The proposals effectively "outsource" Inland Revenue's review of purchase price allocations to the parties.
Inland Revenue has released Purchase Price Allocation: An officials issues paper.
Inland Revenue’s concern is that vendors and purchasers can take different positions on the value of assets sold, creating a potential for tax mis-matches: the vendor’s valuation may result in less taxable income being returned, while the purchaser’s valuation may result in a higher depreciation base or deductions.
The Issues Paper proposes as a solution that the parties should agree the allocation of the purchase price to the various items sold (based on market values). If they agree, the parties must use the agreed values in their tax returns.
If the parties do not agree, the vendor is able to choose the allocation and must notify the purchaser and Inland Revenue. If the vendor does not do this, the purchaser can allocate the purchase price (and must notify the vendor and Inland Revenue). Both parties must use the chosen allocation.
The Issues Paper proposes that Inland Revenue will retain the ability to dispute the purchase price allocation, if it considers the allocation to not be market value based or is otherwise inappropriate.
The Issues Paper proposes:
o If the parties agree on an allocation, the tax returns for each must be filed on that basis.
o If the parties do not agree, the vendor’s allocation must be used for tax purposes.
- The vendor will be required to disclose their allocation to the purchaser and Inland Revenue within a specified timeframe, e.g. 3 months of the assets being treated as disposed of, for tax purposes.
- If the vendor does not provide an allocation, the purchaser can make the allocation of the purchase price. This needs to be provided to the vendor (who is required to use it) and Inland Revenue.
The proposals are expected to be included in a Tax Bill in the first half of 2020 (so expected enactment by the end of 2020, with possible application from 1 April 2021).
Submissions are due by 14 February 2020.
Past commercial practice has been for parties to agree the deal – what is being sold and for how much. Each party has then considered how the purchase price should be allocated to different items. Most commonly, for a sale of land and buildings, the purchaser has allocated the price to depreciable items such as fixtures and fittings and plant rather than non-depreciable buildings and land.
This allocation has not always matched the vendor’s treatment of the same items.
A non-taxable but depreciable/deductible result may arise for the different parties.
This tax mis-match has attracted Inland Revenue’s attention and scrutiny. The proposals aim to prevent this mis-match occurring in future.
The proposals have the potential to affect every commercial transaction involving business assets. (A share purchase would generally be outside the scope.) It will require the parties to turn their mind to the tax values to be attributed to the different assets as part of the commercial deal making process.
The agreed position will affect the tax payable by the vendor on the sale and the purchaser’s future tax deductions. This in turn will impact the commercial deal as it will affect the after-tax value of the transaction.
This tax result may affect the price and, ultimately, whether the deal is done at all.
The proposals are a significant shift in how tax impacts on the commercial deal making process. It raises for us a number of questions:
— Is too much power given to the vendor because, without agreement, the vendor has the ability to unilaterally allocate the price?
— How practical is agreeing tax allocations in the deal process?
— How will allocations work in this scenario?
— Do the purchaser’s fixed assets have to be matched with the vendor’s fixed asset schedule?
— How common are these problems in practice?
— Should only tax avoidance scenarios be at risk of being challenged? The current power would need to be narrowed, if that is the case.
— There will generally not be a single market value for an asset. Assuming the valuations lie within a continuum, what will be the trigger for the Commissioner to challenge?
— Would removing the Commissioner’s power to challenge (and change) valuations be an acceptable trade-off for the vendor and purchaser having to agree values (so that each party has tax certainty)?
These are a mix of practical and tax policy questions. In short, they ask how much will the proposals affect how you commercially do the deal?
The answer requires careful consideration to determine whether the proposals are sensible and acceptable.
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