New Purchase Price Allocation rules from 1 April 2021

Tuesday 16 February, 2021

Are you planning on buying or selling a business? The IRD has changed the rules around how the purchase price is allocated to business assets to avoid buyers and sellers “gaming the system”.

Different asset allocations have different tax consequences

When selling land and buildings or a business, how the purchase price is allocated between the business assets will have different tax implications for the buyer and seller.  In some cases, it was possible for buyers and sellers to allocate different prices to the same assets, to each maximise their tax advantages, resulting in a tax ‘mis-match’ between the buyer and seller.

Generally, in a sale of land and buildings, the buyer will gain a greater tax advantage by allocating the purchase price to depreciable items, such as fixtures, fittings and plant, rather than non-depreciable items such as buildings and land.  Conversely, the seller obtains a greater tax advantage by selling depreciable assets at their book value.

However, for a business sale, a seller typically wants to allocate less value to depreciable property, and more value to non-taxable capital items like goodwill.  The opposite will be true for a buyer who will want to allocate a higher allocation to depreciable property, and less to non-deductibles like goodwill.

Tax ‘mis-match’ detrimental to New Zealand

In December 2019, IRD proposed prescriptive new rules to address a situation it saw as detrimental to New Zealand’s tax base. The new rules will require the parties agree a consistent allocation of the purchase price based on market values, avoiding the existing tax ‘mis-match’. The new rules seek to strike a fair balance between the parties, while adhering as closely as possible to ‘market’ values.

The new rules will apply to both businesses and commercial property (non-residential property) over $1m, or where the buyer’s total allocation to taxable property is more than $100k.  The new rules apply to contracts entered into from 1 April 2021. In most cases it will not apply to the sale of shares. The new rules are a significant shift in the tax implication on commercial dealings between buyers and sellers.

The new rules: who decides the value?

The new rules are as follows:

• If the parties can agree an allocation, they must follow it in their tax returns;
• If the parties do not agree an allocation, the seller is entitled to determine the allocation, and must notify the buyer and IRD of this within two months of the change of ownership of assets (i.e., completion date);
•  If the vendor does not make an allocation within the two-month timeframe, the buyer is entitled to determine the allocation, and must notify the seller and IRD (with no time limit applying to its notice);
• If no allocation is made by either party, the seller will be treated as disposing of the property at market value, and the buyer is treated as acquiring the property for nil consideration.

IRD can challenge an allocation if it considers the allocation does not reflect ‘market value’ or is otherwise inappropriate.

How do you avoid getting caught out by the new rules?

1. Seek tax and legal advice at the start of your negotiations.
2. Agree price allocations or valuation methodology early. This is best achieved in a Heads of Agreement at the outset of negotiations. Alternatively, if possible, vendors can set this out in marketing or sales material.  Failure to do so may lead to a headache down the track which could potentially stifle the sales process.
3. Best practice is to try and agree a price allocation between the buyer and seller.  If no allocation is made, this may create an unfavorable tax position for a buyer and potentially lead to them having no depreciable assets.
4. Consider obtaining an independent valuation of key assets to support the allocations agreed in order to minimise the likelihood of any challenge by IRD.
   
   

If you have concerns about how the new price allocation rules may affect the sale of your land or business, our Commercial Property experts can help.