New rules when buying or selling a business or commercial property

New purchase price allocation rules apply when buying or selling a business or commercial property

New tax rules came into effect on 1 July 2021 regarding the allocation of the asset purchase prices for tax purposes.  Don’t be fooled into thinking that this is a matter that can be dealt with by the accountants later; the impacts of these rules will have a very real result on the bottom line.

To achieve the best outcome, it is important that parties are going into these transactions with a good understanding of their position under the purchase price allocation rules and what each party’s ideal outcome is when negotiating the deal, rather than waiting until after settlement.

The rules were introduced to address Inland Revenue’s concerns that some buyers and sellers have been avoiding an agreed allocation in sale and purchase agreements and instead allocating different prices to the same asset in their tax returns, resulting in a (tax advantageous) mismatch.  Under the new rules, the parties either have the option of agreeing an allocation which will be applied for tax purposes by both parties, or if no agreement is made, then a legislative process applies for determining the allocation.

Transactions subject to the new purchase price allocation rules

The new purchase price allocation rules apply to agreements entered into from 1 July 2021 onwards where the transaction involves the supply of two or more of the following categories of assets:

• Trading stock (excluding timber or the right to take timber)
• Timber or the right to take timber
• Depreciable property, excluding buildings
• Buildings that are depreciable property
• Financial arrangements
• Non-tax base property – or property that does not result in assessable income for the vendor, or deductions for the purchaser

Practically, the rules will most commonly apply to business asset sales (not the sale of shares in a company), commercial property, farms and similar transactions.  However, there will be situations where the rules apply outside these typical scenarios – the sale of bare land with standing timber is one example.  Note also that the asset categories noted above are defined in the tax legislation, rather than how assets are described in the sale and purchase agreement.

There is a de minimis for transactions where the total consideration is less than $1 million, or residential land where the consideration is less than $7.5 million.

How will the new rules apply?

Where the buyer and seller agree on amounts allocated

The first and most straightforward option is to agree the allocation – ideally while negotiating the deal, but parties have until either of them files a tax return for the period in which the transaction occurs.

Where the parties agree on an allocation of the purchase price between the categories of assets supplied (outlined above) these values are required to be used by both parties for tax purposes.  Notification of the agreed allocation is not required to be provided to the Commissioner.  However, if the Commissioner considers the agreed amounts do not reflect the market value, she may override the allocations agreed and specify what values are to be used by each party, subject to some specific de minimis thresholds.

Where buyer and seller do not agree on amounts allocated

The legislative process applies where the buyer and seller do not agree on the amounts allocated (and the transactions exceed the de minimis level of $1 million or $7.5 million for residential land).

This process states that the purchase price will be allocated in the following manner:

• The vendor has the first option to specify the allocation within three months of the sale date. The vendor’s allocation is binding on both parties and the vendor must notify both the purchaser and Inland Revenue of the amounts.  The allocation cannot result in a loss on sale to the vendor.
• If the vendor does not make an allocation within three months, then the purchaser has three months to make the allocation (i.e. within six months of the date of sale). Again, the allocation is binding on both parties and notification must be provided to the vendor and Inland Revenue of the allocation made.
• If the vendor or purchaser fail to make an allocation within the specified time periods then the purchase price allocation falls to the Commissioner. The Commissioner is not required to make an allocation however, and if no allocation is made then the purchaser is denied (deferred) any tax deductions until an allocation is confirmed.  There is accordingly an incentive to either agree upfront, or to make an allocation within the specified time periods.

It is possible for the parties to agree an allocation after following the process above (providing neither party has filed a tax return), in which case the allocation will override the unilateral allocations made under the legislative process.

The Commissioner retains her right to challenge any non-market allocations in either an agreed allocation scenario or where values are determined in accordance with the legislative process above, subject to some specific de minimis thresholds.

How do you ensure you comply with the new rules?

As Inland Revenue says: “It’s best to talk early with a tax professional to make sure you get the details of your sale right from the start,” so do get in touch with us early on if you’re considering buying or selling a business.

If you have questions about how the new price allocation rules may affect the sale of your land or business, our Tax Advisors can help