Purchase price allocations in New Zealand M&A in the tax spotlight
In every sale of a business that is structured as a sale of assets the purchase price must be allocated across the assets to determine the tax consequences of the sale. New Zealand’s Inland Revenue Department (IRD) is concerned that in some cases vendors and purchasers of New Zealand businesses are adopting tax-driven allocations that are detrimental to New Zealand’s tax base.
In December 2019, IRD released a tax issues paper seeking feedback on prescriptive new rules to address this perceived risk, which if implemented would significantly impact New Zealand mergers and acquisitions (M&A) deals.
In IRD’s view, purchase price allocations should not be driven by tax considerations. In all cases vendors and purchasers should adopt consistent allocations that reflect the market values of the assets sold. IRD is concerned that some taxpayers are not taking this approach, and are instead adopting tax driven allocations that minimize income for vendors and/or maximize deductions for purchasers.
It is not clear how material this problem is in practice, but we agree there is some risk from IRD’s perspective under the current tax settings. One obvious risk area is where vendors and purchasers do not agree on a specific purchase price allocation in their sale and purchase agreement. In these situations the parties are left to adopt their own view on value and there are incentives for:
- vendors to maximize allocations towards non-taxable goodwill, and minimize allocations to taxable items; and
- purchasers to maximize allocations towards depreciable or deductible items.
There is a risk that these incentives could result in a mismatch in allocations adopted by the parties that is detrimental to New Zealand’s tax base.
Even where the parties agree on a purchase price allocation and adopt this consistently, in some instances the allocation may not appropriately reflect “market value.” While, generally, the natural tension between a vendor’s desire to minimize allocations to taxable items and the purchaser’s desire to maximize those allocations should help to generate a “market” allocation, that price tension does not always exist. Examples include:
- where one party is a tax-exempt charity or has an existing tax loss balance. If, for example, the vendor is a tax-exempt charity or has sufficient tax losses to shelter any income from the sale, they may be disinterested in the allocation of purchase price between the assets, and the purchaser may be able to negotiate inflated values for items that will be deductible/depreciable to them going forward.
- where depreciable assets are sold. An allocation to depreciable assets in excess of their original cost may be acceptable to the vendor on the basis that the vendor is not taxed on the excess. In these circumstances the purchaser may be able to negotiate an inflated value for the depreciable property, which would generate additional depreciation deductions for them going forward.
- in cross-border transactions. A vendor’s desire to maximize an allocation to non-taxable goodwill may be acceptable to a foreign purchaser who may be able to depreciate that goodwill in their home jurisdiction.
Theoretically, these issues are largely addressed by current tax rules that require many assets to be treated as being sold for market value. However, “market value” is not defined in New Zealand’s tax legislation, and in practice it can be difficult for IRD to rebut the presumption that a price agreed between independent parties reflects market value.
To prevent vendors and purchasers from adopting tax driven allocations that reduce the New Zealand government’s tax take, IRD is proposing that vendors and purchasers in business asset sale transactions should be required to adopt consistent purchase price allocations for tax purposes.
In the first instance parties should agree on the purchase price allocation in the sale and purchase agreement. A question arises regarding how specific an allocation needs to be—is it sufficient to make allocations to broad categories of assets only, or is a line by line breakdown of all specific assets required? On this issue officials suggest that if the vendor treats an item as separate property for its own tax purposes, then the parties would be required to allocate a specific value to that item.
If the parties cannot agree on an allocation, then the default position will be that the vendor will determine the allocation and that allocation must be adopted by both the vendor and the purchaser, provided that the vendor has disclosed that allocation to the purchaser within a specified period.
If the vendor does not disclose the allocation to the purchaser within that period, the purchaser may determine the allocation (with both parties then being required to adopt a tax position consistent with that allocation). In either of these instances, where there is no agreement between the parties, a copy of the allocation must be provided to IRD.
IRD recognizes that purchasers in smaller deals may not be aware of the rules, and in any event are less likely to seek to apply tax driven purchase price allocations. For these reasons, it is proposed that purchasers in low value transactions, where the total amount allocated by the purchaser to deductible or depreciable items is less than NZ$50,000 ($33,000), could be excluded from these consistency rules.
In addition to these consistency requirements, IRD says that in most cases purchase price allocations should continue to reflect market value (with a possible exception in some instances for depreciable property).
In our view the proposals will create headaches for purchasers of business assets as:
- The proposals are weighted in favor of vendors who by default will determine the allocation if the parties do not specifically agree on an allocation.
- While in theory purchasers can address this by front footing purchase price allocations when negotiating sale and purchase agreements, in practice agreeing a purchase price allocation can be difficult under tight transaction time frames, especially for large transactions involving many assets. Purchasers would need to make sure that they build in enough time into transaction time lines to agree the allocation with the vendor.
While the rules would ensure consistency in allocations, they do not directly address the incentives created by asymmetries between a vendor’s and purchaser’s tax profiles (e.g. the charity example raised above) or the difficulty in determining “market values.” Even where the parties have agreed upon an allocation that, in their eyes, reflects true market value, the allocation remains open to IRD challenge.
This increased complexity and risk will be a factor in deciding how to structure M&A transactions, and may lead to more purchasers seeking to buy the shares in a business (which would not involve a purchase price allocation), rather than its assets. This decision necessarily involves weighing the risks of an asset sale transaction against those associated with a share sale (including, for example, the purchaser effectively inheriting the target’s tax history along with the shares).
Irrespective of whether the proposals are enacted, it is evident that IRD is now focusing on purchase price allocations and may start to take more action to enforce its view that purchase price allocations should be based on market value—noting that IRD considers this to be the required position under current law. Vendors and purchasers should be aware of this risk when considering implementing purchase price allocations that do not clearly reflect market value.
Submissions on the issues paper are due by February 14, 2020. It is expected that any amendments arising from the proposals will be included in a tax bill to be introduced in the first half of 2020.
All prospective vendors and purchasers of New Zealand businesses should keep an eye on the development of these proposals and carefully consider their impact on their transactions.
Simon Akozu is a Senior Associate and Zoe Barnes is a Senior Solicitor in MinterEllisonRuddWatts' Tax team.
This article first appeared in Bloomberg.