Tax Alert


Inland Revenue focusing on purchase price allocations 

Tax Alert - August 2018

By Virag SIngh and Vyshi Hariharan

We are aware of an increasing trend for Inland Revenue (IR) to challenge taxpayers’ allocations of purchase price when they enter into business asset sale transactions.  IR’s chief concern appears to be that the values used by either the vendor or the purchaser do not reflect market values.  This is something that everyone either buying or selling a business needs to be aware of, as it can have a material impact on the expected tax outcome of a business sale. The situations that IR are focussing on include:

  • Scenario 1 - parties have agreed to a purchase price allocation in the sale documentation and adhere to this allocation for the purposes of preparing their respective tax returns;
  • Scenario 2 - parties have agreed to a global price for the business / assets, no allocation is agreed to in the sale documentation, and the vendor and purchaser use different allocations for the purposes of preparing their respective tax returns; and
  • Scenario 3 - despite the parties agreeing to an allocation in the sale documentation, either the vendor, purchaser or both do not adhere to this allocation for the purposes of preparing their respective tax return(s) and instead obtain different allocations and prepare their tax returns based on this. We expect this situation to be quite rare, in the absence of other information.

We understand that IR’s key concern is that tax positions taken are not based on market values of the assets sold. In particular, they appear focussed on situations where there is asymmetry in the tax treatment between the respective parties; or where IR believes that the purchase price allocation has been struck to take into account specific tax attributes of the vendor / purchaser (eg where the price allocated to fixed assets is in excess of tax book value and the depreciation recovery is offset by existing tax losses of the vendor or the vendor is exempt from tax). IR have included a project on the tax policy work programme to consider these issues further.

Business asset sales can involve the sale of a range of items (including trading stock, depreciable tangible assets, buildings, land, intangible property, goodwill etc.).  For tax purposes, there is a requirement that certain items (such as depreciable property, trading stock, revenue account property) are disposed (or deemed to be disposed) at their market values.

Market value is not a defined term under the Income Tax Act 2007 (the Act) for the above purposes.  One view is that market value is not one number but rather a range and there are of course a number of valuation methodologies that can be applied.  Under this approach, despite the existence of a market valuation for the asset, there are a number of other factors that could affect the final price at which an item is sold e.g. the nature of the asset and the circumstances of the buyer/seller.

Scenario 1

Where independent parties, operating on an arm’s length basis, agree on an allocation in the sale documentation and adhere to that allocation in their respective tax returns, then our view is that those allocations should be respected as market value allocations.  There is a natural tension when parties in this situation negotiate and agree on an allocation of the overall sale price.  There should be no room for interference by IR to disturb this allocation unless the arrangement is a sham.

Scenario 2

Where there is a global purchase price agreed for the sale of the assets of a business and no allocation has been agreed, either party can end up allocating in an inconsistent manner.  This inconsistency could be tax driven.  For example, sellers could be motivated to allocate to depreciable assets amounts that are equal to or less than the tax written down values of those assets, while purchasers may be motivated to allocate to depreciable assets as much as possible to enhance future depreciation deductions.  The irony of this inconsistency is that both allocations could potentially be supported by two market valuations (undertaken by each party).  Once IR intervenes to review the inconsistency, there could well be a third market valuation (being the one obtained by IR itself).  This is clearly an undesirable and potentially quite expensive outcome for the taxpayers.

Scenario 3

Our understanding is that only in very rare circumstances are parties proceeding to obtain their own valuations and adopt tax positions in accordance with those valuations, despite agreeing to different allocations in the sale documentation. In this case, IR has tools to address this inconsistency (both within the specific provisions, and by virtue of the specific and general anti-avoidance rules).  Once parties have agreed to a price and allocation of that price, then we expect that they should be bound by that price and allocations both for tax and non-tax purposes as that is ultimately the cost of that item in its truest sense.  Given that parties have agreed allocations, then the presumption should be that this should reflect the market values of the items being sold.

Summary & Recommendation

To mitigate risks in the current environment we recommend that taxpayers:

  • ensure that, where possible, the sale documentation includes an allocation of purchase price across the classes of assets being sold, and they agree in writing to file their income tax returns in accordance with the documented allocation (if required due to the transaction timeline the parties could document in the agreement that they will seek to agree the allocation post-signing).
  • consider obtaining an independent valuation of material assets being bought/sold and subject to commercial negotiations to support the allocation agreed.
  • consider what contractual protection may be available for an increased tax liability arising from the other party and / or IR adopting a different allocation to what is documented eg through the sale and purchase agreement or W&I insurance.

Please contact your usual Deloitte advisor if you have any questions or would like to discuss this issue.



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