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New Purchase Price Allocation Rules

New rules that will impact property investors, especially those involved in commercial property, are set to be introduced effective from April 1, 2021, writes Mark Withers.

By: Mark Withers

30 November 2020

The new rules will impact the way parties to a transaction will allocate the price between two or more assets that may have differing tax treatments for each party.

In a property context, price is typically allocated between land, building and items of chattel and fit out.

The Government is concerned that at present it is common for vendors and purchasers to adopt different allocations between the assets that are beneficial to each party but detrimental to the tax base.

The objective of the changes is to prevent any overall loss of tax revenue when vendors and purchasers adopt different price allocations that minimise their respective tax liabilities.

Consider This Example:

A commercial building is sold for $2 million. The original cost of the property was $1.5 million with building and fit out now depreciated to $1.2 million.

The vendor believes the market value of the improvements to be the same as the depreciated book value and allocates the price accordingly, avoiding any depreciation recovery. The purchaser, though, gets the improvements valued and determines an allocation of $1.4 million to them. This creates a difference of $200,000 between the allocation made by the vendor and the purchaser and results in tax revenue being lost.

‘The Government is concerned that at present it is common for vendors and purchasers to adopt different allocations between the assets that are beneficial to each party’

Inland Revenue Wants To See This Situation Prevented

The thrust of current law is to require disposal of assets to occur at “market value” but the practical interpretation of this and how it is agreed and confirmed between vendor and purchaser is where officials believe mischief lies.

The proposed amendments, if enacted, would apply to agreements for the disposal and acquisition of property entered on or after April 1, 2021.

The key points of the proposal are:
• if the parties agree on an allocation, it must be used in both tax returns
• if the parties do not agree, the vendor determines the allocation and must notify the Commissioner and purchaser within two months of the sale
• If the vendor does not make an allocation within two months, the purchaser is entitled to notify IRD of their own allocation
• the Commissioner can change any allocation if she considers it does not reflect market value
• if neither vendor or purchaser notify IRD of an allocation the purchaser is treated as having acquired the property for nil consideration and will be denied any depreciation claim
• vendors will not be allowed to allocate values that are below their depreciated book values to ensure there are no losses on disposal available
• The purchase price allocation rules will not apply to transactions where the total purchase price is less than $1 million or the purchaser’s total allocation to taxable property is less than $100,000.

It seems certain that these new rules will require both vendors and purchasers to consider their respective tax positions around asset allocation at the point of negotiation and it will be another factor that will have a material impact on how property negotiations play out.

It will certainly be important for the purchasers to notify IRD of an allocation if the vendors don’t as the consequences of a deemed nil cost base on assets that would otherwise have been depreciable will be another trap for the unwary. ■

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