Buyers and sellers beware! New Tax Rules 2021: What you need to consider when buying or selling a business

If you are buying or selling a business this year, think carefully about how the purchase price should be allocated to the assets being sold/purchased.  As of 1 July 2021, new tax rules governing purchase price allocation in business sale and purchase transactions will come into effect. 

We provide a brief summary on the reasons behind the new rules, what the rules require, and what this means for you.

The Current Tax Issue

There are no legislative rules governing the way in which buyers and sellers of businesses are allocating the purchase price to assets.  Without any requirement for parties to make consistent allocations, there is a loophole for parties to maximise tax advantages when filing their tax returns.

Because different asset categories are taxed differently, essentially a seller may choose price allocations that minimise their taxable income and a buyer may choose different allocations to maximise their deductions.  As you would expect, Inland Revenue (IRD) is concerned that such allocations are detrimental to the Government’s revenue base.

New Rules – effective for agreements entered into on or after 1 July 2021

The Taxation (Annual Rates for 2020-2021, Feasibility Expenditure, and Remedial Matters) Bill introduces new rules requiring parties to adopt consistent purchase price allocations (based on relative market values) and values for each asset category.  The new rules will apply to business and commercial property agreements entered into on or after 1 July 2021 where the total purchase price is more than $1 million.

In short, under the new rules:

• If the parties have agreed an allocation prior to filing their tax returns, then the parties must follow that allocation when filing their returns.

• If the parties have not agreed an allocation prior to filing their tax returns, the seller is entitled to make an allocation that reflects the greater of the relative market value of the assets and the seller’s tax book value of the assets.  The seller must then notify IRD and the buyer of the allocation within 3 months of the change of ownership of the assets.  Unsurprisingly, this rule incentivises buyers to agree on allocation with the seller prior to filing tax returns.   

• If the seller fails to make an allocation within the prescribed timeframe of 3 months in accordance with paragraph 2 above, the buyer is entitled to make an allocation that reflects the relative market value of the assets proportional to the other purchased assets.  The buyer has 6 months to notify IRD and the seller of the allocation.

• If the parties do not notify the relevant people in accordance with paragraphs 2 and 3 above, then the Commissioner of IRD will determine the allocation.

What this means for you if you are buying or selling a business?

• In the early negotiation stages with another party, we recommend seeking legal and tax advice.  It is important that you understand the legal and tax implications of the transaction (including tax consequences of price allocation).

• When negotiating the terms of the transaction documentation, ensure that you agree on method of valuation of the assets and negotiate price allocation.

• Ideally, you should agree on price allocation with the other party before you enter into an agreement with them.  This avoids getting into a situation, if you are a buyer, where the seller has the ability to make the allocation (and vice versa).

If you have any questions or concerns regarding business sale and purchase matters, please get in touch with Sarah or Jono.