Chapter 2 – Issues with mixed supplies and allocation of purchase price

2.1 The most common types of mixed supplies appear to be sales of land and buildings (both commercial and residential) and sales of businesses. A less common example is a sale of forestry land, where the bare land may be on capital account, but the timber is always on revenue account. Essentially, any time a person sells or buys, in a single transaction, two or more items with different tax treatments, there is a need for an allocation of the consideration between those items.

2.2 Although this allocation is required for income tax and often accounting purposes, it generally has no, or little, other commercial significance. It does not affect the amount payable, nor does it affect the manner or timing of the payment. It is therefore possible for the parties to agree it in their transaction documents, or to be silent about it.

2.3 The example illustrates the significance of the tax allocation.


Suppose A Co has agreed to sell its business to B Co. The assets include land and buildings (all acquired after May 2010), fit-out and other depreciable property, receivables and trading stock. The purchase price for all of the assets on a going concern basis is $15 million. Assume for simplicity no liabilities are to be assumed by B Co so the consideration provided is limited to the cash price.

A Co is entitled to a deduction for the depreciated cost of its fit-out and other depreciable property, and the cost of its receivables and its trading stock. It will only be taxable on the portion of the sale price attributable to these items (in the case of depreciable property, up to the original cost of the property), and not the portion attributable to the land and buildings, or goodwill. Accordingly, the amount retained by A Co after tax will be twenty eight percent higher to the extent it is allocated to the land and buildings or goodwill than if it is allocated to the other items.

Suppose A Co believes that an appropriate allocation of the price is as set out in the following table. This table also shows the tax effect of the allocation for A Co.

A Co Cost*
A Co Profit
A Co Tax
Land and buildings 3,000 2,000 1,000 0
Depreciable property 6,000 6,000 0 0
Receivables 1,000 1,200 (200) 56
Trading stock 1,500 1,400 100 (28)
Goodwill 3,500 0 3,500 0
Total 15,000 10,600 4,400 28

* or tax book value, where relevant

B Co’s position is generally the opposite of A Co’s. The tax outcome of the transaction is less favourable for B Co as the amount allocated to the land and buildings and goodwill increases, because B Co can claim no deduction for those items. In other respects, their interests are not opposed. For example, B Co will be better off allocating the price to fast-moving trading stock than to depreciable assets, since the deduction for trading stock will be able to be claimed sooner than the deduction for the cost of depreciable assets. That allocation will therefore maximise the present value of its tax deduction. From A Co’s perspective, the allocation between trading stock and depreciable property is generally irrelevant, since it will be taxable either way (unless the amount allocated to depreciable property exceeds its original cost).

Suppose then that B Co believes a greater amount should be allocated to depreciable property and receivables, and less to goodwill. If this allocation was required for A Co, the tax payable for A Co would be:

A Co Cost
A Co Profit
A Co Tax
Land and buildings 3,000 2,000 1,000 0
Depreciable property 9,000 6,000 3,000 (840)
Receivables 1,200 1,200 0 0
Trading stock 1,500 1,400 100 (28)
Goodwill 300 0 300 0
Total 15,000 10,600 4,400 (868)

This allocation would decrease A Co’s after-tax return from the transaction by $896,000. It would increase B Co’s after-tax return from the transaction by the present value of the additional deduction for depreciable property and trading stock. This will be less than $896,000, by reason of the time value of money reducing the value of the depreciation deductions.

Generalising from the example

2.4 Vendors are better off after tax if the global consideration in a mixed supply is allocated so that it is not taxable. This will generally mean allocating it to capital assets or goodwill, rather than to revenue account assets such as inventory, timber, patents or consumables. Of course, if all of the vendor’s assets are on capital account, or they are all on revenue account, or if the vendor is tax exempt, there is no tax advantage to the vendor from the allocation.

2.5 Purchasers benefit if the consideration is allocated so that it is deductible as soon as possible. This will generally mean allocating it:

  • first to revenue account assets such as trading stock which will be sold within a short period or to depreciable assets with a short depreciable life;
  • then to revenue account assets which may be sold after a longer period or depreciable assets with a longer depreciable life;
  • away from non-deductible items like land, buildings and goodwill.

2.6 It is generally assumed that the natural commercial tension between the parties ensures that in an arm’s length sale, an agreed allocation, that must be followed for tax purposes, will reflect market values. The tax status of depreciable property means that this will not always be the case.

The special case of depreciable property

2.7 Depreciable property raises an additional issue. Consider the vendor’s position first.

2.8 To the extent that the allocation does not exceed the cost price of the asset to the vendor, the vendor should view an allocation to a depreciable asset in the same category as an allocation to a revenue account asset, such as timber or trading stock. On sale, the vendor will be taxable on the amount allocated to the asset up to the amount of the original cost (with a deduction for any remaining undepreciated cost).

2.9 Any excess of the amount allocated over that original cost is not taxable to the vendor.[4] Accordingly, allocation to depreciable property in excess of the vendor’s original cost has the same effect for the vendor as an allocation to land held on capital account or goodwill.

2.10 The purchaser’s position is not bifurcated in this way. Provided the purchaser is not associated with the vendor, it will be entitled to a deduction over time for the whole of the consideration, including the amount that is not taxable to the vendor because it exceeds the vendor’s original cost.

2.11 Accordingly, an allocation to a depreciable asset of an amount in excess of its original cost to the vendor gives a tax deduction to the purchaser at no cost to the vendor (to the extent of the excess above cost). It may be beneficial, for example, in the sale of land, buildings and fit-out, for the parties to allocate to the fit-out an amount more than the cost of the fit-out to the vendor, since that amount would be deductible to the purchaser and not taxable to the vendor.

2.12 In the example considered above, suppose that the original cost of the depreciable assets to the vendor was $8 million. If the vendor agrees to accept the purchaser’s allocation of $9 million to that property, rather than insisting on its own $6 million valuation, the effect will be to:

  • increase the vendor’s income from sale by $2 million; and
  • increase the purchaser’s deductions by $3 million.

2.13 It is therefore likely that the $9 million allocation will result in less tax being paid overall than the $6 million allocation, though the benefit will accrue entirely to the purchaser and the cost will be incurred entirely by the vendor. It is possible that the vendor might be more willing to adopt the purchaser’s allocation if the purchaser is prepared to share some of the benefit of the allocation in the form of an increased purchase price.

2.14 The possibility of depreciable property having a value greater than cost has increased considerably since fixed life intangible property and software became depreciable. Such property is often self-created, which tends to produce a very low cost-base due to a failure to accurately capitalise expenditure. However, it can have a very high value. The asymmetry between the vendor’s treatment (on capital account, to the extent it exceeds cost) and the purchaser’s (depreciable, sometimes over a relatively short period) means that the parties may have a common interest in overstating the amount allocated to such property.

2.15 There may also be other situations when the vendor is agreeable to accepting an allocation that is tax favourable for the purchaser because there are no implications for them, such as when the vendor is exempt from income tax.

Inconsistent allocations

2.16 The discussion to date assumes that only one allocation applies, to both the parties. However, if each party can adopt its own allocation, there is no tension. In the example, the vendor can treat itself as having sold depreciable property for $6 million, while the purchaser treats itself as having acquired the same property for $8 million. This is good for the vendor and purchaser, but not so good for the rest of the community, since the effect of the inconsistent allocations is that the sale of the property reduces total taxable income by $2 million over time.

Concluding remarks on the significance of allocation for tax

2.17 The discussion so far has made the point that while an allocation of the global consideration is of little or no commercial significance in most sales of business assets, the allocation adopted by a party in its tax return will often have tax consequences. Chapter 3 considers the law governing how an allocation should be made.


[4] There is an exception for patents, where the whole amount payable is taxable to the vendor – see the Income Tax Act 2007 section CB 30.