Currently, if you enter into a sale and purchase agreement for the sale of business assets, there is no standard practice for how the price should be allocated to the assets. For example, a single price may be agreed for all assets, or the agreed price might be allocated on a line by line basis to each asset.
If the purchase price is not allocated with sufficient detail, inconsistent outcomes can arise when each party takes a tax position.
Take, for example, a business comprised of land and depreciable property that is being sold for $800k. The vendor’s fixed asset register includes depreciable property that originally cost $400k that has been depreciated down to $150k, and land that originally cost $350k.
The vendor takes the view that the depreciable property was sold for $100k and claims a $50k loss on disposal. The $350k gain on the sale of the land is treated as a non-taxable capital gain.
Conversely, the purchaser treats the depreciable property as purchased for $250k (thereby providing a future depreciable cost base of $250k), allocating the remaining $550k purchase price to the land.
The mismatch between the consideration adopted by the vendor and purchaser in relation to the depreciation property will mean their total tax deduction is overstated by $150k. The difference in value is funded by the Government – it is ‘out of pocket’.
To avoid this outcome, draft legislation was introduced in June 2020 that prescribes how assets are to be treated on sale. The proposed legislation provides an ordered approach:
- If the parties agree a purchase price allocation, they must both follow it in their tax returns.
- If the parties do not agree an allocation, the vendor is entitled to determine it, and must notify both the purchaser and IRD of the allocation within two months of settlement date. However, the allocation to taxable property cannot result in additional losses on the sale of that property.
- If the vendor does not make an allocation within the two-month timeframe, the purchaser is entitled to determine the allocation, and notify the vendor and IRD.
- If no allocation is made by either party, the vendor is treated as selling for market value, but there is a risk the purchaser is deemed to acquire property for nil.
A de-minimis has also been proposed – if the parties do not agree an allocation, the rules will not apply to a transaction if the total purchase price is less than $1 million, or the purchaser’s total allocation to taxable property is less than $100,000.
Irrespective of the agreed values, IRD may still challenge them if they consider they do not reflect market value. The rules will apply to sale and purchase agreements entered into from 1 April 2021.