Nowhere are these failings more evident than assigning a true market value to SMSF assets.

With listed equities, cash and term deposits, and listed trusts, it’s pretty straightforward.

But unlisted trusts, permitted loans and property are another matter.

With rising interest rates, SMSFS are increasingly likely to add debt as an asset in their portfolios while property – residential and commercial – has always been a hardy staple.

An added complication is the looming legislation to impose a higher tax rate on superannuation balance earnings above a $3 million threshold, and the focus this will bring on asset valuations.

‘Dog’s breakfast’

At the SMSF Association’s recent national conference, delegates were told of an SMSF trustee who had loaned $1.1 million (a third of the fund’s assets) to an unrelated third party that was only partly secured.

To make matters worse, the unsecured line of credit was a handshake arrangement. Little wonder the audit report described it as a “dog’s breakfast”.

In another example, an SMSF loaned money to an unrelated party for a property project in 2018 that was repaid on time. So, the fund immediately decided to extend another six-month loan to the same party – an arrangement that was rolled over every six months.

The only difference was the loan was now unsecured.

So, although the loan was documented, the interest rate on the latest loan was an attractive 12 per cent, and there was a history of repayment, the fact it was unsecured meant the fund’s accounts raised concerns.

Property, too, can be a pitfall for trustees.

Take an SMSF that has a holiday house rented out in the peak season on an informal basis.

The auditor will want documentary evidence to show that the SMSF is the only recipient of the rent, and that the trustee is not pocketing some of the money.

Where the property owned by the SMSF is a business premise, related tenants can be another issue.

Compliance requires a current, enforceable lease agreement specifying arm’s length rent and terms, which must be adhered to by both parties. Rental valuations should be current, backed by comparative data or a demonstrable method such as competitive rental yield.

Complex evaluations

Rent doesn’t always require yearly valuation, with many leases periodically adjusting it. But with the start of a new lease or exercise of an option, a new valuation is mandatory. Long-term leases should not rely solely on periodic CPI adjustments, but should periodically adjust to market rates to satisfy the arm’s length criteria.

Property valuations are becoming more problematic. Some trustees are even prepared to have their annual reports qualified because they believe the valuation is “fair”, relying on the ATO’s guidelines stating that having a qualified independent valuer isn't obligatory provided the valuation is based on objective data.

But property valuations that remain the same over several years, and despite obvious changing market conditions, will attract the attention of the ATO.

It’s worth adding that the ATO recommends using an independent valuer when the valuation is complex, or the asset represents a significant percentage of the fund’s assets.

When valuations are complex, trustees benefit from professional expertise, making the ATO’s guidance both common sense and consistent with auditing standards.

Regardless of the asset’s weighting in the fund, trustees must ensure they have robust evidence for asset valuations, supported by comparable sales data or other relevant information.

Certainly, trustees can expect their auditors to evaluate and scrutinise the quality of any expert’s conclusions and underlying data in line with auditing standards.

Remember, too, it’s not just a tax issue. What if these funds with undervalued assets have members receiving a pension. In all likelihood, the property value has increased, so is the fund meeting the minimum pension payment required?

Can ECPI (exempt current pension income) be legally claimed?

Finally, trustees must realise their auditors have a statutory duty to examine the validity and accuracy of an SMSF’s financial records and ensure the fund is compliant with the legislative requirements.

But that doesn’t mean a trustee can’t query an auditor’s report. Indeed, unless specified otherwise, an auditor is required to inform the trustee of any queries they have.

This provides an opportunity for the trustees to work with their auditor, take any corrective action, and to be prepared if the ATO comes knocking.

*This article first appeared in the Wealth Section of the Australian Financial Review and is re-printed with kind permission of the AFR