Purchase Price Allocation
Buying or selling a business is a significant decision, and commonly involves vendor and purchaser negotiations on many aspects of the transaction.
The price is often one of the first points to be negotiated. Irrespective of whether the transaction is for shares in a company or its underlying assets, a single amount is typically agreed. However, where the transaction is for assets it is important to remember that the tax implications of selling the assets (e.g. trading stock, depreciable plant, equipment, goodwill and liabilities) needs to be determined and the amount derived is fundamental to this process.
For tax purposes, the price is allocated between the various assets on the balance sheet by a ‘purchase price allocation’ (PPA). For example, if depreciable assets are sold as part of a transaction and values have not been agreed on an asset by asset basis, the purchaser and vendor could determine different ‘market values’ resulting in inconsistent treatment.
This issue is exacerbated by the fact that vendors are motivated to allocate high values to non-taxable capital assets such as land or goodwill, whilst minimising the value attributable to assets such as trading stock, or plant and machinery, which reduces the vendor’s tax bill on sale.
Conversely, purchasers can gain a tax advantage by allocating as much value as possible to revenue account assets and depreciable property, to provide larger future tax deductions.
Consequently, the Government is concerned that the tax base is eroded, if different pricing allocations are adopted by vendors and purchasers in a transaction.
To address this, Inland Revenue (IRD) issued an official consultation paper in December 2019, with an aim to implement legislation in 2020, which seeks to ensure consistency in application of the PPA by both the vendor and purchaser.
In theory the IRD’s proposal is simple. The vendor and purchaser must use the same PPA across the various assets included in the transaction, through mutual agreement. If they cannot agree, IRD proposes that the purchaser must use the vendor’s allocation when filing their tax return. If the vendor does not prepare the allocation for any reason, then the purchaser can make it instead.
It is proposed that details of the PPA are provided to IRD within three months of the transaction. This additional disclosure is expected to encourage all parties to apply ‘market value’ fairly due to the risk of subsequent review by IRD.