Chapter 4 – Issues arising in practice
- Inconsistent valuations
- Consistent valuations not within a market range
- No explicit market value requirement for a purchaser of depreciable property
- Place of anti-avoidance rules
4.1 In many mixed supplies the vendor and purchaser agree an allocation to depreciable property, financial arrangements and trading stock using relative market values and, follow it in their respective tax returns. Discussions with advisors suggest that this is best practice. Officials expect that it will become more common if the proposals in this paper are enacted.
4.2 However, there is also no doubt that this practice is far from universal. The parties may prefer not to agree an allocation, on the basis that this gives them freedom to make their own assessments of value, and scrutiny from the Commissioner is unlikely to occur or, if it does occur, to result in any adjustment even where there is inconsistency.
4.3 In some cases, for example, vendors treat depreciable fit-out as sold for its depreciated value, whereas purchasers treat it as acquired for a much higher value. In others the lower vendor valuation of depreciable property may result from the parties employing separate valuers. The difference in valuation of the fit-out is compensated for by the parties taking correspondingly different views on values for the land or building, which generally has no impact on tax.
4.4 In other instances, the Commissioner is aware of a purchaser in a mixed supply agreeing to an allocation, but then taking the view that the allocation should not be followed for tax purposes because it was much lower than indicated by relative market values the purchaser could point to (similar to the purchaser in the Hansen decision referred to above). Unless the purchaser seeks the Commissioner’s guidance, this kind of behaviour is difficult for the Commissioner to detect, and almost certain again to lead to a loss of revenue, since the vendor will be relying on the agreed allocation. Resolving the inconsistency may be impossible if the vendor is liquidated after the sale takes place.
4.5 Where the vendor and purchaser adopt different allocations based on separate valuation advice it can be difficult for the Commissioner to resolve the difference, particularly given that outside of trading stock, there is no requirement for consistency of allocation. Even though the vendor’s and purchaser’s use of different valuations will almost always be to the detriment of the Revenue, it may be difficult for the Commissioner to determine which valuation to challenge or decide whether to challenge both. This is particularly true where the property is not frequently traded. For example, the Hansen and Edge decisions, where the Commissioner was successful in challenging an allocation to trading stock, both involved livestock for which reliable values were available. In Rusk, where the property at issue was timber, issues relating to the unique and non-fungible nature of standing timber and land were more significant, and the result of the case appears to have been a decision that meant the taxpayer vendor was treated as selling for a lower value than that adopted by the purchaser as the cost price of the trees.
4.6 Valuation is a matter of judgement, and in many mixed supplies, there will be a range of values for taxable property which can reasonably be said to be based on relative market values. So long as the parties each choose within this range, it may be difficult or impossible for the Commissioner to eliminate any gap and thus there is revenue leakage. The closer two valuations are to each other, the less inclined the Commissioner will be to expend resources on pursuing a challenge, and this will be especially true if two separate disputes are required.
4.7 Generally, where two non-associated parties agree to an allocation and have opposing interests in the amounts allocated to different assets, the Commissioner will accept this is the product of natural tensions and represents market value. However, there have been instances when the Commissioner has not accepted that an agreed allocation is in line with market value. The Hansen decision makes it clear that when the property is trading stock, the Commissioner has power to challenge an agreed allocation on the basis it does not reflect market values. No law change seems to be required in this respect.
4.8 The argument is sometimes made that a purchaser of depreciable property in a mixed supply is not subject to a requirement to treat themselves as having acquired that property for an amount based on relative market values at all. This is on the basis that while section EE 45(10) explicitly requires the vendor to treat depreciable property disposed of with other assets as sold for its market value, there is no such provision applying to the purchaser. Using this argument, a purchaser might argue that it could rely on an inappropriately high allocation, based on agreement with the vendor.
4.9 From a policy perspective, anti-avoidance provisions should not be relied on to address the issue. Such rules are a backstop to clear black-letter law. Amending the law creates more certainty than relying on anti-avoidance provisions as specific cases of avoidance need to be identified and the outcomes are subject to litigation uncertainty. Moreover, an anti-avoidance provision cannot be generally used to require parties to use the same allocations when the law does not require consistency other than in specific situations.
Officials seek feedback on:
- The issues arising in practice set out in this chapter – in particular, whether there are aspects or issues that have not been taken into account.
- Whether there are any additional issues arising in practice with respect to purchase price allocations in mixed supplies.