible assets

mining, quarrying or prospecting rights
mining, quarrying or prospecting information
items of intellectual property
in-house software
IRUs (indefeasible rights to use an international telecommunications submarine cable)
spectrum licences
datacasting transmitter licences.

The market value ascertained by applying valuation shortcut 1 may be affected by a balancing adjustment event occurring under the income tax law. A taxpayer that has an assessable balancing adjustment amount because of a balancing adjustment relief has the option of revising the adjustable value. The revision ignores any balancing adjustment amount that reduces the amount available for decline in value of the depreciating asset.

Valuation shortcut 2

Depreciating assets that have been depreciated on an accelerated basis

A revised adjustable value can be taken as the market value for all depreciating assets where all of the following apply:

they have been depreciated on an accelerated basis and:
their individual adjustable values amount to 1% or less of the joining entity's ACA
they are eligible for a deduction under Division 40 of the ITAA 1997, except for the same intangible assets that are not eligible for valuation shortcut 1.

The revised adjustable value reflects an amount calculated as if the asset had been depreciated at normal rates in accordance with its effective life. This ignores the effect of broadbanding of effective life under the accelerated depreciation provisions and can ignore the effect of a balancing adjustment amount. The effective life is prescribed by the Commissioner, unless the taxpayer has self-assessed the effective life for depreciation purposes.

To work out the revised adjustable value at the joining time, the taxpayer must recalculate the asset's depreciation from the time it was first depreciated by the joining entity up to the joining time. The taxpayer can also choose to exclude from the adjustable value of the asset any balancing adjustment amount that had reduced the amount available for a depreciating asset's decline in value. The depreciation rates to be used for the recalculation are the applicable standard (that is, non-accelerated) rates that would have applied to that particular asset for the period from the time the asset was first depreciated by the joining entity up to the joining time.

Valuation shortcut 3

Trading stock

This shortcut is not available for joining entities that were majority owned by the prospective head company at 27 June 2002. The trading stock of such entities must be treated as a retained cost base asset.

The terminating value at the joining time can be taken as the market value for assets that are items of trading stock, except where either of the following applies:

the trading stock comprises livestock, standing or growing crops, crop-stools and trees planted and tended for sale
the value of the trading stock has been affected by market volatility, market collapses, obsolescence or any other event to the extent that its terminating value would not be a reasonable approximation of its market value at the joining time. In such cases, the trading stock should be market valued appropriately at the joining time.

Valuation shortcut 4

Employee share interests

Shares and stapled securities issued under an employee share scheme (ESS interests) that represent 1% or less of the membership interests in an entity are disregarded for the purposes of determining whether an entity is wholly owned. However, the head company still uses their market value to calculate its allocable cost amount for membership interests in the joining entity.

The availability of this shortcut option acknowledges that valuing minority interests is a difficult and complex process.

Where an employee, under the former Division 13A of the ITAA 1936, holds shares or stapled securities, those interests will have been market valued where either of the following applies:

the employee has elected to have the discount given in relation to their acquisition of the ESS interests included in their assessable income at the time they were acquired
the employee has not elected to have the discount included in their assessable income but the cessation time has occurred and the employee continues to hold the shares.

This also applies where the employee has previously held rights and has exercised those rights, and now holds shares or stabled securities.

For employers providing ESS interests to their employees after 30 June 2009, Division 392 of TAA 1953 requires employers to report the discount they give in relation to those interests to us by 14 July after the end of the financial year in which they are provided. In order to meet their reporting requirements, employers will need to have market valued the ESS interests.

The valuation shortcut operates as follows.

The head company may rely on these existing market valuations when calculating the employee share interest component of the allocable cost amount for the joining entity, provided:

for ESS interests acquired before 1 July 2009, the valuation was for the purposes of Division 13A in accordance with the former sections 139FB, 139FD and, in the case of rights, 139FE of the ITAA 1936, or
for ESS interests acquired after 30 June 2009, the valuation was for the purposes of Division 83A in accordance with Subdivision 960-S of the ITAA 1997 or in accordance with any method specified by regulation in the Income Tax Assessment Regulations 1997,and
the original market valuations were appropriately documented, and
the decision to use the existing market valuations is documented and, they are, if necessary, updated in accordance with the requirements set out under 'Use of existing valuations'.

Valuation shortcut 5

Membership interests that are unlisted shares

As all membership interests in a wholly-owned subsidiary will be held by the head company or other members of the consolidated group, they will not be listed on a stock exchange. The availability of this valuation shortcut acknowledges that valuing unlisted membership interests is a difficult and complex process.

Where any ESS membership interests in the joining entity have been market valued for Division 13A of the ITAA 1936 or Division 83A of the ITAA 1997, the head company can rely on these valuations to work out the cost of all its membership interests in the joining entity, provided:

the ESS membership interests acquired before 1 July 2009 were valued for the purposes of Division 13A in accordance with the former sections 139FB and 139FD, or
the ESS membership interests acquired before 1 July 2009 were valued for the purposes of the former Division 13A and

arose because of the granting of qualifying rights, and
those rights have been exercised, or the cessation time in relation to those rights has occurred, and the employee continues to hold the shares, and
those rights were valued in accordance with the former sections 139FC, 139FD and 139FE, or

the ESS membership interests acquired after 30 June 2009 were valued for the purposes of Division 83A in accordance with either of the following

subdivision 960-S of the ITAA 1997
a method for calculating the value of an ESS interest specified by regulation in the Income Tax Assessment Regulations 1997, and

the original market valuation was appropriately documented, and
the decision to use the existing market valuation is documented and they are, if necessary, updated in accordance with the requirements set out under Use of previous valuations.

Appendix

ATO products dealing with valuations

This appendix lists some of our advice and guidance products that deal with matters involving valuations.

For more information about market valuation where the GST margin scheme applies, refer to our Valuation issues paper.

Table 1: Products based on the nature of the transaction or event

Nature of transaction	Examples of tax context	ATO products (not exhaustive)
Capital gains tax (CGT) events generally	Wherever market value is required	TD 10W: Capital Gains: What are acceptable valuations for CGT purposes? TD 97/1: Income tax: property development: if land, originally acquired as a capital asset, is later ventured into a business of development, subdivision and sale, how is the market value of the land calculated at the time it is ventured into the business?
	Transfers to related parties	Transferring real estate to family or friends.
	Defining an asset	TR 2004/13: Meaning of an asset for the purposes of Part 3-90 of the Income Tax Assessment Act 1997
Share buy-backs	Valuing shares in buy-backs	TD 2004/22: Income tax: for Off-Market Share Buy-Backs of listed shares, whether the buy-back price is set by tender process or not, what is the market value of the share for the purposes of subsection 159GZZZQ(2) of the Income Tax Assessment Act 1936? PS LA 2007/9: Share buy-backs.
Unlisted shares for ESS schemes	Form for completion by a registered company auditor.	Declaration of the value of unlisted shares .
Trading stock	Valuation of land as trading stock in property development Valuation of land that is ventured into a property development	TD 92/132: Income tax: property development: if land is trading stock, do related interest costs, council rates and land taxes, form part of the cost price for trading stock valuation purposes? TD 97/1: Income tax: property development: if land, originally acquired as a capital asset, is later ventured into a business of development, subdivision and sale, how is the market value of the land calculated at the time it is ventured into the business?
Allocation of value to underlying assets	Disposals and transfers of more than one asset for a single undivided amount	TD 9: Capital gains: How do you apportion consideration received on the disposal of a composite asset?
GST margin scheme	Valuing partially completed developments	GSTR 2000/21: Goods and services tax: the margin scheme for supplies of real property held prior to 1 July 2000 GSTR 2006/7: Goods and services tax: how the margin scheme applies to a supply of real property made on or after 1 December 2005 that was acquired or held before 1 July 2000 GSTR 2006/8: Goods and services tax: the margin scheme for supplies of real property acquired on or after 1 July 2000
Consolidated entities	Consolidation events generally - including entries, exits, cost base setting and determining the allowable fraction	TR 2005/17: Income tax: goodwill: identification and tax cost setting for the purposes of Part 3-90 of the Income Tax Assessment Act 1997 TD 2007/1: Income tax: consolidation: in working out the market value of the goodwill of each business of an entity that becomes a subsidiary member of a consolidated group, should the value of related party transactions of each business of the entity be recognised on an arm's length basis? TD 2007/27: Income tax: consolidation: is the cost base of the goodwill referred to in subsection 711-25(2) of the Income Tax Assessment Act 1997 limited to the cost base of goodwill under subsection 705-35(3) of that Act?
Self managed superannuation funds	Valuing fund assets	Valuation Guide for Self-managed super funds: Self-managed superannuation funds
Research and development concession	Value of contributions to R&D	IT 2451: Guide to the research and development tax concession - paragraphs 12-14
Fringe benefits tax	Car parking fringe benefits	TR 96/26: Fringe benefits tax: car parking fringe benefits - paragraphs 46 and 50

Table 2: Products and methodologies based on asset class

Real property
Components	Examples of tax context		ATO product			Commonly adopted methods
All types of land, with or without buildings and improvements Rights associated with land, including leases and licences to occupy Partially completed developments (GST margin scheme)	First element of cost base under ss110-25(2) ITAA 1997 Capital proceeds using the market value substantiation rule: s116-20 ITAA1997		TD 97/1: Income tax: property development: if land, originally acquired as a capital asset, is later ventured into a business of development, subdivision and sale, how is the market value of the land calculated at the time it is ventured into the business? TR 97/25: Income tax: property development: deduction for capital expenditure on construction of income producing capital works, including buildings and structural improvements TD 92/132: Income tax: property development: if land is trading stock, do related interest costs, council rates and land taxes, form part of the cost price for trading stock valuation purposes? Transferring of real estate to family or friends			Direct comparison. Capitalisation of net income. Discounted cash flow analysis.
	GST margin scheme		GSTR 2006/7: Goods and services tax: how the margin scheme applies to a supply of real property made on or after 1 December 2005 that was acquired or held before 1 July 2000 GSTR 2006/8: Goods and services tax: the margin scheme for supplies of real property acquired on or after 1 July 2000 GSTR 2000/21: Goods and services tax: the margin scheme for supplies of real property held prior to 1 July 2000 MSV 2005/1: A new tax system (goods and services tax) margin scheme valuation requirements Determination MSV 2005/1 MSV 2000/1: A new tax system (goods and services tax) margin scheme valuation requirements Determination (No.1) 2000 MSV 2000/2: A new tax system (goods and services tax) margin scheme valuation requirements Determination (No.2) 2000 GST essentials
Plant and equipment
Components	Examples of tax context		ATO product		Commonly adopted methods
					Going concern - based on optimised depreciated replacement cost. Disposal of surplus assets/orderly realisation of assets: based on auction realisable value less costs of sale.
Business
Components		Examples of tax context	ATO product	Commonly adopted methods
		First element of cost base under ss110-25(2) ITAA 1997 Capital proceeds using the market value substantiation rule: s116-20 ITAA 1997 CGT rollovers Asset sales or divestments Cost base setting Entries into consolidated groups Exits from consolidated groups Thin capitalisation		Common specific approaches: comparable transaction comparable trading capitalisation of earnings discounted cash flow, and calculation of net assets. (These methods will often overlap)
Securities
Components		Examples of tax context	ATO product	Commonly adopted methods
Equity Hybrid Debt		CGT rollovers Cost base setting Entries into consolidated groups. Exits from consolidated groups.	TD 2004/22: Income tax: for off-market share buy-backs of listed shares, whether the buy-back price is set by tender process or not, what is the market value of the share for the purposes of subsection 159GZZZQ(2) of the Income Tax Assessment Act 1936? PS LA 2007/9: Share buy-backs	Common specific approaches: business valuations adjusted for the relevant security interest trading benchmarks (eg VWAP/closing price), and security based discounted cash flow.
Intangible assets
Components		Examples of tax context	ATO product	Commonly adopted methods
Identifiable intangible assets Intellectual property		General examples can include: CGT rollovers Asset sales or divestments Cost base setting Entries into consolidated groups Exits from consolidated groups, and Capital allowance issues relating to IP.	TR 2005/17: Income tax: goodwill: identification and tax cost setting for the purposes of Part 3-90 of the Income Tax Assessment Act 1997 TD 2007/1: Income tax: consolidation: in working out the market value of the goodwill of each business of an entity that becomes a subsidiary member of a consolidated group, should the value of related party transactions of each business of the entity be recognised on an arm's length basis? TD 2007/27: Income tax: consolidation: is the cost base of the goodwill referred to in subsection 711-25(2) of the Income Tax Assessment Act 1997 limited to the cost base of goodwill previously identified under subsection 705-35(3) of that Act?	Common specific approaches: comparable transaction incremental income excess earnings relief from royalty replacement/reproduction cost, and simulation analysis.
Goodwill			TR 1999/16: Income tax: capital gains: goodwill of a business

Table 3: Commonly used valuation methods for selected securities

Event or transaction description	Legislative references and ATO guidance (not exhaustive)	Selected valuation approaches (under certain circumstances) (This should not be taken as definitive guidance and will vary depending on the particular case. We recommend that you contact us to discuss the circumstances in more detail before seeking a ruling)
Off-market takeovers	ITAA 1997: subsection 124-800(1) subsection 116-20(1) subsection 124-790(1) para 110-25(2)(b) TD 2002/4	From the time that the bid becomes unconditional, closing price at the time of acceptance, up to and including the deemed effective date of compulsory acquisition.
Merger/scrip restructure via a scheme of arrangement	ITAA 1997: subsection 124-800(1) subsection 116-20(1) subsection 124-790(1) para 110-25(2)(b) subsection 124-780(5)	1-day VWAP on implementation date of scheme.
Demergers	ITAA 1997: section 125-70 section 125-80 TD 2006/73	For cost base allocation - five-day VWAP from the commencement of trading.
Equal capital reductions	ITAA 1997: subsection 116-30(3A)	Closing price or 1-day VWAP or 5-day VWAP.
Selective capital reductions	ITAA 1997: subsection 116-30(3A)	Establishment of market value under ss 116-30(3A).
Employee share acquisition schemes	ITAA 1936: former section 139FB	Establishment of arm's length value under former s 139FB of the ITAA 1936 which has continued application under the IT(TP)A 1997.
Off-market buy-backs	ITAA 1936: subsection 159GZZZQ(2) section 159GZZZM TD 2004/22 PS LA 2007/9	Establishment of market value under ss 159GZZZQ(2) of the ITAA 1936.

VWAP = volume weighted average price

Last Modified: Friday, 24 August 2012

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