New Purchase Price Allocation Rules
Property and Business Transactions
When looking to enter 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 2021.
What is purchase price allocation?
Purchase price allocation refers to the breaking down of the sale price into distinct amounts for each asset class. Because the tax treatment for each class of asset can differ, the PPA affects both the tax paid, and the tax benefits received.
The rules require the purchase price to be allocated between the following classes of assets (as relevant):
• Trading stock
• Depreciable property other than buildings
• Financial arrangements
• 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
• Timber (or the right to take timber)
The two key implications of the new rules are as follows:
1. Where parties have agreed on a purchase price allocation and this 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?
Transactions that are affected by these new rules involve the sale of a combination of supplies being:
• Revenue account property (such as trading stock);
• Depreciable property (such as plant or machinery); and
• Capital account property (such as land, buildings or goodwill).
Affected transactions can include the sale and purchases of commercial property, businesses, lifestyle blocks and farms. In some cases, residential property transactions are affected.
Purchase Price 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 (GST inclusive) or higher.
2. The sale and purchase of residential property with a purchase price of $7,500,000.00 (GST inclusive) or higher.
Should parties fail to agree on a price allocation by settlement, the vendor has the right within three months of the settlement date to decide the allocation alone, and must then notify the purchaser and IRD of the allocation they have chosen.
Should the vendor not make the allocation within the three-month timeframe, this 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 their tax return is completed.
Real Estate and the PPA
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 new addenda to be attached to their standard agreements dealing with this issue. These addenda also provide a more balanced procedure for agreeing on an allocation when the vendor would otherwise have the right to unilaterally decide the allocation.
Blackwood Montagna’s advice:
It is recommended that purchase price allocation are discussed and agreed upon a during the negotiation or due diligence phases. It is also good practice to document how any potential allocation adjustments are to be decided once the agreement is executed. This will avoid any potential disagreements that could arise later.
Before you enter into a commercial agreement, our suggestion is that both parties obtain advice from your accountants and lawyers. Ensuring that you understand all potential tax implications will save many headaches down the road and leave you clearer on how to negotiate the best outcome for both parties.
If you would like to discuss the implications of these new rules on you, feel free to get in touch with the team at Blackwood Montagna.