The purchase price allocation (“PPA”) income tax rules came into effect on 1 July 2021.
These rules are particularly significant to those selling and purchasing commercial property and businesses. PPA is where parties allocate the total purchase price among the various types of assets in a transaction, such as buildings, stock and plant etc.
For transactions entered prior to 1 July 2021, parties could allocate the purchase price to assets outside of sale and purchase agreements to achieve more favourable tax outcomes. For example, a vendor would allocate less of the purchase price to a depreciable asset to reduce their income upon sale and accordingly their tax liability, whereas a purchaser would allocate more of the purchase price when buying the same depreciable asset to increase their expenses and thus reduce their tax liability.
The new rules provide for prescribed PPA, which ideally should be included in agreements and based on market value to uphold NZ’s tax base.
The rules apply to mixed asset transactions i.e., business asset sales, farm and forestry sales, commercial property sales and high value residential sales which generally involve two or more categories of assets.
The rules do not apply to mixed asset transactions below $1 million and residential sales below $7.5 million; however, it is still best practise to agree on the PPA where applicable.
It is suggested that the agreed PPA is included within sale and purchase agreements before they are entered, and where it is not agreed or for urgent or unconditional transactions, provision is made within the agreement for the parties to agree on the PPA within a certain timeframe following settlement.
Once the PPA is agreed, each party must use it when completing their next respective tax returns.
The PPA must be based on market value, and where IRD considers the agreed allocations do not reflect this, it can prescribe a different PPA.
Where parties to a transaction cannot agree on a PPA prior to filing the next relevant tax return, the vendor can determine the PPA within 3 months from settlement by notifying IRD and the purchaser. If the vendor fails to do this, the purchaser may determine the PPA within 6 months from settlement by notifying IRD and the vendor. If the purchaser does not notify both parties, the IRD determines the PPA, and the purchaser may be denied any entitled tax deductions until the next tax year.
To avoid the situation above where the vendor may in the first instance unilaterally determine the PPA where it is not agreed from the outset, it is important to raise this issue when discussing the terms of a transaction, together with obtaining the relevant tax and legal advice prior to entering a binding agreement.
It is also suggested that independent market values are obtained for the assets involved to reduce the risk of IRD overturning a PPA agreed between the parties.
For tailored advice on the new PPA rules, you can contact your legal and tax advisors.