Purchase Price Allocation proposals
Purchase Price Allocation proposals
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 proposals in more detail
The Issues Paper proposes:
- Both vendor and purchaser would be required to use the same allocation of the total purchase price in all cases.
- A hierarchy of allocation rules:
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 party not making the allocation would be unable to challenge it. However, if contrary to the proposal, a challenge was to be allowed, the Issues Paper states that it would be a challenge between the parties and not with Inland Revenue.
- Proxy values, for example, tax book value or cost, may be available under certain circumstances.
- The Commissioner will retain the ability to dispute an allocation if it does not reflect (her view of) market values. Parties following the proposed allocation rules are not necessarily protected from challenge by Inland Revenue. However, the proposals are expected to provide “practical certainty” because it will be difficult and uneconomic for Inland Revenue to challenge allocations in most cases. Therefore, high value and high risk (for example, where a tax exempt purchaser or vendor is involved) situations are likely to be most at risk of challenge.
- A “de minimis” for low value transactions may be available. The proposed level is not specified but there is an example where the total amount allocated to deductible/depreciable items is less than $50,000.
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.
Why the need for change?
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.
Our initial comments
The proposals are a significant shift in how tax impacts on the commercial deal making process. It raises for us a number of questions:
- The proposal is intended to change behaviour by making the parties agree.
— 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?
- The vendor and purchaser may have different views of the assets. Compare the fixed asset schedule for a vendor with a purchaser’s fixed asset schedule. They will be different because the vendor may have built up the assets over time while the purchaser acquires the end result.
— How will allocations work in this scenario?
— Do the purchaser’s fixed assets have to be matched with the vendor’s fixed asset schedule?
- It is likely that the acquisition will need to be “fair valued” for financial reporting purposes. This does not always match the purchase price allocation. Will the parties having to agree an allocation value make the financial reporting process easier (because the fair value and purchase price will be better aligned)?
- The Commissioner’s power to dispute allocations allows the Commissioner’s view of the market value to be substituted for the agreed allocation. This is likely to be in situations where one of the parties to the transaction does not care. (For example, a sale by a vendor holding the asset on capital account to a purchaser acquiring on revenue account, and vice versa, or transactions between tax exempt/tax loss and tax paying entities).
— 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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