Chapter 3 – Current law


3.1 Chapter 2 considered the commercial and tax significance of purchase price allocations. This chapter considers the legal constraints on allocations for tax purposes and the degree to which there is a requirement for consistent allocations.

Statute

3.2 Several provisions in the Income Tax Act 2007 require the amount allocated to taxable assets, by either or both of the vendor and purchaser, to be determined on the basis of market values.

Trading stock (broadly defined)

3.3 Section EB 24 applies to a person who sells trading stock along with other assets. It requires the amount apportioned to trading stock to reflect the respective market values of the trading stock and the other assets. It also treats the purchaser as adopting the allocation of the vendor. This ensures consistency in the allocation.

3.4 Trading stock for this purpose is broadly defined. It includes livestock, timber, anything acquired for the purpose of disposal, and land the sale of which is subject to tax. It does not include depreciable property or financial arrangements. With those exceptions, it seems to cover most if not all property the sale of which is subject to tax.

Depreciable property

3.5 Subsection EE 45(10) provides that an amount a person derives from the disposal of a depreciable item when that disposal occurs along with a disposal of other items (for example, in a sale of a business or a commercial property) is its market value. This requirement only applies to the vendor. Purchasers are entitled to claim depreciation for the cost of depreciable property, with no explicit statutory rule applying in the case of a mixed supply.

Financial arrangements

3.6 Sections EW 38 and EW 42 in the financial arrangements rules state that all disposals of financial arrangements for inadequate consideration are deemed to be for market value for the vendor and purchaser respectively. Therefore, neither party can allocate less than market value to financial arrangements in their tax returns. There is no explicit constraint on them allocating a greater amount, and no requirement for their allocation to be the same.

Case law

3.7 As a general proposition, taxpayers bear the onus of proof in relation to an allocation of the price in a mixed supply. There are a number of New Zealand cases dealing with such allocations:

  • Buckley & Young Ltd v CIR (1978) 3 NZTC 61,271. This case involved a single payment for the dual purpose of obtaining the employee’s resignation and for a restrictive covenant. The question for the Court was whether the expenditure should properly be treated as deductible or on capital account. The case established a number of relevant apportionment principles:
    • The onus is on the taxpayer to justify an apportionment if challenged by the Commissioner.
    • Such a justification is likely to require some reference to market value.
    • The apportionment should be objective. Absolute precision/scientific process is not required, but there has to be sufficient evidence to justify a conclusion that a particular part is actually attributable to a particular item.
    • It is not a question of what a reasonable and prudent taxpayer would have expended; it is what this particular taxpayer in fact paid. This implies that under the current law the taxpayer is not free to adopt whatever value they please, even if there is no specific statutory requirement to use market values in the circumstances.
  • Rusk v CIR (1986) 8 NZTC 5,128. This case involved a challenge by a taxpayer to the Commissioner’s allocation of value to timber in a sale of forestry land by the taxpayer where the allocation of the price between land and timber was not agreed between the parties. The taxpayer was successful in arguing that the Commissioner’s allocation gave too high a value to the timber, though the amount substituted by the Court appears to have been higher than that argued for by the taxpayer. It seems likely from the case that the value adopted by the purchaser was different from that approved by the Court.
  • Edge v CIR [1958] NZLR 42. This case involved a mortgagee sale to the taxpayer of a farm as a going concern, with no agreed allocation of the purchase price. Included in the assets sold was livestock which had been valued a week before the sale at £6,471. The taxpayer sought to treat this amount as the purchase price of the stock. The Commissioner successfully challenged this, on the basis that the sale was at a discount, and the discount needed to be applied to the trading stock, just as it applied to the land and plant. Accordingly, the purchaser was only allowed a deduction for trading stock of £4,711.
  • Hansen v CIR [1973] 1 NZLR 483. This case involved a sale of a farm as a going concern, where the parties had agreed an allocation of £27,750 to livestock. The purchaser nevertheless obtained a valuation of the livestock which showed a value of £82,645. The vendor returned £27,750 as income from sale of the livestock, but the Commissioner challenged this figure (under a predecessor to current section EB 24) on the basis that it was not market value. The Privy Council upheld the Commissioner’s assessment that the vendor should be taxed on £82,645.

3.8 The Hansen case is particularly useful in demonstrating that in determining the sale value of the items sold in a mixed supply for tax purposes, an agreed allocation of a global price between arm’s length parties is not accorded the same respect as a series of individual and independent sales of the same items.

Summary

3.9 There are statutory provisions for the allocation of the price in a mixed supply to trading stock, depreciable property and financial arrangements, requiring market values to be used by at least the vendor, and some requiring consistency between the vendor and purchaser. However, there is no consistency of rules across the asset categories.

3.10 Several principles have emerged from case law that highlight the important considerations in determining the validity of an allocation in relation to trading stock.

3.11 Although these principles are helpful, the lack of consistency in the statutory language has given rise to some problems in practice, as discussed in the next chapter. Officials therefore consider that the existing provisions alone cannot be relied on to achieve the desired policy outcomes.

Feedback

Officials seek feedback on:

  • Whether this chapter correctly summarises the relevant law and practice.
  • Are there relevant legal or practical considerations our summary has omitted?