On 1 July 2021, new income tax rules came into effect relating to “purchase price allocation” (PPA). 

These rules apply to “mixed asset” sale and purchase agreements entered into on or after
1 July 2021
, whether conditional or unconditional, with:

(a)  In the case of commercial property or business sales/purchases (or any other mixed asset sales) a purchase price of more than $1million; or

(b)  In the case of residential property, a purchase price of more than $7.5million.

It is important for anyone involved in transactions of this nature to understand the new PPA rules and how they work, as they can have major financial implications for the buyer and seller.

What is a “mixed asset” sale and purchase transaction?

A “mixed asset” sale and purchase transaction is one that involves different classes of assets that have different tax treatments, for example land, chattels, and intangible assets. 

Examples of mixed asset transactions may include commercial property, forestry and farm, business, and some residential property transactions.

What are the PPA rules about?

The idea of the PPA rules is that different assets in a sale/purchase transaction will have different tax treatments, and so the parties can agree in writing the way the purchase price will be allocated to those various assets - i.e. how much of the purchase price will be allocated to each asset type.  The parties can thereby determine their income tax positions in accordance with that PPA.

According to the Inland Revenue Department (IRD), in the past some buyers and sellers have avoided agreeing on a PPA and have instead each been allocating different prices to the same transaction in their respective tax returns.  IRD has said this is detrimental to New Zealand’s tax base because it has reduced the amount of tax that is collected, and so the new rules are designed to prevent buyers and sellers from taking this uneven approach any longer.

PPA can have a substantial effect on each party’s tax position.  For example, in sales of land and buildings, the buyer’s tax position is generally improved by allocating the purchase price to things which depreciate (such as fixtures, fittings, and plant) rather than non-depreciable items.  Conversely, a seller is likely to want to allocate more value to non-taxable items such as goodwill.  PPA is an area where tailored accounting advice is vital for both parties.

When do the PPA rules apply?

The PPA rules do not apply:

  1. To residential land and chattels transactions with a total purchase price of less than $7.5million; and
  2. To any other transactions with a total purchase price of less than $1million.

The PPA rules are much more likely to come up in commercial transactions involving commercial property, businesses, farms or forestry – as it is not unusual for these sorts of transactions to have a purchase price of $1million or more. 

There may also be situations where PPA does not apply to one or both parties, such as where a party is tax-exempt.  This is where expert accounting advice will be vital. 

How do the PPA rules work in practice?

The parties must agree a PPA for a “mixed asset” transaction in writing.  If there is no agreed PPA, then the right to determine the PPA operates as follows:

  1. The seller will generally have the first, unilateral right to determine a PPA within three months of settlement.  The seller must notify IRD and the buyer of the allocation, and their decision binds the buyer.
  2. If the seller does not do so within the timeframe, the buyer has a unilateral right to determine a PPA within six months of settlement.  The buyer must notify IRD and the seller of the allocation, and their decision binds the seller.
  3. If neither party determines a PPA, the Commissioner of IRD will determine a PPA that binds both buyer and seller. 

It is very important for buyers to understand that unless they agree a PPA with the seller, the seller has the first right to decide the PPA, and that could have a significant impact on the buyer’s tax position.  

Where is PPA recorded?

Addenda have been added to the relevant ADLS/REINZ forms for recording the PPA.  The relevant forms are:

  • Agreement for Sale and Purchase of Real Estate – Tenth Edition 2019 (2);
  • Agreement for Sale and Purchase of a Business – Fourth Edition 2008 (6); and
  • Particulars and Conditions of Sale of Real Estate by Tender – Fifth Edition 2020).

The addenda are flexible to record the parties’ particular circumstances and how the PPA is occurring in the relevant transaction.  

The importance of professional advice

Ideally the PPA will be negotiated at the same time as the other terms of the transaction are being agreed. 

It is extremely important that parties to a mixed asset transaction take legal and accounting advice at the outset, to understand the consequences of any proposed allocation, before entering into a transaction or signing an agreement.  

If you are unsure of your obligations, it you should take legal and accounting advice.