2.1 This chapter explains some key valuation concepts and describes stakeholder concerns which may arise more generally and not just in a tax context.
2.2 Stakeholders concerns which are not limited to taxation include:
- lack of regulation and standard setting in the valuation profession;
- valuations being opinions and the use of ranges; and
- significant costs and the uncertainty of the benefits of valuations.
What is valuation?
2.3 Valuation is generally 'the process of establishing the value of an asset or liability' or 'the amount representing an opinion or estimate of value'.2 Valuation may involve valuing tangible (such as plant, equipment, antiques, collectables, inventory and property) or intangible assets (such as shares, goodwill, businesses, rights, intellectual property and financial instruments).
2.4 The Accounting Professionals and Ethical Standards Boards (APESB) in Australia defines valuation as:
the act or process of determining an estimate of value of a business, business ownership interest, security or intangible asset by applying Valuation Approaches, Valuation Methods and Valuation Procedures. A Valuation does not involve the verification of information in respect of the business, business ownership interest, security or intangible asset being valued.3
How valuation is performed
2.5 Broadly, valuation is performed by a person, the valuer, who estimates the most likely value of an asset or liability at a particular point in time. The valuer arrives at this estimate by selecting the most appropriate methodology to apply to a certain set of inputs.
2.6 These inputs usually include the facts and assumptions related to the asset or liability being valued. The inputs are provided by the client in their engagement instructions to the valuer together with a description of the asset or liability being valued and the particular point in time with reference to which the asset should be valued. The valuer may, depending upon the circumstances, also make enquires to test the inputs provided.
2.7 The valuer's opinion typically includes a range of values within a certain level of confidence and/or an estimated value (point estimate), depending on the circumstances. This opinion is generally communicated to the client in a report that includes the basis and reasons for it.
2.8 The output of the valuation process, therefore, is sensitive to the inputs provided in the client's instructions and the methodologies chosen by the valuer.
2.9 As valuations are opinions and involve professional judgement they may be independently assessed by a valuation review or critique. Such review or critique may be defined as an 'act or process of considering and reporting on a valuation undertaken by another party, which may or may not require the reviewer to provide their own valuation opinion.'4
2.10 The International Valuation Standards Council (IVSC) describes the valuation review as being an integral part of professional practice in order to ensure the 'accuracy, quality and appropriateness' of valuation reports.5 A valuation review may test the strength of a valuation by focusing upon:
- the apparent adequacy and relevance of the data used and enquiries made;
- the appropriateness of the methods and techniques employed;
- whether the analysis, opinions, and conclusions are appropriate and reasonable; and
- whether the overall product presented meets or exceeds Generally Accepted Valuation Principles (GAVP).6
Valuations of market value
2.11 As stated earlier, valuers may be engaged to express an opinion on the market value of an asset at a particular point in time.
2.12 In most cases, the term 'market value' in Australia takes on its generally accepted meaning developed from judicial authority, such as the test provided in Spencer's case7 which established the concept as being the price that a willing but not anxious purchaser would pay to a willing but not anxious seller. More specifically, market value is the value struck in the following conditions:
- between a willing but not anxious vendor and purchaser;
- in a hypothetical market;
- the parties are fully informed of the advantages and disadvantages associated with the asset being valued; and
- both parties are aware of current market conditions.
2.13 The above definition may be adjusted for specific markets. For example, the IVSC definition adopted by real property valuers is:
The estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm's length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion.8
2.14 Furthermore, market valuations are to take into account the 'highest and best use' of an asset which the IVSC defines as 'the use of an asset that maximises its potential and that is physically possible, legally permissible and financially feasible.'9
Valuer and valuation regulation and standard setting
2.15 Stakeholders have raised concerns that, unlike the legal or medical profession, there is generally no system of regulation or licencing that covers all valuers. As a result, there is a level of uncertainty for clients as to whether they have engaged an appropriate valuer.
2.16 A more specific concern was raised in relation to the relatively limited pool of professional valuation expertise in certain markets within Australia. This limitation gives rise to difficulties including conflict of interests for taxpayers and the ATO.
2.17 There are limited circumstances in which legislative restrictions or requirements are placed on people who may perform valuations. For example, several Australian States regulate land valuers through legislation directly. Qualification and registration is mandatory with the relevant State government departments in these cases. These valuers may also be deregistered by the same department if registration requirements are not maintained.
2.18 Certain states also require valuers, who undertake valuations on behalf of the government, to comply with the valuation and property standards promulgated by the Australian Property Institute (API) which is a professional valuer association.
2.19 There are also certain circumstances in which government bodies mandate a specific process for a valuer appointment. For example, in relation to retail shop leases, the New South Wales Civil and Administrative Tribunal may only appoint a specialist retail valuer from a list of valuers nominated by the Presidents of the API (NSW) and the Real Estate Institute (NSW) where called upon to determine the market rent of a lease.10
2.20 Generally, valuers may belong to professional bodies and associations. These associations usually have purpose statements such as:
- increasing or maintaining professional standards of its members; and
- providing continuing professional education to its members.
2.21 Some of these professional associations may be subject to Professional Standards Schemes. In this respect, the Professional Standards Councils in each state are responsible for approving applications from 'occupational associations' to be covered by the scheme.
Professional Standards Schemes are a statutory innovation. They require occupational associations to improve their professional standards and protect consumers by implementing robust risk management strategies and adhering to professional indemnity insurance standards. It rewards such practices by limiting the occupational liability of members of occupational associations.11
2.22 These associations must implement risk management procedures in relation to:
- membership entry requirements;
- continuing occupational education;
- codes of ethics and practice;
- complaints and discipline of association members;
- standards for Professional Indemnity Insurance for all its members; and
- risk management which track the above and any claims against members.
2.23 Whilst Professional Standards Schemes do exist, they are restricted to a limited number of professional bodies involved in undertaking valuations in a particular context.12
2.24 However, some self-regulation does exist. For example, with respect to mineral and petroleum asset valuation, members of professional bodies such as The Australasian Institute of Mining and Metallurgy (AusIMM) and the Australian Institute of Geoscientists are bound by an industry code known as the Code for the Technical Assessment and Valuation of Mineral and Petroleum Assets and Securities for Independent Expert Reports or 'the VALMIN code'.13
2.25 There are generally no regulatory restrictions on who can perform valuations of businesses.14 However, people performing such valuations are generally expected to '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.'15
2.26 Certain business valuers are members of CPA Australia, Chartered Accountants Australia and New Zealand (CAANZ) and the Institute of Public Accountants (IPA) and are therefore bound by various professional and ethical standards as set out by the APESB.
2.27 The APESB has issued the Accounting Professional and Ethical Standard (APES) 225 Valuation Services as well as Guidance Note (GN) 20 Scope and Extent of Work for Valuation Services to assist accountants in applying the standard.16 Additionally, CAANZ administers a 'Business Valuation Specialist' designation for those members who meet certain requirements.17
Valuation as opinions and use of ranges
2.28 Notwithstanding professional qualifications and accreditation, valuation is said to be both an art and a science. As noted by the IVSC, 'value is not a fact but an opinion…'18 Despite the need to rely on objective data there is a necessary degree of subjectivity and professional judgement.
2.29 Due to this reliance on professional judgement, the outcome of valuations may be imprecise, which the valuer may express through a range of values with varying levels of confidence. Furthermore, valuers may have differing opinions as between themselves based on their professional judgment although neither may be incorrect. Where valuations are used to calculate an obligation to pay a specific amount, the subjective nature of valuations and any ranges provided result in a number of challenges. Depending on the circumstances, a client may require a valuation to produce a range of values or a specific value i.e. a point estimate. For example, expert valuation reports assessing the reasonableness of a corporate takeover offer may produce a range of reasonable values. In contrast, the tax legislation requires taxpayers to use specific Australian dollar values for the purposes of correctly assessing and reporting their tax liabilities.
2.30 Providing a specific dollar value for a valuation without qualification in a range of circumstances may be problematic as the value is typically subject to at least some uncertainty. Therefore, a valuation report typically explains the factors causing uncertainty and their effect on the possible values. Notwithstanding any difficulties with providing a specific value, the usefulness of the report may be undermined where a valuer provides too broad a range of possible values.19
2.31 For a given data set, a valuer may be able to produce a range of values at a given level of confidence. If their data is limited, the valuer may be required to produce a very wide range for a given level of confidence. If a client requires a narrower range, for example, to make the report more useful to them, the valuer may either:
- attempt to gather more data, so that the range of values is narrower whilst maintaining the same confidence level, potentially increasing the cost of the valuation; or
- given the same amount of data, provide a narrower range, but with a reduced level of confidence.
2.32 A range of values in a valuation report may be presented by a normal distribution of probabilities. For certain purposes, a client may select the 'mid-point', or mean, as the most appropriate point estimate. For example, the Australian Securities and Investments Commission considers an average of values within the range provides a 'fair and reasonable' price in a takeover context for the purpose of the Corporations Act 2001.20
2.33 However, a range does not necessarily indicate that all values within that range are as likely as each other. To illustrate this point, the following diagram highlights three scenarios in which simply reporting a mean value obscures the distribution of probabilities. In Scenario A, the variability is narrow and immaterial. In Scenario B, the variability is wide but normally distributed. Scenario C shows a heavily skewed distribution 'with the most likely outcome being significantly lower … than the mean outcome.'21
Figure 1: Three different distributions of possible values all showing a mean of 71,393,224,327
Source: Confidence Accounting: a proposal, ACCA, the Chartered Institute for Securities and Investment, Long Finance, 5 July 2012.
2.34 In this respect, the IVSC has recommended ranges should not be used to communicate valuation uncertainty as users of valuations often require a specific value and a range would not be acceptable. Furthermore, users may incorrectly assume that 'an equal probability attaches to any outcome within the range' or 'there is no possibility of a valuation falling outside of the indicated range.'22
2.35 The IVSC has also highlighted that a lack of data not only results in more uncertainty with a valuation but also causes difficulties in quantifying that uncertainty.23 The IVSC, therefore, advocates that any material valuation uncertainty should always be disclosed with a qualitative description and any quantitative explanations provided only where appropriate.24
Significant costs and uncertain benefits of valuations
2.36 Stakeholders raised concerns that the need to rely on professional valuers to undertake valuations increases the costs of complying with regulations or legal requirements. In addition, due to differences in various regulations or statutory regimes, the same assets or liabilities may need to be valued more than once, further increasing compliance costs.
2.37 Some stakeholders have indicated that depending on circumstances there may be no benefits in engaging a professional valuer or the benefits may be marginal particularly where an administrator or regulator may subsequently seek to challenge that valuation. Parties may seek to avoid the cost of a professional valuation in such cases by undertaking a private or director valuation.25
2.38 The inputs and methodologies used in valuations may be different depending on the purpose of the valuation and the requirements of the relevant laws. For example, financial statements prepared according to accounting standards may require assets to be valued using certain approaches. A common approach is to use 'fair value'.26
2.39 Assets may also need to be valued for insurance purposes. For example, a valuation may need to estimate the cost of replacing and rebuilding a house to determine the amount of insurance coverage and related premiums. A common approach is to use 'reinstatement cost'.27
2.40 In certain proposed corporate takeovers, the Corporations Act 2001 may require an independent expert's report to form an opinion as to whether the takeover offer is 'fair and reasonable'. Such an opinion would need to consider the value of the interests in the target company.28
2.41 Each of the above types of valuations may require the use of a different 'standard of value' i.e. fair value, reinstatement cost and fair and reasonable. A valuation for one purpose, therefore, may not necessarily be useful or acceptable for another purpose.
2.42 Furthermore, laws imposing valuation do not necessarily lend themselves to a common or unified valuation approach, even if one standard of value is commonly used. This difference in approach arises from the difference in statutory schemes. For example, the Full Federal Court recently cited with approval the following comments made by the New South Wales Court of Appeal in Leichhardt Municipal Council v Roads and Traffic Authority of New South Wales:
Matters of valuation turn in large measure on the precise statutory scheme. These schemes differ from one area of discourse to another. It is always important to commence with the precise words of the statute. There appears to be a tendency to take a judgment about one statutory regime and classify its conclusion as a “valuation principle” which is applied to any process of valuation, no matter how different the statutory regime may be.
The need to determine the value of assets arises in many different legal contexts. It is the context which determines the relevant principles of valuation to be applied. An assumption that there is in existence some abstract body of “valuation principles” applicable in all contexts, irrespective of the statutory s cheme or contractual provision, is liable to lead to error. Judgments in one context may prove instructive by way of an analogy when dealing with another context. Nevertheless, statutory differences must be borne in mind. The ultimate task must always come back to the application of the principles in the particular context…29
2.43 The IGT acknowledges that the above stakeholder concerns raised in relation to valuations have much broader relevance and are well beyond taxation specific matters.
2.44 There seems to be a lack of standardisation, as far as valuations are concerned, across the various regulatory regimes and commercial landscape. Where standardisation has occurred, it is limited to a particular field or regulation. However, there may be good reasons for differences in valuation methods or approaches for a given market or purpose.
2.45 It is beyond the scope of this IGT review to make specific recommendation for changes to a broad range of regulations and standardisation of valuations and valuers across different fields or industries. However, where valuations are required for regulatory or compliance purposes, the regulator should be mindful of the costs associated with valuations and should seek to minimise such compliance costs. For example, the regulator may consider leveraging off comparable valuations obtained for other purposes.
2.46 The remainder of the report makes observations and recommendations with respect to valuations as it relates to tax administration, including aspects of the tax laws. Improvements in the administration of tax-related valuations may prove to be useful in generating a broader debate on the valuation costs imposed by the various regulatory regimes and commerce.
5 IVSC, International Valuation Guidance Note 11, Reviewing Valuations (2007).
7 Spencer v Commonwealth (1907) 5 CLR 418.
8 IVSC, IVS Framework (2011) para .
10 Retail Leases Act 1994 (NSW) s 72AB(2).
12 These organisations are the Association of Taxation and Management Accountants, the Australian Property Institute, the Australian Valuers Institute, CPA Australia, the Institute of Chartered Accountants Australia and the Institute of Public Accountants.
14 See for example Soia v Bennett [No 5]  WASC 289 at 367.
17 Chartered Accountants Australia and New Zealand, 'Business Valuation' (undated) http://www.charteredaccountants.com.au/Industry-Topics/Business-valuati….
18 Above n 8, para .
19 Australian Securities and Investments Commission (ASIC), Regulatory Guide RG 111 Content of expert reports (October 2007) paras RG [111.62] and [111.63].
20 ASIC, Regulatory Guide RG 163 (December 2000) which refers to Re Btr Plc and Btr Nylex Limited v Westinghouse Brake and Signal Company (Australia) Limited; Ian Edric Prowse; Hawker De Havilland Limited and Australian Securities Commission  FCA 55 (21 February 1992) paras  and .
21 Ian Harris, Professor Michael Mainelli and Jan-Peter Onstwedder, 'Confidence Accounting: A proposal (Association of Chartered Certified Accountants, the Chartered Institute for Securities & Investment and Long Finance, 5 July 2012) p 7.
22 IVSC, Technical Information Paper 4 – Valuation Uncertainty (January 2014) para .
23 Ibid paras  and .
24 Ibid para .
25 A director valuation is performed by the director of a company for the purposes of applying the accounting standards in its financial statements.
26 Australian Accounting Standards Board (Cth), AASB Standard AASB 13 Fair Value Measurement (2013).
28 Above n 19, para [RG 111.11].
29 Leichhardt Municipal Council v Roads and Traffic Authority of New South Wales  NSWCA 353 at  and ; Commissioner of Taxation v Resource Capital Fund III LP  FCAFC 37 at .