Selling or buying a business? New tax rules for allocation of purchase price

Greg Neill
New tax rules are set to be introduced for parties involved in the sale of business assets and the allocation of the agreed purchase price across such assets.

Typically, a business sale will involve several different categories of assets including trading stock, depreciable assets and goodwill. Each asset category requires different income tax consequences to be considered and therefore the allocation of the purchase price to each asset category will be important for the parties concerned.

There will generally be a tension between the purchase price the vendor wants to attribute to the different assets being transferred compared to what the purchaser wants to attribute. For example, a purchaser will generally want to allocate a higher proportion of the purchase price to assets that are depreciable property to increase the on-going depreciation deductions, and less to non-deductible items such as goodwill. However, vendors generally prefer to allocate less value to depreciable property to minimise depreciation recovery income and allocate more value to non-taxable capital items such as goodwill.

From a tax perspective, it is best practice for the parties to agree how the purchase price for the assets should be allocated across the various categories of assets concerned. This may be done in the sale and purchase agreement itself or subsequently by a separate side letter or agreement. It is not compulsory to agree an allocation of the purchase price but, if the parties don’t, they run the risk that each party will not allocate in the same way and consequently adopt conflicting tax positions. 

The Taxation Bill Annual Rates for 2020–21, Feasibility Expenditure, and Remedial Matters was introduced in June. The Bill will make it compulsory for each party to adopt an agreed allocation where one has been included in the agreement. In addition, if no such allocation has been agreed, the vendor will be required to determine the allocation and notify the purchaser and Inland Revenue. It will therefore be in the interests of a purchaser to have an agreed allocation in the document. Inland Revenue will have the ability to reject the allocation if they conclude it doesn’t reflect the relative market values of the assets and request the parties adopt a different allocation.  

It is proposed the application of the new rules will be subject to certain de minimis thresholds. For example, the rules will not apply to a transaction if the total purchase price is less than $1 million. The principles outlined above nevertheless remain important in this context. The new rules are expected to apply to sale transactions entered into from 1 April 2021. 

If you would like to know more about the tax rules relating to business asset transactions, please contact the Crowe Tax Advisory team.
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