If you are looking to enter into a sale or purchase transaction for a property or a business, it is important that you are aware of the new purchase price allocation rules that came into effect on 1st July and apply to all qualifying agreements entered into from this date.
The two key implications of the new rules are as follows:
1. Where parties have agreed on a purchase price allocation and the agreement is documented, this allocation must now be used by both parties when filing their tax returns.
2. Where the purchase price crosses a relevant monetary threshold, purchase price allocation is now required by law and both parties must use the same allocation.
What transactions are affected?
Typically transactions affected by these new rules involve the sale of a combination of supplies being:
1. Revenue account property (such as trading stock);
2. Depreciable property (such as plant or machinery); and
3. Capital account property (such as land, buildings or goodwill).
Affected transactions may include the sale and purchases of commercial property, businesses, lifestyle blocks and farms. In rare cases residential property transactions may also be affected.
What is purchase price allocation?
Purchase price allocation refers to the breaking down of the sale price into distinct amounts for each asset class. This allocation affects both the tax paid and the tax benefits received because the tax treatment for each class of asset can differ.
The rules require the purchase price to be allocated between the following classes of assets (as relevant):
1. Trading stock;
2. Buildings;
3. Depreciable property other than buildings;
4. Financial arrangements;
5. Property for which the sale of does not give rise to taxable income for the vendor or the purchaser (such as land or goodwill); and
6. Timber (or the right to take timber).
When is purchase price allocation required?
Allocation is now required in the following scenarios:
1. The sale and purchase of mixed supplies with a purchase price of $1,000,000.00 (including GST) or higher.
2. The sale and purchase of residential property with a purchase price of $7,500,000.00 (including GST) or higher.
Should the parties fail to agree on a price allocation, the vendor will have the right within three months of the settlement date to decide the allocation unilaterally. This allocation must then be notified to both the purchaser and to IRD.
Should the vendor fail to make the allocation within the three month timeframe, the right passes to the purchaser. If the purchaser then also fails to notify the vendor and the IRD of an allocation, the IRD will make the allocation themselves.
Should a unilateral allocation occur, the key implications are as follows:
1. There is no right to contest the allocation.
2. The vendor loses the opportunity to claim a loss on disposal of assets that are worth less than their book value at the time of settlement.
3. If a party other than the vendor makes the allocation, it may allocate a higher value for the vendor’s depreciable assets than that recorded on the vendor’s books. This means that the vendor will have to account for depreciation recovered on those items when its tax return is completed.
Advice
Before you enter into a commercial agreement, we suggest that you obtain both tax and legal advice to ensure that you understand all potential tax implications.
We recommended that you discuss and agree on a purchase price allocation during the negotiation or due diligence phases. This avoids any potential disagreements that may arise later when the transaction is less malleable. It is also good practice to document how any potential allocation adjustments are to be decided once the agreement is executed.
If the purchase price of a business or commercial property is $1,000,000.00 (including GST) or higher (or if you are dealing with residential property with a total price of $7,500,000.00 (including GST) or higher), the Auckland District Law Society and the Real Estate Institute of New Zealand have released helpful new addenda to be attached to their standard agreements dealing with this issue. These addenda also provide for a more balanced procedure for agreeing on an allocation when the vendor would otherwise have the right to unilaterally decide the allocation.
If you would like to discuss the implications of these new rules on you, feel free to get in touch with the team at Harmans.
The information contained in this site is provided for informational purposes only, and should not be construed as legal advice on any subject matter.
