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On 1 July 2021, the new Purchase Price Allocation Rules (PPA) came into effect. These new rules are aimed at stopping taxpayers from allocating asset values in a way that gives them a more favourable tax outcome when buying and selling assets. The rules do this by allowing one party to decide the price allocation if the parties do not record the allocation in a written agreement.
The new rules apply specifically to the sale of assets like commercial property, forestry land or a business where the sale price is $1M or more. They also apply to the sale of residential land where the sale price is $7.5M or more.
These new rules are meant to ensure that where a Sale and Purchase Agreement records an overall price that includes two or more different categories of an asset, the vendor’s and purchaser’s tax position concerning the allocation of the price between the asset classes are aligned. The rules apply to agreements entered into on or after 1 July 2021, and involve assets within two or more of the following categories:
1. Trading stock, other than timber or a right to take timber
2. Timber or a right to take timber
3. Depreciable properties other than buildings
4. Buildings that are depreciable property
5. Financial arrangements
6. Purchased property for which the disposal does not give rise to assessable income for the vendor, or deductions for the purchaser e.g. land.
The rules are intended to encourage the vendor and purchaser to apply the same allocation of the sale price to the different asset classes (such as goodwill and plant or machinery). When the parties can’t agree, the rules set out which party can make an allocation and in what time frames.
What if Parties Can't Agree?
If the parties don’t agree on the purchase price allocation in writing, then the vendor has the first right to decide on the PPA. The Vendor can specify the allocation, subject to specific constraints, and must notify the purchaser and Inland Revenue within 3 months following the settlement date. Both parties will then be obliged to use this allocation.
If the vendor doesn't specify the allocation and notify the purchaser and Inland Revenue within the 3-month period following the settlement date, then the purchaser can decide the allocation and must notify the vendor and Inland Revenue within 6 months following the settlement date. Both parties will then be obliged to use this allocation.
If neither the purchaser or the vendor has made an allocation and notified Inland Revenue within 6 months following the settlement date, Inland Revenue will allocate the price to the assets at market value and the purchaser's tax deduction (if any) may be denied until the following year’s tax return.
If Parties Agree
The best practice would be for both purchaser and vendor to agree on the purchase price allocation (PPA) in writing before filing the tax returns in which they take a tax position on the purchased property, and then both parties would follow that PPA in their respective tax returns. If that is the case, the property is treated as being sold and bought for that price.
It's worth noting that the sale and purchase price agreement does not necessarily have to record the final price and asset allocations. If this isn't recorded, the mechanism for that price to be set (ie independent valuation), should at least be specified along with the timeframe for that to happen.
The new Purchase Price Allocation Rules clearly give the vendor the upper hand. There could also be problems if the parties aren’t clear about who owns the fit-out items where the transaction relates to the purchase of leased premises. Often fit-out will have been purchased and owned by the tenant and ownership of the fit out may not transfer with a land sale.
Property transactions are complex, and it is always best to seek out advice from your lawyer and accountant before entering into any agreements. So, whether you are a vendor or purchaser, we're here to help.