From 1 July 2021 new rules require both parties to a sale and purchase of two or more assets with different tax treatments to allocate the same amounts for each asset.
Background to the tax change
When buying or selling a business the parties typically focus on the total sale price, with less regard to the value of the specific assets making up the sale price. A business sale usually comprises fixed assets such as plant and equipment, stock held for resale, and intangibles such as “goodwill”. The value of the components should be at “market value”.
The sale of goodwill is not taxable to the vendor and non-deductible to the purchaser. Therefore, vendors prefer a higher goodwill value while purchasers prefer a lower goodwill value. If the allocated values were not stipulated in the sale and purchase agreement, then so long as both buyer and seller could support their preferred market valuations, they allocated the total sale price accordingly for tax purposes.
This created an opportunity for both buyer and seller to allocate the sale price differently to their own best tax advantage.
What is changing?
IRD are tightening those rules.
After 1 July 2021 the seller will have 3 months from the date of settlement to determine an allocation and notify this to both the buyer and Inland Revenue. If after 3 months the seller has not made a notification, then the buyer has 3 months to notify the seller and Inland Revenue.
Notifications to Inland Revenue can be made through myIR and should include the phrase “Purchase price allocation” in the subject line. The notification should include both parties’ names, IRD number, date of agreement and settlement, transaction value and price allocation at the level of asset classes that are subject to particular income or deduction rules.
When neither party determines and notifies an allocation, then IRD may determine the allocation.
If the parties do not agree an allocation and record it in a document before the first tax return for the transaction is filed, the allocation will be determined by a notification made by one of the parties, or IRD.
However, a unilateral allocation does not need to be notified if the total consideration for the purchased property is less than:
- a) $1 million, or
- b) $7.5 million, if the only purchased property is residential land (which includes residential buildings) together with its chattels.
Where the parties have not agreed an allocation, and neither party notifies a unilateral allocation (filing of a return containing an allocation is not notification of an allocation):
- the IRD may determine the allocation,
- the purchaser is not entitled to any deductions for the purchased property until the IRD notifies an allocation to the purchaser.
IRD cannot challenge an allocation to an item of depreciable property if its original cost is less than $10,000, the total amount allocated to the item and any identical items is less than $1 million, and the amount allocated to the item is no less than its tax book value and no greater than its original cost.
This can get complicated!
If you are buying or selling “business assets” negotiate and specify the allocation prices in the Sale and Purchase agreement (when both parties are keen for the agreement to become unconditional). Allocating the values in the agreement reduces uncertainty and the simplifies tax compliance for both parties.
“Let us never negotiate out of fear.
But let us never fear to negotiate.”
John F Kennedy