Purchase price allocation

Taxation (Annual Rates for 2020–21, Feasibility Expenditure, and Remedial Matters) Bill

Officials' report to the Finance and Expenditure Committee on submissions received on the Bill

February 2001

Purchase price allocation

Overview
Comments on proposal as a whole
Level of allocation
- Issue: Required level of allocation unclear
Vendor’s power to determine allocation
Tax book value floor on vendor’s unilateral allocation
- Issue: Tax book value floor on vendor’s allocation should be omitted
Amortisable improvements rule
- Issue: Rule for allocation to amortisable improvements unnecessary / problematic
Allocation timeframes
Denial of purchaser deductions
Market value and commissioner challenge
De minimis/safe harbour thresholds
Application date
- Issue: Application date too early
Various drafting issues

OVERVIEW

The proposal is to insert sections GC 20 and GC 21. These sections will apply to sales of commercial property, businesses, and other bundles of assets, if entered into on or after 1 April 2021.

The purpose of the proposal is to require a buyer and seller to make the same allocation of the total purchase price to the different assets (or classes of assets) sold. For example, in a purchase of commercial property, the proposal requires that the seller and buyer allocate the same amount to the land, the building, and the fit-out.

This prevents the parties making inconsistent allocations which in aggregate result in a loss of revenue. This can happen, for example, if the seller allocates less of the sale price to fit-out than the buyer does.

The proposal requires parties who agree an allocation between themselves to follow that allocation in their respective tax returns. If they do not agree, the vendor may notify an allocation to the buyer and the Commissioner. The allocation binds both the vendor and the purchaser. If the vendor does not make an allocation within two months of the transaction, the purchaser can notify an allocation, which binds both the purchaser and the vendor.

Submissions were received, from business groups, advisors and an individual. Only one submitter was explicitly in favour of inconsistent allocations being allowed, but no submitters supported the proposed solution. Some argued that the required level of consistency could be achieved without legislative change, using increased information gathering and case intervention by the Commissioner. Others argued that any legislative change should involve empowering the Commissioner to resolve inconsistencies, rather than giving the seller the power to make a unilateral binding allocation. Yet others argued that the power to make the allocation should first be given to the buyer.

As set out below, various technical changes have been recommended in response to submissions, but officials remain of the view that the basic approach adopted in the Bill is sound.

COMMENTS ON PROPOSAL AS A WHOLE

(Clause 40)

Issue: Support for proposal

Submission

(Navtej Singh)

This submission supports the purchase price allocation amendments, as they will help to address the tax mismatches resulting from different price allocations by vendors and purchasers in asset sales.

Recommendation

That the submission be noted.

Issue: Support for requirement that parties follow agreement in tax returns

Submission

(Chartered Accountants Australia and New Zealand, EY)

If parties agree a purchase price allocation, they should be required to follow that agreed allocation in their tax returns.

Recommendation

That the submission be noted.

Issue: Legislative changes are unnecessary and disproportionate to mischief; operational approach is more appropriate

Submission

(Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group, Deloitte, EY, Russell McVeagh, PwC)

Purchasers and vendors will often have different views of the value of a business and its assets – this is a normal and expected outcome of well-functioning markets. Tax law should not interfere with it. (EY, Chartered Accountants Australia and New Zealand).

The proposals create a compliance burden for virtually the entire transaction market. The proposed rules in section GC 21 are not practical, do not reflect the intricacies of commercial negotiations, and do not appropriately accommodate situations where parties do not or cannot agree an allocation within the timeframe for the transaction.

A targeted operational approach would be more appropriate; Inland Revenue should conduct compliance audit activity to estimate the true extent of the problem. It should issue an operational statement outlining that where parties adopt different values, or non-market values, they risk costly and time-consuming disputes with the Commissioner. Also, Inland Revenue should use enforcement action to modify behaviour.

Given that in most mixed-asset transactions the parties already agree an allocation, it is not clear that the rules in GC 21 are required. (PwC)

Inland Revenue’s concern about the Commissioner’s lack of valuation expertise is inconsistent with the myriad of rules and Commissioner overrides that already exist and require the use of market (or other) values. The Commissioner will challenge some cases, argue valuation and obtain expert advice. Examples of areas in which this occurs are: transfer pricing, dividends, trading stock, and fringe benefit tax. Also section BG 1. The Commissioner sees both sides of a transaction and has access to an unrivalled base of asset sale transactions. (Russell McVeagh)

The Government’s aims would be largely achieved by simply requiring written agreement between the vendor and purchaser. The incentive to comply with the rules would be the risk of challenge by Inland Revenue. This could be made even more effective by placing a requirement on the parties to notify Inland Revenue of their agreed allocation. Written agreement between transacting parties has become more common, partly due to increased audit activity in the area, and the suggestion of law change. (PwC) Parties are typically advised to agree an allocation in their documentation, and typically do agree one. The best evidence of what a vendor has received or a purchaser has paid is the contract under which the asset was sold. (Russell McVeagh)

Only if that does not work should a legislative approach be considered. Inland Revenue should utilise new systems and processes from BT – Inland Revenue has not grasped the new capabilities of its system. Policy and operational practice should evolve. This legislative approach eschews intelligence gathering, development of commercial capabilities, and fails to enforce existing Income Tax Act rules. It may cause collateral damage and drive bad behaviour.

The proposals appear to be based on the troubling premise that existing law is not being enforced. The remedy for this should be to improve enforcement practices, not to introduce new and prescriptive rules that may unnecessarily complicate and in some cases confer on one party a unilateral power to vary commercial arrangements, which is unprecedented in the tax laws. In a self-assessment-based tax system, the fact that Inland Revenue scrutiny is unlikely to occur or result in adjustment is concerning. If this is true, the resource-intensive process of reviewing and amending the law will be somewhat futile. The taxpayers who were not complying with the old law will not, in an environment in which scrutiny is unlikely, comply with the new law (Russell McVeagh) – particularly taxpayers that are currently taking tax positions counter to what they have agreed in a legally binding transaction. (Deloitte)

An operational approach should be taken alongside appropriate remedial amendments. (Deloitte)

The only law change should be to clarify that purchasers must allocate purchase price based on the market values of the assets acquired. (Corporate Taxpayers Group)

Symmetrical treatment in all transactions is not the right focus. The real issue is that the Commissioner is not able to monitor which asymmetric allocations are problematic and which ones are justifiable. If parties do not agree an allocation, they should be able to adopt different allocations, but be required to provide electronic disclosures to the Commissioner to justify their allocations and reasons for disagreement. Inland Revenue is underestimating the significant deterrent effect such disclosure requirements would have. The Department can use analytic tools to identify material discrepancies and examine valuations for genuine avoidance. (EY, Chartered Accountants Australia and New Zealand)

Comment

Officials agree and acknowledge that purchasers and vendors will usually have different views of the value of a business and its assets. Commercially, a vendor will not generally sell assets unless the vendor thinks they are worth less than the purchaser is paying for them, and a purchaser will not buy the assets unless the purchaser thinks the opposite – notwithstanding distressed sales. But if only one asset is sold, it is bought and sold for a single price, and that price is the value of the asset for both parties for tax purposes. Officials see no reason why this consistency principle should be departed from where two or more assets with different tax treatments are sold together. Section GC 21 is not a case of the tax law interfering with markets – it is a case of the tax system not tacitly subsidising commercial transactions by allowing parties to treat an asset as bought for one price and sold for another, in order to minimise their respective tax liabilities.

With regard to evidence of the problem, audit activity undertaken by investigators is what spurred the development of these proposals in the first place. The evidence base includes a number of large commercial property transactions and sales of going-concern businesses. Furthermore, anecdotal evidence from some tax advisors suggests that inconsistent allocations are a frequent occurrence, due to parties asserting different views of market value.

There will always be a debate around how much audit evidence is required for a policy response – whether operational or legislative – to be regarded as necessary. The Commissioner has, on multiple occasions, taken cases against vendors and purchasers adopting inconsistent allocations and has frequently failed to drive the parties to agreement – an unsurprising outcome, given the lack of a statutory requirement for consistency, other than in relation to trading stock. The fact that consistency cannot be reliably achieved, even with considerable resource outlay from Inland Revenue, suggests that a more fundamental change to the regulatory framework is warranted.

Officials do not consider the additional compliance burden of a consistency requirement for purchase price allocation to be substantial. Price negotiation may be more protracted in some cases, but business practices can be expected to adapt.

The current tax law does not require a vendor or purchaser to file its tax return on the basis of an allocation it agreed with the other transacting party as part of the sale and purchase. This is a gap in the law and is the reason for proposed section GC 20. Some parties may continue to ignore an agreed allocation despite the proposed law change, but if they do, they will be non-compliant and the Commissioner will have a legislative basis for amending their returns. Moreover, parties can be expected to comply with the new law, because they have an incentive to do so.

A requirement for disclosure will persuade some taxpayers to agree an allocation. However, Inland Revenue’s experience is that it will not persuade all to do so, and where it does not, existing law makes it difficult, time consuming and in many cases impossible to bring the parties together.

Finally, the power to allocate is not the power to vary a commercial arrangement. If the parties agree, they must follow their agreement. If they do not agree, there is no arrangement with respect to the allocation, and the purchase price allocation rules will apply as appropriate.

Recommendation

That the submission be declined.

Issue: Lack of evidence for applying rules to business sales

Submission

(Corporate Taxpayers Group)

The rules, if they proceed, should not apply to business sales. There is a lack of evidence about the scale of the issue with businesses. The rules should be restricted to sales of commercial and residential property. Requiring all transactions to comply with highly complex and detailed rules to address an issue caused by a subset of bad taxpayers comes at the expense of all taxpayers. We note:

Commercial property is where most discrepancies have been identified.
Information is provided to Inland Revenue about real property transfer (under the Land Transfer Act).
Most real property transactions are undertaken with a standard form (Auckland District Law Society), which can be updated to specify purchase price allocation rules.
Focusing on property negates many practical issues.
Issues relating to transacting through auctions can be managed to ensure fair outcomes.

Comment

Officials are aware of a number of transactions involving inconsistent allocation of the purchase price in business sales, some of them very large. Officials have also been told that the requirement for consistency for trading stock is often ignored in practice.

Recommendation

That the submission be declined.

Issue: Stakeholder feedback should have greater bearing on proposed amendments

Submission

(Deloitte, Federated Farmers of New Zealand Incorporated, Jim Gordon Tax Ltd)

Given the extent of disagreement with the proposals, stakeholder feedback should have a greater bearing on the proposed amendments and ensure they reflect commercial reality, and that the compliance burden is in line with the scale of the problem.

The proposals should be withdrawn for further consultation, and then brought back to Parliament. (Federated Farmers of New Zealand Incorporated, Jim Gordon Tax Ltd)

Comment

Stakeholders have provided much useful feedback on the proposals throughout the policy development process – in submissions on the officials’ issues paper, in meetings with officials, and most recently in submissions on the Bill – and officials have made a number of changes in response. Many of these changes have been aimed at reducing compliance costs and acknowledging commercial realities: requiring consistency only at an asset class level rather than asset-by-asset; making the backstop rules for non-agreement more neutral by putting a tax book-value floor on a unilateral allocation by the vendor; and so on. Given the extent of consultation undertaken, in line with the Generic Tax Policy Process, officials do not consider it is necessary to withdraw the proposed amendments from the legislation for later reintroduction. However, officials will continue to engage and consult with stakeholders as the Bill progresses.

Recommendation

That the submission be declined.

Issue: Tax not the only driver of purchase price allocation

Submission

(Corporate Taxpayers Group)

Tax is not the only driver of a purchase price allocation. There are other areas of commercial significance that are relevant for purchase price allocation, including insurance cover terms, caps on damages that can be claimed for a breach of contract, and other regulations.

Comment

Officials acknowledge that a purchase price allocation can have relevance for non-tax reasons in some cases. However, that is true only for a limited set of transactions, and even then, tax is usually much more significant. For example, it seems unlikely that the amount allocated by a vendor to an asset for tax purposes would limit the amount the purchaser could then insure that asset for. Nor would an excessive tax allocation by a purchaser mean that an insurer was bound to accept that figure as the appropriate replacement value for the asset. Commercial considerations are no more than a weak constraint, if any, on tax-optimising allocations.

Recommendation

That the submission be noted.

Issue: Impact of proposals on commercial transactions in COVID-19 context

Submission

(EY)

The impact of the proposals on commercial transactions should not be ignored in the current COVID-19 context, in which there will be more transactions involving distressed businesses, with vendors and purchasers having different views of the value of business assets.

Comment

Officials consider that the rules will be equally workable for distressed sales as for normal transactions. Inland Revenue will monitor the performance of the rules.

Recommendation

That the submission be noted.

Issue: Amendment of disputes regime in the Tax Administration Act to enable three-way dispute would be a better way to achieve consistency

Submission

(Corporate Taxpayers Group)

The disputes regime in the Tax Administration Act 1994 should be amended to clarify that the Commissioner can enter a three-way dispute involving a vendor and purchaser if the parties do not file tax returns with the same allocation. A joint dispute is most efficient.

Comment

Officials carefully considered the option of amending the disputes regime, and had discussions with legal sections of Inland Revenue. The approach would require the development of a bespoke disputes process, which would most likely have been rarely used and would be unlikely to apply correctly in all situations. The process would generate significant costs on both sides. It is unlikely to be feasible, and the benefits would be outweighed by the costs.

Recommendation

That the submission be declined.

Issue: Degree of acceptable asymmetry should be allowed

Submission

(EY)

There should be some degree of acceptable asymmetry, as there may be genuine reasons for parties to have divergent views as to relative price allocations. Seeking symmetry in all cases is overcorrection. Not all asymmetry is due to tax avoidance.

For example:

Taxpayers could fall outside the proposed rules where the discrepancy in allocations has a tax effect of less than $500,000.
Alternatively, the law could provide the Commissioner with the discretion to accept an asymmetric allocation under certain conditions.

Comment

The proposal already contains de minimises (though officials are proposing to remove the $100,000 taxable/deductible property threshold – see Issue: “Consistency thresholds too low”). If a transaction falls below the de minimises, the parties are not required to allocate consistently, notwithstanding that they must still allocate based on market values. If an additional de minimis for asymmetry is introduced, parties will simply ensure that they agree divergent allocations equal to the de minimis. Some kind of agreement would still be required between the parties so that they ensured the de minimis would not be exceeded. It is simpler and more effective to have no such de minimis.
Officials do not consider that a Commissioner discretion in relation to asymmetric allocations would be desirable. The rules are designed to avoid Commissioner intervention in transactions except as a last resort, for reasons set out in officials’ response to the Issue: “Proposal gives vendor incentive not to agree to an allocation”.

Recommendation

That the submission be declined.
That the submission be declined.

Issue: Lack of international precedent for approach

Submission

(PwC)

Other jurisdictions facing the same problems do not seem to have introduced the hierarchy of rules proposed for New Zealand.

Comment

Many other jurisdictions (for example, the United States, the United Kingdom, Australia) have a comprehensive capital gains tax (albeit frequently at discounted rates), which reduces the degree to which vendors and purchasers can gain tax advantages through price apportionment. It presents a stronger risk in New Zealand, which lacks a general capital gains tax.

Even so, some countries have made efforts to ensure consistency, though they have not taken precisely the same approach as proposed here. The proposed approach is intended to minimise the need for Inland Revenue intervention.

Regardless, although international precedent can be a helpful source of information and insight, its absence should not necessarily preclude New Zealand from implementing a desirable reform.

Recommendation

That the submission be noted.

Issue: Rules will create issues in competitive bids and auctions

Submission

(Corporate Taxpayers Group, PwC)

The rules will create issues in competitive bid processes, where purchasers must submit bids prior to advancing to a full due diligence process. The outcome of the initial bidding process could be materially influenced by whether particular bidders have specified a potential purchase price allocation (because it could impact on the vendor’s returns).

In a competitive bid process where an overseas vendor is bidding against a New Zealand purchaser, the New Zealand purchaser is in a weaker bargaining position because the overseas vendor may care less about the allocation, depending on the tax rules in its home jurisdiction.

Comment

Market participants will be able to deal with issues arising in competitive bid processes in a number of ways. Bids may be expressed by the bidder to be conditional on a specified allocation, for example. Or the person requesting bids may specify an allocation, in order to ensure that all the bids are made on an even footing.

In terms of cross-border transactions, foreign bidders will be subject to a range of regulatory requirements in New Zealand and in their home country, which may improve or worsen their competitive position. Free trade or investment agreements may go some way towards levelling the playing field. New Zealand domestic tax rules should be set with a view to reducing distortions for participants in the domestic economy, and not to accommodate possible cross-border concerns.

Recommendation

That the submission be noted.

Issue: Operation of rules unclear where there is foreign purchaser

Submission

(Deloitte)

The operation of proposed section GC 21 is unclear where there is a foreign purchaser. An allocation could be agreed in relation to assets that will remain in New Zealand post-completion but not in relation to assets that will leave New Zealand post-completion (because the foreign purchaser has no incentive to agree an allocation to those assets).

Comment

If an allocation is agreed in relation to some assets and not others, then the purchase price allocation rules will apply to each bundle of assets separately. In this case, section GC 20 would apply to the agreed allocation for assets that are to remain in New Zealand post-completion, requiring the parties to file on the basis of their agreement. Section GC 21 would apply to the assets that are to leave New Zealand post-completion. The vendor would determine an allocation, and that allocation would have no impact on the purchaser, for whom the assets will not be in the New Zealand tax base going forward.

In practice, however, if the purchaser is indifferent to the allocation to some assets, the vendor should not have a problem getting the purchaser to agree with the vendor’s allocation to them.

Recommendation

That the submission be noted.

Issue: GST implications of proposals have not been considered

Submission

(Chartered Accountants Australia and New Zealand, nsaTax Limited)

Consideration should be given to the GST consequences of the purchase price allocation when a transaction is not zero-rated, and particular categories have different GST treatments – for example, a taxable supply versus a GST exempt supply. When a transaction includes both taxable and exempt supplies and the parties have not agreed an allocation, it will be important to take GST into account in determining the allocation. (Chartered Accountants Australia and New Zealand).

Under section GC 20, the purchase price allocation needs to be agreed before either party files an income tax return for the year. This is several months after the filing of GST returns for which the allocation could be pertinent. (nsaTax Limited)

Comment

It is unusual for a transaction subject to GST to require apportionment. Sales of businesses are generally entirely zero rated as sales of a going concern. Most sales involving land are subject to compulsory zero rating. In the rare situations where an apportionment between taxable and exempt supplies is required, it will be a unilateral apportionment by the vendor, as the vendor will provide a tax invoice to the purchaser. The purchaser will then claim input tax credits in accordance with its intended use of the supplies going forward.

In most cases, the values used in the GST apportionment will be consistent with the values allocated for income tax purposes, as parties will either have agreed on the values, or the vendor will do the income tax allocation unilaterally and so will naturally be using the same values as for its unilateral GST apportionment. An inconsistency might arise if the vendor sets the GST apportionment but does not agree an income tax allocation with the purchaser or notify it of a binding allocation within the timeframe for doing so. In that case, the purchaser may conceivably notify the vendor a binding allocation on the basis of values that differ from the GST values set by the vendor. Officials consider that this would be a fringe case, and the tax implications of the inconsistency are unlikely to be material. There may be none, if the vendor subsequently issues the purchaser a GST credit or debit note to align the GST values with the income tax values.

It is not proposed that the purchase price allocation rules have any effect on, or be affected by, the GST valuation rules.

Officials consider that the impact of the proposals on GST is minimal, and no amendments are required.

Recommendation

That the submissions be declined.

Issue: Rules need to accommodate price adjustments

Submission

(Chartered Accountants Australia and New Zealand, New Zealand Law Society, PwC)

The rules should be flexible enough to cover purchase price adjustments; earn-outs; warranty claims; later disbursement of funds held in escrow, where the funds are ultimately paid back to the purchaser rather than across to the vendor; other contractual recourse the purchaser has against the vendor, and so on. Consideration may not be finally determined until months or years after the transaction.

The legislation could allow for the same rules to apply at the time any further consideration is paid. (New Zealand Law Society)

Comment

Officials agree that a consistent allocation of price adjustments would also be desirable. However, the basis for allocation may not simply be the relative market value of the property. For example, the nature of the adjustment may mean that it is clearly allocable to one asset or class of assets (for example, a payment for breach of a warranty in relation to a defect in an item of property sold). Accordingly, a further consultation process would seem desirable before drafting such rules.

Recommendation

That the submission be noted.

Issue: Inland Revenue should educate taxpayers about new rules

Submission

(Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group, EY)

Inland Revenue should take a proactive approach to educating taxpayers and tax agents about the new rules.

The rules are more likely to be successful if Inland Revenue proactively educates taxpayers, particularly smaller businesses and tax agents. Not all taxpayers seek advice from an accountant or tax agent before entering into a transaction. An education campaign will make smaller taxpayers aware of new requirements and avoid the consequence of no deductions for the purchaser.

Inland Revenue could advocate for standard form sale and purchase agreements that reference the need for parties to agree an allocation. It should also issue guidance.

Comment

Officials acknowledge that it is important for taxpayers to be aware of the new purchase price allocation rules and will undertake an education campaign to achieve this.

Recommendation

That the submission be accepted, noting that guidance will be provided.

Issue: Time required for taxpayer education and update of standard form agreements

Submission

(nsaTax Limited)

Any law change should be effected in close consultation with the Real Estate Institute of New Zealand (REINZ), the Law Society, and the Auckland District Law Society (ADLS), so that there is sufficient time for the ADLS standard form agreements to be available, and adequate education for their respective members before the new rules come in.

Comment

Officials recognise that these organisations have an important role to play in taxpayer education and compliance, and will ensure these groups are informed about the progress of the proposals.

Recommendation

That the submission be accepted, noting that guidance will be provided.

LEVEL OF ALLOCATION

(Clause 40)

Issue: Required level of allocation unclear

Submission

(Corporate Taxpayers Group, Deloitte, nsaTax Limited)

The Bill commentary states that parties do not have to allocate an amount to every individual item – they can allocate at a high level of asset categories. This is not clear in the wording of the legislation and should be added.

As the draft legislation refers to “items of depreciable property”, is the required level of allocation for asset categories or individual items? Under the proposals as currently drafted, vendors and purchasers are required to agree an allocation for every item of depreciable property. (nsaTax Limited)

Comment

Officials agree that the wording of the legislation with respect to the required level of allocation is unclear, and propose that the provisions be rewritten accordingly. Officials note that the existing provisions in the Income Tax Act, requiring individual assets to be valued at market rate, still apply in a mixed supply. However, these need to be modified if the individual assets are part of a class that has been treated as sold for the vendor’s tax book value.

Recommendation

That the submission be accepted.

VENDOR’S POWER TO DETERMINE ALLOCATION

(Clause 40)

Issue: Proposal gives vendor incentive not to agree to an allocation

Submission

(Russell McVeagh, Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group, Deloitte, PwC, Navtej Singh, Jim Gordon Tax Ltd, Federated Farmers of New Zealand Incorporated)

The proposal fundamentally impacts the relative commercial bargaining position of the parties involved, in favour of the vendor. Allowing either party to determine the allocation will lead to inappropriate valuations which favour the party that sets them.

It is fundamentally wrong to give primary power to the vendor. A vendor could use the rules to their own bargaining advantage, and refuse to agree to an allocation with the purchaser, knowing that it will get the power to allocate if it does not (a particular risk where there are multiple possible purchasers). The vendor might wait until the last minute to allocate a price, giving the purchaser less time to negotiate.

The onus of proof for a particular purchase price allocation is on the taxpayer (see Buckley v Young Ltd (1978) 3 NZTC 61,271 (CA)). Currently, both parties have an equal incentive to agree an allocation to avoid risk and uncertainty as to their tax position. New section GC 21(2) would change that by giving the vendor an incentive not to agree an allocation, so they can unilaterally determine it instead. Whether or not the purchaser can deal with this by negotiating the price will depend on the strength of the parties’ bargaining positions. There are flow-on effects from this that could negatively impact commercial activity in New Zealand.

While in theory the purchaser could refuse to go ahead with the deal until an allocation has been agreed, commercial pressures or a lack of tax advice prior to negotiations could mean that the purchaser is unaware of the importance of agreeing an allocation before the deal is finalised, or is unable to do so. In reality, a number of factors mean allocations are not agreed on or even considered before the sale and purchase agreement is signed, so allocations are often decided afterwards.

Comment

The vendor will have no incentive not to agree an allocation if by agreeing one it can get a better price. A purchaser faced with a vendor that will not agree an allocation in advance can either refuse to transact, or significantly discount the price.

Market value is a range, and naturally the party that allocates will tend to make an allocation favouring itself. Giving priority to one of the parties to unilaterally determine the allocation where the parties have not agreed one, is the only way for consistency to be achieved that does not require the Commissioner’s intervention.

The Commissioner knows less about the transaction than the parties, has little valuation expertise, and is generally indifferent to what allocation is chosen, provided it is a single allocation. It would be administratively burdensome, and uncertain for the parties, for the Commissioner to be charged with determining a unilateral allocation in the first instance any time the parties could not agree one themselves. Similar issues would arise with the use of an independent arbitrator.

The tax book value floor protects purchasers that are unable to agree an allocation with the vendor as part of the sale and purchase. The floor also means that if the vendor wishes to allocate less than tax book value to taxable property, it must agree an allocation with the purchaser. Officials consider the floor is a useful compromise to improve the neutrality of the consistency rule.

Officials note that under section EB 24 the purchaser already has to use the vendor’s allocation for trading stock, and trading stock is defined widely for this purpose to include most assets in the tax base, other than depreciable property and financial arrangements. It has not been made clear to officials why the existing trading stock rule is seemingly unproblematic, but the extension of it to depreciable property and financial arrangements is unacceptable (though officials are aware that some advisors operate on the basis that the provision does not require consistency).

Commercial negotiations vary widely depending on the market power and sophistication of the parties. The allocation will be one issue amongst many for negotiation. The parties will be significantly more likely to agree an allocation once the new rules come into effect.

Recommendation

That the submission be noted.

Issue: Purchaser allocation would be more appropriate

Submission

(Chartered Accountants Australia and New Zealand, EY, PwC)

If one of the parties is given the right to unilaterally allocate (in the event the parties fail to agree), the purchaser’s allocation should be given primacy, since the purchaser intends to continue the business and therefore sees the value in the assets going forward. Vendor valuations may misconceive how the business will be used in the future.

Moreover, the purchaser is less likely to adopt an unjustifiable price allocation for tax purposes because it will carry an ongoing risk. Some purchasers are required to comply with acquisition accounting and so are more likely to adopt fair values, or risk audit.

Comment

Officials acknowledge the case for purchaser priority, and consider that it would also be tenable. A purchaser allocation might also be likely to accelerate the recognition of taxable income in some cases, as it would create more income for the vendor.

However, there are a number of reasons for preferring a vendor allocation:

Only the vendor will know its tax book value. If tax book value is a useful compromise in cases of no agreement, this supports a vendor allocation.
Adopting a vendor-first approach is consistent with the existing rule for trading stock (section EB 24).
The vendor may wind up its business shortly after the transaction occurs. In the case of a corporate or trust vendor, the sale proceeds, net of income tax, may have been removed by the owner. If the vendor has been left with insufficient funds to pay tax on the basis of a purchaser valuation, the Commissioner will be left with an uncollectable tax debt. Vendor allocation is less likely to have this outcome.

Officials also note that there is no reason for preferring the future value the purchaser sees in the assets over the value the vendor places on the assets.

Recommendation

That the submission be declined.

Issue: Safeguard allowing purchaser to allocate if vendor does not is illusory

Submission

(Chartered Accountants Australia and New Zealand)

The safeguard allowing the purchaser to set values if the vendor fails to do so is more illusory than real.

Comment

The purchaser allocation is not intended to be a safeguard – it is intended to give an engaged purchaser a way to make an allocation if the vendor does not notify one on a timely basis.

Recommendation

That the submission be noted.

Issue: Some vendors may be difficult to engage with post-transaction

Submission

(Corporate Taxpayers Group)

Where assets are transferred ahead of liquidation, receivership or similar event, the vendor may be difficult to engage with post-transaction. In these situations, it may be more appropriate to provide priority to the allocation of the purchaser.

Comment

If the parties have not agreed an allocation and the vendor does not notify an allocation to the purchaser within three months of settlement, the Bill provides that the purchaser will then have three months to notify the vendor of a binding allocation. This will always give the purchaser sufficient time to make an allocation before it has to file a tax return. More details on timeframes are given in the section “Allocation Timeframes”.

Recommendation

That the submission be noted.

Issue: Default allocation to depreciable property in absence of agreement should be tax book value

Submission

(Corporate Taxpayers Group)

Rather than the vendor’s value having precedence over the purchaser’s, if the parties do not agree an allocation, the default should be that the depreciable property is transferred at tax book value. The Commissioner will then be in a neutral or more favourable position, compared with the vendor keeping and continuing to depreciate the assets.

The purchaser will be restarting depreciation with a lower cost base than the vendor, so annual depreciation deductions will be lower.

However, where the market value is clearly less than the tax book value, that value and allocation should be allowed.

Comment

In effect, section GC 21(8) already provides for a tax book value default (for all classes of property – not just depreciable property) by imposing a tax book value minimum on a vendor’s unilateral allocation. The vendor may choose to allocate a higher than tax book value to depreciable property or other property if it considers that value to be more accurate, though it will not generally be incentivised to do so.

Recommendation

That the submission be noted.

Issue: Purchaser may ignore vendor’s allocation if outcome unrealistic or inequitable

(Jim Gordon Tax Ltd)

The small to medium enterprise (SME) sector already ignores tax legislation that it considers inappropriate (for example, fringe benefit tax). There is a real risk that a purchaser will ignore a vendor allocation of values in order to secure a more realistic outcome that is based on the economics of the transaction and the market values of the assets.

Rather than allow the vendor to allocate non-market values to assets, and risk the purchaser ignoring those values and instead using market values, there should be a compulsory requirement for an independent valuation to be obtained for assets in the tax base whose value exceeds a certain minimum amount, and for that valuation to be followed by both parties in their allocations.

Comment

If parties are unable to agree values between themselves but find the statutory hierarchy of unilateral party allocation rules unacceptable, they may make contractual provision for asset values to be determined by an independent valuer. Nothing in the statute will preclude such an arrangement. During policy development, officials considered the submitter’s suggestion of a mandatory independent valuation to resolve cases of non-agreement. However, this approach would impose an additional valuation cost on parties in all cases where an allocation has not been agreed – as well as a burden on whomever is required to choose the valuer – and parties may not always consider these costs to be warranted. There would be no guarantee that the valuation would produce a more favourable outcome for the purchaser than a vendor allocation or an agreement between the two parties.

If the purchaser thinks it is likely to lose more by following a vendor allocation (which in many cases will be tax book value) than by contributing to the cost of a binding independent valuation, it may insist on the latter as part of the sale and purchase agreement. Conversely, if the tax at stake does not justify the costs and uncertainty associated with obtaining a valuation, the purchaser may settle for the statutory backstop of vendor allocation.

Recommendation

That the submission be declined.

TAX BOOK VALUE FLOOR ON VENDOR’S UNILATERAL ALLOCATION

(Clause 40)

Issue: Tax book value floor on vendor’s allocation should be omitted

Submission

(Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group, Deloitte, EY, nsaTax Limited,)

Proposed section GC 21(8) – the rule stipulating that the vendor cannot unilaterally allocate less than carrying values to taxable property, resulting in an additional loss on its sale – should be omitted. The rule is arbitrary, anti-avoidance in nature, and shows that the vendor allocation process is flawed. (Chartered Accountants Australia and New Zealand, EY)

In a distressed sale, the rule does not reflect commercial reality. In these situations, the actual market value of property being sold will be less than its adjusted tax value or cost, and the vendor will suffer a real loss on the sale of the property. (Chartered Accountants Australia and New Zealand, EY, nsaTax Limited)

The rule may be impossible to comply with. The total purchase price may not allow the allocation required under GC 21(8), where a sale is made at a genuine commercial loss. (Deloitte)
Use of an allocation floor will mean that excess proceeds will be added to remaining assets, inflating their market value. (Chartered Accountants Australia and New Zealand)
The rule is inconsistent with the wider intent of the proposals that market values should always be used. (Corporate Taxpayers Group, nsaTax Limited)

Comment

Officials agree that there will be many transactions where the actual market value of taxable property being sold is less than its tax book value, and the vendor will suffer a real loss on that property, even if the transaction as a whole shows a profit. The vendor can recognise this loss by agreeing an allocation with the purchaser. The vendor is only restricted to tax book value if it and the purchaser do not agree an allocation, and the vendor is in the position of unilaterally allocating the purchase price.

Officials note that, in a sale where the total sale proceeds are less than the sum of the vendor’s tax book values for all the taxable assets, the vendor will not be able to comply with a tax book value floor. Accordingly, officials recommend amending the legislation to provide that, in such a case, the vendor’s allocation to taxable property will be its tax book value reduced (pro rata) in proportion to the difference between the aggregate tax book value of the taxable property and the purchase price. This pro rata will only be applicable once the value ascribed to property outside the tax base is zero; to the extent that the value is greater than zero, it can be reduced to absorb some or all of the vendor’s loss. The pro rata only applies for the taxable property.
The argument that the allocation floor will cause “excess proceeds” to be added to remaining assets, inflating their market value, is unclear or incomplete. If the vendor thinks a taxable asset is worth less than its tax book value, then the requirement for the vendor to allocate a minimum of tax book value means that the proceeds remaining to allocate to non-taxable assets will be less than the vendor would otherwise think appropriate. The value of non-taxable assets will only be “inflated” if the vendor believes the value of the taxable assets is higher than their tax book values, but allocates book values anyway. That would be a choice by the vendor, which could be challenged by the Commissioner.
Officials accept that the tax book value floor is inconsistent with the requirement in the proposals that market values should always be used. As a general principle, the use of market values should be favoured, because they reflect commercial realities. However, officials consider that, in the context of a unilateral vendor allocation, an exception to the principle can be justified.

The primary objective of the purchase price allocation proposals is to ensure that vendors and purchasers adopt the same allocation, as the loss to the revenue base arises predominantly from the use of different values, rather than from the use of non-market values per se. The desired outcome under the proposals is that parties agree a market value allocation between themselves, rather than resort to the unilateral allocation rules in section GC 21. The vendor allocation is intended only as a backstop if the parties cannot agree an allocation, and officials consider that improving the neutrality of this backstop with the imposition of a tax book value floor takes precedence over ensuring the allocation is market value. The floor provides some protection for a purchaser that is unable to agree an allocation with the vendor, and has the effect that in most cases, the purchaser will effectively step into the vendor’s shoes.

Officials reiterate that a vendor can avoid the tax book value restriction by agreeing an allocation with the purchaser. Agreement is always the desired outcome, and will be respected by the Commissioner in almost all cases.

Recommendation

That the submission be accepted, subject to officials’ comments.
That the submission be declined.
That the submission be noted.

AMORTISABLE IMPROVEMENTS RULE

(Clause 40)

Issue: Rule for allocation to amortisable improvements unnecessary / problematic

Submission

(Chartered Accountants Australia and New Zealand, Federated Farmers of New Zealand Incorporated, Jim Gordon Tax Ltd)

Proposed section GC 21(9), which provides that improvements amortised under section DO 4, DO 12 or DP 3 must be allocated their diminished value, should be omitted. Although a purchaser is only allowed to amortise from the diminished value of the improvement, parties should still be permitted to allocate a different value to it if they think the true market value is different.

The proposed rule is inconsistent with the market value requirement, and will interfere with true market value allocations to other items.

Comment

Officials agree that, provided the purchaser is only allowed to amortise from the diminished value (in accordance with tax law), it should not be problematic for the parties to allocate a different value to the improvement in order to better reflect its true market value – and better reflect a market value allocation to the other assets being sold. The relevant section will be removed.

Recommendation

That the submission be accepted.

ALLOCATION TIMEFRAMES

(Clause 40)

Issue: Timeframe for vendor allocation insufficient

Submission

(Deloitte, KPMG, EY)

Two months may not be sufficient for a vendor to make an allocation, particularly if attention has not previously been given to the issue during the transaction process, or where pricing was changing. The vendor will often need to obtain new valuation guidance, which may be difficult to finalise within two months of change of ownership. A minimum of three months is more reasonable, and was suggested in the issues paper on the proposal.
The timing for notification of the tax allocation should be extended to align with the existing timeframe for financial reporting and filing of income tax returns. There is no justification for a truncated timeframe for the allocation ahead of the assessment to which the notification relates. (EY)

Comment

Officials recommend extending the period for a vendor to make an allocation from two months to three months post-settlement. Officials also note that the vendor will have time to work on its allocation in the period between execution of an agreement and settlement.
The justification for a truncated allocation timeframe ahead of filing due dates is twofold. First, the behavioural objective of the purchase price allocation proposals is for parties to agree an allocation before completing their transaction, so the allocation can be factored into the negotiations. This is the optimal outcome from a revenue and commercial perspective, but is clearly predicated on the parties making an allocation well before filing their tax returns for the transaction.

Second, the backstop rules in section GC 21 for determining an allocation in the absence of agreement are intended to give both parties an opportunity to determine the allocation before tax returns are due, notwithstanding that one of the parties (the vendor) is necessarily given the first opportunity. It is possible for a vendor or purchaser to have to file a tax return for a transaction as soon as six months post-settlement, if the transaction was settled on the last day of an income year, and the taxpayer has a late balance date. Accordingly, officials recommend to reformulate the backstop rules so that the vendor has three months post-settlement to notify an allocation and, if it fails to do so, the purchaser has three months. These symmetrical allocation windows total the minimum amount of time a party might have to prepare a tax return for its transaction.

Allowing the vendor until the first filing date to make an allocation would mean taking away any ability for the purchaser to make a binding allocation before tax returns are due. Officials consider that it is more equitable and practical to give the purchaser the opportunity to determine the allocation if the vendor fails to use it. This is likely to promote a timelier resolution of allocation in cases where the vendor is disengaged.

Recommendation

That the submission be accepted.
That the submission be declined.

Issue: Timeframe for purchaser allocation unclear

Submission

(Corporate Taxpayers Group, KPMG)

Under section GC 21, when the vendor does not allocate and the responsibility falls to the purchaser, there is no timeframe given to the purchaser to make the allocation. The position should be clarified.

For example, if a deal is settled on day 1 of an income year, the tax return would not need to be filed until two years later. In this case, the vendor would have two months to make an allocation, and then if it failed to make one, the purchaser would have 22 months.

For clarity, section GC 21(3) should require the purchaser to notify the Commissioner and vendor of its allocation within six months of the change of ownership (though the section probably will not be applied very often). (KPMG)

Comment

As noted in the comment on the previous submission, officials recommend modifying the provisions here. The purchaser will have three months to notify the vendor of a binding allocation – that is, until six months after the transaction.

After six months, the Commissioner will have a discretion to achieve consistency as they see fit. The parties may still make and notify allocations (as though they had done them unilaterally within six months of settlement), but the Commissioner may choose whether to bind the vendor to a late purchaser allocation, bind the purchaser to a late vendor allocation, or impose her own allocation (on audit or otherwise). The rationale for this approach is that if an allocation has not been notified by six months post-settlement, it is likely that the parties are either unaware of the purchase price allocation rules or have been deliberately non-compliant, and some level of Commissioner intervention is necessary. Officials consider that it is unlikely parties will get to this point without knowing about the rules, since standard form sale and purchase agreements will be updated to include provisions for the rules, and many small transactions – where parties may have weaker tax knowledge – should be excluded by the de minimis thresholds. However, officials are investigating more ways to improve the visibility of the rules.

Lastly, if the parties ignore the rules and file their returns with different allocations, then on audit, the Commissioner may require allocations to be furnished, and may determine the allocation at that time, with all the usual consequences of non-compliance and reassessment.

Recommendation

That the submission be accepted, subject to officials’ comments.

Issue: Vendor could be left with no way to comply with rules

Submission

(Deloitte)

Poorly advised vendors could be left with no way to adhere to the proposed rules if their obligations are only discovered after the two-month period expires and the purchaser is indifferent or sour.

This may occur especially with foreign bidders, who will often be indifferent to purchase price allocation due to taxpayer-friendly income tax treatments for some assets (for example, goodwill) in their home jurisdiction.

Comment

Vendors that fail to notify the purchaser within the recommend three-month time frame, and do not themselves receive a purchaser notification within the three-to-six month period, will be able to notify an allocation to the Commissioner that complies with the tax book value floor, just as they would have done if they had notified the allocation within three months of settlement. Whether that allocation binds the purchaser or is over-ruled in favour of a binding purchaser or Commissioner allocation will be at the Commissioner’s discretion, as explained in officials’ response to the previous submission.

Recommendation

That the submission be noted.

Issue: Rules will increase divergence between tax and accounting

Submission

(Chartered Accountants Australia and New Zealand, EY)

The proposed rules will increase the divergence between tax and accounting balance sheets. Tax will be done quickly – within the two-month period – while accounting, under IFRS 3 or similar, can be done up to a year post-transaction. Given the increasing reliance on the IFRS balance sheet (which is subject to strict regulations) for tax, this divergence seems an odd outcome for Inland Revenue to be enabling. Parties should be allowed to follow the IFRS 3 accounting treatment for tax purposes. Though admittedly this issue will only affect a small number of taxpayers.

Comment

Tax/book differences are common. For example, there are differences in when depreciation can start, what depreciation rates are, what expenses are included in cost, etc. As the submission notes, this will only affect a small number of taxpayers. Presumably, the period of time required to undertake an IFRS 3 valuation may mean it cannot always be used even by the purchaser for tax purposes.

Recommendation

That the submission be declined.

DENIAL OF PURCHASER DEDUCTIONS

(Clause 40)

Issue: Denying purchaser deductions if it does not make/notify an allocation is overly punitive

Submission

(Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group, Deloitte, Federated Farmers of New Zealand Incorporated, Jim Gordon Tax Ltd, PwC)

Denying the purchaser deductions if it does not make and notify an allocation is overly punitive. Less sophisticated parties may not be aware of the law change and may find themselves unintentionally subject to this rule. Even an indifferent purchaser could be taxed on gross sale proceeds when it in turn comes to sell.
The purchaser should be treated as acquiring the property for market value. (Chartered Accountants Australia and New Zealand)
If the rule (section GC 21(7)) proceeds, it should be amended so it does not override the de minimis exception (GC 21(5)) or the low value depreciable property exception (GC 21(6)).
It is not clear what would happen if the ability of the purchaser to notify its allocation was frustrated – for example, if the vendor no longer exists, due to being liquidated following a business sale. The purchaser could lose its cost base in this situation, which seems unreasonably harsh. (PwC)

Comment

The intent of this rule is to defer deductions rather than deny them entirely, though officials recognise that this is not clear in the legislation as drafted. Officials recommend that the purchaser’s deductions be deferred until the earlier of:
- the time when the purchaser notifies an allocation to the Commissioner; and
- the time when the Commissioner notifies a binding allocation to the purchaser.
The purchaser will then become entitled to claim, in the next tax return filed, the deductions it was denied in the year/s in which it and/or the vendor failed to notify an allocation. This approach fits the updated unilateral allocation scheme proposed by officials, set out in the previous section of this officials’ report (“Allocation timeframes”).
Officials consider that the rule deferring deductions is necessary to incentivise the purchaser to make and notify an allocation, rather than ignore the consistency requirement and file a different allocation from the vendor (if any). Treating the purchaser as acquiring the property for market value would not provide this incentive. Officials understand that, under current section EB 24, purchasers often take the view that the Commissioner is unlikely to penalise them for simply making a market value allocation, even if it is not consistent with the vendor’s allocation. Deferring deductions provides a clear signal to the purchaser that it is expected to notify an allocation so that consistency can be enforced. If, under the proposed rules, the purchaser does ignore the consistency requirement and files a different allocation from the vendor, it will face use-of-money interest and penalties on audit.

To address the concern about parties not being aware of the rules, officials are investigating ways to prompt parties to consider their compliance.
Officials agree that this deduction deferral rule clearly should not override the de minimis exception for consistency (section GC 21(5)), and recommend amending section GC 21(7) accordingly.

The deduction deferral rule should be applied in relation to low value depreciable property. The deduction deferral applies where no allocation has been notified to the Commissioner, while the depreciable property safe harbour provides protection to parties from a Commissioner challenge in relation to that property. The objective of the deduction deferral rule is to drive the purchaser to notify an allocation, so that the Commissioner can ensure the purchaser and vendor adopt the same allocation – the presence or absence of low value depreciable property in the transaction is irrelevant to the desirability of that objective. If the transaction is above the de minimis thresholds and the parties have not agreed an allocation, the Commissioner should be notified of an allocation. It is not clear what would be achieved by carving deductions for low value depreciable property out of the deferral rule.
In terms of what would happen if the purchaser’s ability to notify its allocation was frustrated, due to a vendor no longer existing (for example) then, as a practical matter the purchaser would only have to notify the Commissioner. The purchaser will not be denied deductions merely because it is technically unable to notify its allocation to a vendor that no longer exists. Officials will clarify this in their guidance.

Recommendation

That the submission be accepted, subject to officials’ comments.

Issue: Purchaser’s acquisition for nil not symmetrical with vendor

Submission

(nsaTax Limited)

There is a value inconsistency in section GC 21(7): in the absence of an allocated amount, the vendor disposal is treated as occurring at market value, but the purchaser is treated as having acquired the same property for nil. This clearly gives rise to a mismatch, which the proposed amendments are supposedly designed to address.

Comment

As clarified in comments on the previous submission, officials propose to reframe this rule – which is needed to incentivise the purchaser to notify the Commissioner of a non-agreed allocation – as a deferral of deductions, rather than a denial. In most cases, officials expect the purchaser will eventually notify an allocation, which will either bind the vendor, or – if notified more than six months after settlement – possibly be disregarded in favour of a vendor or Commissioner allocation, at the Commissioner’s discretion. In either case, the final result will be symmetry between the parties. The interim position may be asymmetry where the parties have not been complying with the rules, but that would be a problem under any other possible formulation of the rules.

Recommendation

That the submission be accepted, subjected to officials’ comments.

Issue: Timing of deductions unclear where purchaser makes late allocation

Submission

(New Zealand Law Society, PwC)

It is not clear how a purchaser’s allocation made late (under section GC 21(7)) will work with respect to the timing of the purchaser’s deductions. This should be clarified.

Under proposed section GC 21(7), if neither party makes an allocation, the vendor is deemed to dispose of the property at market value, and the purchaser is deemed to acquire it for nil consideration, meaning they gets no deductions. It is intended that the purchaser can change this at any time by making an allocation, but the timing of deductions in that case needs to be further considered.

For example, if a purchaser acquires a financial arrangement or revenue account property in one accounting period but no allocation is made until the next period, do the relevant deductions/adjustments apply in the year of disposal or the year the allocation is made? Base price adjustments under the financial arrangement rules (EW 31(2)) should occur in the year of disposal. Deductions for revenue account property and trading stock must be taken in the year of disposal (EA 1 & 2). If a deduction does not arise until the allocation is made, it may be too late for the purchaser to actually claim it. Also, the purchaser might manipulate the timing of deductions.

The new rules could include a discretion for the Commissioner to agree a reasonable approach with a purchaser where an allocation has not been made, but an unreasonably harsh outcome for the purchaser has arisen. (PwC)

Comment

Officials recommend clarifying in the legislation that the purchaser’s deductions will be allowed in the income year for which a return is filed, after either the purchaser has notified an allocation to the Commissioner, or the Commissioner has notified a binding allocation to the purchaser – whichever is earlier.

Recommendation

That the submission be accepted.

MARKET VALUE AND COMMISSIONER CHALLENGE

(Clause 40)

Issue: Unclear whether discounts permissible

Submission

(Corporate Taxpayers Group)

It should be clarified that discounts can be applied as appropriate, where there is bargaining, a fire sale etc, and the Commissioner should not unduly question these transactions.

Comment

Officials consider that the concept of “respective market values” allows for a discounted purchase price and allocation. However, officials recommend amending the wording to “relative market values” to allow for discounted asset values.

Recommendation

That the submission be accepted, subject to officials’ comments.

Issue: Agreed allocation should not be challenged absent sham or avoidance

Submission

(Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group, EY, KPMG)

Proposed section GC 20(2) should be amended. The Commissioner should be bound by an agreed allocation where negotiations are conducted at arm’s length, absent sham or tax avoidance. Market value is a range, and an allocation within this range should be respected.

At the very least, further guidance should be provided, outlining the circumstances in which the Commissioner can challenge an allocation that has been agreed by an unrelated vendor and purchaser. (KPMG)

Comment

Officials agree and acknowledge that market value is a range. Having regard to their care and management responsibilities under the Tax Administration Act, the Commissioner will not invest resources in challenging an agreed allocation unless she believes there is sham, tax avoidance, or otherwise significantly unrealistic values. The Commissioner will need a reason to challenge. It would not be useful to legislate an additional criteria for the Commissioner to meet.

Recommendation

That the submission be declined.

Issue: Pro-rata based on vendor’s tax book values should be market

Submission

(Chartered Accountants Australia and New Zealand)

Where parties have allocated the purchase price to specified asset categories, but based the price on a global market value for each category, a pro-rata allocation of the agreed value to each asset in that category based on the vendor’s net tax book value or cost should be deemed to be market value for the individual depreciable assets.

Comment

The proposed rules are not intended to require agreement to an allocation to individual assets within an asset class. However, the Commissioner will retain the power to challenge an allocation that is not market value. Parties using sensible methods to allocate an agreed allocation to individual assets – noting the existing provisions that require market value allocations to individual assets – should be safe from challenge. There is no need for a special rule for this.

Recommendation

That the submission be declined.

Issue: Unclear how fluctuation in market value during negotiation dealt with

Submission

(Deloitte)

Where a transaction is being negotiated over a period of time (for example, two years), the market value of the global purchase price may have fluctuated, whereas the taxpayer’s purchase price allocation was based on an earlier valuation of the assets at the start of the negotiation.

How to deal with this is not currently clear in the rules, but could be addressed through guidance.

Comment

Parties will have practices to deal with potential fluctuations in market value between the time an allocation is agreed and the time the transaction is completed, if they wish to do so. A simple solution would be for the parties to scale an agreed allocation up or down pro rata to equal the final purchase price. Officials will address this question in their guidance.

Recommendation

That the submission be noted.

Issue: Commissioner should issue guidance on market value

Submission

(EY)

The Commissioner should issue guidance on the process for determining “market value”, to provide certainty for transacting parties.

Comment

Taxpayers may find the Commissioner’s Statement for determining the market value of employee share scheme shares (CS 17/01) helpful. The Commissioner may issue more guidance on market value in the future.

Recommendation

That the submission be noted.

Issue: Interaction of proposed rules with existing market value provisions unclear

Submission

(New Zealand Law Society)

There are numerous provisions in the Income Tax Act that deem assets to be disposed of at market value. The proposed rules do not specify that an agreed allocation applies for all purposes. The interaction of the purchase price allocation rules with the various market value deeming sections should be clarified.

For example, depreciable property, carbon units, revenue account property, trading stock must all be disposed of at market value. See sections GC 1, EE 45(3), EB 24 etc.

Comment

Officials recognise that, although proposed sections GC 20 and GC 21 will ensure consistency of allocations at the level of the specified asset categories, they will not ensure that the amount allocated to a category is allocated to the assets within that category at market value. Existing rules deal with the valuation of individual assets. These general market value provisions will co-exist with the proposed purchase price allocation rules, with the combined effect that vendors and purchasers must use market values at both an individual asset and asset class level.

Officials recommend amendments to make it clear that the total amount allocated to the assets within a class must equal the amount allocated to that class under section GC 20 or GC 21 as applicable. This will be relevant if a vendor is making a unilateral allocation under section GC 21 and is being required to use tax book values at a minimum, even though it considers the market value of the taxable property to be lower.

Recommendation

That the submission be accepted.

Issue: Unclear whether tax-accounting divergence indicative of non-market transaction

Submission

(Corporate Taxpayers Group)

The purchase price allocation for financial reporting/accounting may differ from the allocation for tax (accounting normally done post-transaction), for example, to recognise assets fair value, which could include asset impairment, goodwill etc. Officials should form a view on whether such a divergence would be treated as an indication that a transaction occurred on a non-market basis.

The allocation for the financial statements is normally audited some time after the transaction.

Comment

Officials do not consider that a discrepancy between accounting and tax would necessarily cause the Commissioner to treat the tax allocation as not being at arms-length. However, if the discrepancy is material, and there is no explanation for it, then the Commissioner may well make an enquiry, and the accounting valuation might be used as evidence in support of an adjustment.

Recommendation

That the submission be noted.

Issue: Commissioner currently not required to notify other party of challenge

Submission

(PwC, Corporate Taxpayers Group)

There is currently no requirement on the Commissioner to notify the other party if a party’s allocation has been challenged, so the other party might not know about the challenge. There is also no mechanism for the other party to adjust its allocation when the Commissioner is successful in a challenge.

If there is a dispute which leads to a different value being allocated than the value in the parties’ tax returns, the Commissioner should use section 113 of the Tax Administration Act 1994 (TAA) to amend the value in the tax returns. This is compliance-friendly. (Corporate Taxpayers Group)

The legislation should be amended to require the Commissioner to inform a party if an allocation is altered as a result of a challenge to the other party, and to allow the first party to amend its tax return to reflect the new allocation. (PwC)

Comment

If the Commissioner is challenging an allocation, they will take the operational steps necessary to ensure any new allocation is adopted by both parties, as consistency is required by the new purchase price allocation rules.

The Commissioner would inform the other party of the new allocation and allow it to adjust its tax return accordingly. For example, if the Commissioner successfully challenges a purchaser’s allocation to depreciable property as too high, the Commissioner would inform the vendor and allow it to adjust its return also (assuming it has adopted the purchaser’s allocation). This could be done under section 113 of the TAA.

Recommendation

That the submission be declined.

Issue: Transfers within wholly owned groups exposed to risk

Submission

(Corporate Taxpayers Group)

Where a business is sold within a wholly owned group, a taxpayer should be able to allocate on the basis of tax book value or cost with no ability for the Commissioner to challenge. This would allow wholly owned groups to restructure without risk.

Tax book value and cost are not arbitrary figures – they are already the basis for the business’s tax position. But the taxpayer could apply to the Commissioner for a higher cost base if it wanted to. There is precedent for this in section EB 5 – trading stock transferred within wholly owned groups can be valued at cost.

The consolidation regime can be used to get around valuation issues with intra-group transfers, but the regime comes with its own issues, such as removing an entity from the consolidated group.

Comment

The focus of these amendments is consistent allocation. They are not concerned with the issue of non-recognition for transactions between associated parties. That may be an appropriate subject for a further reform. Officials note that there are already ways for corporate groups to achieve non-recognition treatment.

Recommendation

That the submission be declined.

DE MINIMIS/SAFE HARBOUR THRESHOLDS

(Clause 40)

Issue: Consistency de minimis incomplete

Submission

(EY, KPMG, New Zealand Law Society)

The de minimis in section GC 21(5), which is intended to exclude parties from the consistency requirement, is incomplete. It only overrides some of the consistency requirements, not all of them. The de minimis needs to override GC 21(7) (“No allocated amount”) etc.

Comment

This is a drafting error and officials recommend this be addressed.

Recommendation

That the submission be accepted.

Issue: Consistency thresholds too low

Submission

(Corporate Taxpayers Group, PwC)

The $1 million total purchase price threshold and the $100,000 threshold for the purchaser’s allocation to taxable property should be increased. These thresholds are too low to be of practical use, particularly for transactions involving land and buildings. Most commercial property transactions that will fall under the new rules will exceed $1 million of consideration, with a large amount of the consideration attributable to land outside the tax base. The amount attributable to depreciable property will usually exceed $100,000. The threshold should be materially increased (to say $5 million), where significant value is from land outside the tax base.

Comment

The de minimis thresholds are intended to exclude small transactions where the amount of tax at stake is low enough for there not to be material discrepancies between parties’ tax positions, and where parties may be relatively unsophisticated in their tax compliance. Although buildings are now depreciable property, residential buildings remain non-depreciable. Accordingly, few sales of residential rental property will be caught by the new rules. Sales of commercial property are unlikely to be made without advice.

However, officials recommend two changes to the de minimis thresholds.

First, officials recommend removing the $100,000 deductible property threshold. We consider it may be problematic for transactions over $1 million where a vendor assumes the purchaser’s allocation to deductible property will be well under $100,000, and therefore disregards the consistency rules, but then three-to-six months after the transaction the purchaser notifies the vendor of a binding allocation with an allocation to deductible property that is higher than $100,000. The total transaction price threshold is easily evaluated by both parties and is therefore less likely to lead to unexpected outcomes.

Second, officials recommend introducing a separate transaction price threshold of $7.5 million for residential property transactions. Residential buildings and most residential fitout are non-depreciable, so in most cases the only taxable/deductible property in residential property transactions will be chattels such as whiteware (if any), which are unlikely to have a high value in aggregate. This makes residential property a low revenue risk area, and a higher de minimis for these transactions is therefore appropriate. This change is unlikely to have a material fiscal impact.

Officials recommend keeping the de minimis for all other transactions at $1 million.

Recommendation

That the submission be declined, subject to officials’ comments.

Issue: Low-value depreciable property threshold incorrectly based on tax book value

Submission

(Matter raised by officials)

The submission is to correct a drafting error from adjusted tax book value to original cost.

Comment

Proposed sections GC 20(3)(c) and GC 21(6)(c) refer to the “adjusted tax value” of the purchased property being $10,000 or less, while the Commentary refers to the “original cost” of the property being “less than $10,000”. This is a drafting error. The policy intent is for the threshold amount to be original cost, since that is the true upper bound for depreciation planning.

For example, a piece of industrial equipment might have an adjusted tax value of $8,000, but an original cost of $80,000 – it has simply been depreciated for the past nine years, and would be fully written-off the next year (if the depreciation rate is 10% straight-line). A tax book value allocation by the vendor may potentially understate the vendor’s true taxable income by tens of thousands of dollars, since the value of the machine could be closer to its original value of $80,000. The corresponding tax effect of this undervaluation could then be thousands or tens of thousands of dollars. Thus, if the Commissioner cannot challenge the allocation because the adjusted tax value of the machine is less than $10,000, the revenue loss from that single asset could be significant.

Recommendation

That the submission be accepted.

Issue: Low-value depreciable property threshold should also apply to purchaser

Submission

(Deloitte, PwC)

The safe harbour for low-value depreciable property in proposed section GC 21(6) should also reference subsection GC 21(3) – currently, the safe harbour does not appear to apply to the purchaser’s allocation. Parties should be able to gain the benefit of certainty if an allocation made under section GC 21(3) meets the GC 21(6) requirements. Not allowing the same protection to purchasers’ allocations further disincentivises vendors to reach an agreed allocation with the purchaser.

Comment

The safe harbour will be of no value to the purchaser when it is making a unilateral allocation. The Commissioner will generally only challenge an allocation to depreciable property if it is too low, and if they substitute a higher value, it will be favourable for the purchaser, because the purchaser will then get higher depreciation deductions going forward.

The other situation in which the Commissioner may challenge the allocation is if it is substantially above the original cost of the property to the vendor; in that case, the purchaser is getting stepped up depreciation with no additional tax consequences for the vendor (the amount above original cost is a capital gain), and for most depreciable assets it would be rare for such a high value to be accurate. But because of that asymmetry, the safe harbour does not protect allocations above original cost. So overall, the safe harbour has no real utility for the purchaser.

However, for the sake of simplicity, officials recommend redrafting the legislation so that the safe harbour applies to an allocation by either party.

Recommendation

That the submission be accepted.

Issue: Low-value depreciable property threshold should be relative or increased

Submission

(Chartered Accountants Australia and New Zealand, EY)

The $10,000 original cost threshold in section GC 20(3) for allocations to depreciable property ranging from adjusted tax value to original cost should be made relative.

Ten thousand dollars is insufficient and should be increased to reduce unnecessary compliance costs for assets which have a low risk of mis-valuation. The amount should be relative – it could be a percentage of the transaction value, to avoid issues with large-scale transactions.

Alternatively, the $10,000 threshold should be increased significantly, to at least $100,000.

Comment

This rule is intended to allow the vendor’s tax book value to be allocated to low-value assets such as office equipment with assurance that this allocation will not be challenged. It would not be appropriate to extend the safe harbour to higher value assets, where discrepancies between tax book value and market value could be material.

Recommendation

That the submission be declined.

APPLICATION DATE

(Clauses 40 and 2(22))

Issue: Application date too early

Submission

(Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group, Deloitte, Russell McVeagh, Jim Gordon Tax Ltd, Federated Farmers of New Zealand))

The application date should be extended to 12 months after the date of enactment (that is, 1 April 2022).

This would allow time for the Auckland District Law Society’s standard sale and purchase agreement, and other standard agreements, to be changed. It would also allow time for an education campaign covering all potentially impacted taxpayers.

The proposal will significantly affect the primary sector, and there is a risk one or both parties to a primary sector sale and purchase agreement will ignore the new rules if the private sector is not given a chance to understand the rules before they become effective. (Jim Gordon Tax Ltd)

Alternatively, as a compromise, the application date for smaller transactions (say below $15 million) could be deferred for three months. This should not adversely affect the Government’s forecasts. Moreover, farmland did not appear to be considered when forecasts were prepared, so any gain from transfers of farmland were likely not included in the forecasts. A window to allow for taxpayer education is necessary to encourage compliant behaviour by SMEs, and farmers in particular. (Federated Farmers of New Zealand)

The current application date is too early for parties to prepare for the changes.

Comment

Changing the application date would have fiscal consequences. Officials consider that a 1 April 2021 enactment date will be feasible for taxpayers, as we are working with private and public-sector organisations to promote these changes.

Recommendation

That the submission be declined.

VARIOUS DRAFTING ISSUES

(Clause 40)

Issue: Provisions not appropriately located in legislation

Submission

(Chartered Accountants Australia and New Zealand)

The provisions should be in part F (recharacterisation of certain transactions), not part G (avoidance and non-market transactions).

Comment

Officials acknowledge that the provisions could be located in part F. However, it is not inappropriate that they are located in part G. The purpose of the rules is to prevent property being treated as bought for one price and sold for another in order to minimise tax. In this regard, the rules have an anti-avoidance dimension.

Recommendation

That the submission be declined.

Issue: Unilateral allocations should be worded as optional and not mandatory

Submission

(Deloitte)

The obligations in proposed sections GC 21(2) and (3) should be expressed with the word “may” instead of “must”; the existing wording strictly makes the obligation for a unilateral allocation to be made mandatory, when this is at odds with the wider proposal.

Comment

Officials agree that the unilateral allocation rules should be expressed as optional, as it should be clear that the parties can agree an allocation at any time before the first tax return for the transaction is filed.

Recommendation

That the submission be accepted.

Issue: Term “respective market value” ambiguous

Submission

(Deloitte)

The reference to “respective market value” in sections GC 21(2) and (3) is ambiguous, and a clear definition should be provided in the legislation.

Comment

Officials recommend changing this wording to “relative market value”. Officials consider that it is clear from the plain meaning of the words in the context that this term means the market value of a class of property in relation to the market values of the other classes of property. “Relative market value” contemplates transactions where the total purchase price is higher or lower than the price that would be calculated as the sum of the market values of all the assets if they were bought and sold individually – that is, where the parties are placing either a premium or a discount on the transfer of the assets as a bundle.

Recommendation

That the submission be accepted, subject to officials’ comments.

Issue: Tax book value floor for vendor should apply as if section EE 11 did not apply

Submission

(Deloitte)

Proposed section GC 21(8)(a) should be amended to clearly state that it is intended to operate as if section EE 11 did not apply.

Comment

Officials do not see the need for this clarification; section EE 11(4) allows for part-year depreciation loss, so is not in contradiction with proposed section GC 21(8)(a). Officials note that this section will be simplified to refer to “tax book value”.

Recommendation

That the submission be declined.

Issue: References to “person A” and “person B” difficult to follow

Submission

(EY)

The references to “person A” and “person B” throughout the proposed sections GC 20 and 21 make the legislation difficult to follow. It would be easier to read if the parties were referred to as the “vendor” and “purchaser” throughout.

Comment

“Vendor” and “purchaser” are possible synonyms, but would require definition, and may carry legal connotations that unintentionally limit the application of the rules. “Person A” and “person B” are more neutral terms, and their meaning is clear from the context.

Recommendation

That the submission be declined.

Issue: Phrase “to which other income or deduction provisions of this Act apply or don’t apply at all” unclear

Submission

(EY)

It is not clear what is meant by the phrase “…to which other income or deduction provisions of this Act apply or do not apply at all.”

Comment

Officials agree that this phrase is unclear and recommend amending it.

Recommendation

That the submission be accepted.

Issue: Heading to section GC 21 unclear

Submission

(EY)

The heading to section GC 21 is not reflective of the content and does not adequately differentiate between sections GC 20 and 21. The heading could be better phrased as “Effect of parties not agreeing to a purchase price allocation.”

Comment

Officials agree that the heading could be clearer and recommend amending it to distinguish it more from section GC 20.

Recommendation

That the submission be accepted.

Issue: Use of word “disposes” misleading

Submission

(nsaTax Limited)

Sections GC 20 and 21 apply “when a person (person A) disposes of, to another person (person B), property (the purchased property)”. This wording should be clarified to ensure the rules only apply to sale and purchase situations. The use of the word “disposes” is misleading, as there are many disposal provisions in the Income Tax Act which could result in the new rules having unintended application. For example, trust resettlements, inheritances, disposal of assets to a partnership on formation etc.

Comment

Officials recommend clarifying that the rules apply to disposals for consideration. Further limitations on the application of the rules are not desirable.

Recommendation

That the submission be accepted, subject to officials’ comments.

Issue: Standard of identicality in phrase “materially identical” unclear

Submission

(nsaTax Limited)

In sections GC 20(3) and GC 21 (6), the word “identical” in the phrase “materially identical” would indicate that the assets are not just similar or of the same class. What is the standard?

For example, a car yard is sold with a total value of ten vehicles exceeding $1 million. If the vehicles are not materially identical because they are a different make and model, does the de minimis provision apply or not?

Comment

Officials recommend simplifying the phrase to “identical”.

Taxpayers will make a reasonable assessment of identicality. Items that are interchangeable and are ascribed the same per item value by the parties will be identical. For example, a fleet of Priuses which are ascribed the same or a similar value may be identical. A Prius and a Lamborghini would not be.

Recommendation

That the submission be noted.