When purchasing a business or farm it is very common for the business or farm to contain a mixture of property, such as depreciable property (e.g. plant & equipment), non-depreciable property (e.g. land), revenue account property (e.g. trading stock & livestock) and capital account property (e.g. goodwill).
On 10 December 2019 Inland Revenue issued an issue paper on the allocation of the purchase price of assets.
An issue that Inland Revenue has identified is how to allocate the agreed purchase price across the mixture of property. This allocation generally has minimal commercial significance but can have a material impact on both the vendor and purchaser’s tax obligations.
Whilst in most cases it is necessary for market values to be used when determining values of property, there are no rules that require the vendor and the purchaser to use the same values. In some cases, the vendor and purchaser may have quite different tax outcomes. Herein lies the issue Inland Revenue is concerned about.
To remedy this issue, Inland Revenue has proposed the following rules for transactions involving a mixture of property:
- In all cases the vendor and purchaser will be required to use the same allocation of the total purchase price across the different types of property;
- That this is achieved by a hierarchy of rules – if the parties:
- Agree on an allocation, both must file their returns using this allocation;
- Do not agree on an allocation, then:
- The purchaser must use the vendor’s allocation. There would be a requirement for the vendor to disclose this allocation to the purchaser and Inland Revenue within a specified period, for example, within three months of settlement;
- If the vendor fails to provide the allocation, the purchaser may make the allocation. This would be binding on the vendor and be required to be provided to them and Inland Revenue.
- Those allocations must be based on relative market values, except possibly where there is a disagreement on the value of the depreciable property. In this case depreciated cost or original cost may be allowed to be adopted instead;
- It may be appropriate to have a de minimus for these suggested changes.
As it currently stands, the proposal puts more power in the hands of the vendor. Therefore, if no changes are made to these proposals it would be important for a purchaser to agree to the values of the property before entering into a sale and purchase agreement. Otherwise, they may be stuck with the vendor’s values that may not be favourable.
We will provide an update on these proposals in a future edition of topical taxes once we learn more.
Craig is an expert in reviewing and analysing client’s financial statements and tax returns and provides specialist taxation advice, you can always expect Craig to have his finger on the taxation pulse.