Buying or selling a business? by Dale Adamson
Attempts to save on fees can have expensive consequences. For example, incorrectly completing the fields in the sale and purchase agreement resulting in $45,000 in unplanned GST. We managed to sort a practical solution for the client, but this stress could have been avoided. Another example was a technically unenforceable agreement and inability to zero-rate a property sale, where the named purchaser had not been incorporated at settlement date. Again, this required some additional work to resolve the situation.
Adding to the existing legal and GST risk areas is new IRD legislation regarding apportionment of purchase price (“APP”), effective 1 July 2021.
In the past, there was no requirement for buyers and sellers to agree on allocation of the purchase price between assets. Of course, each party would allocate to best minimise their tax liability, resulting in a mismatch from IRD’s perspective.
The new APP rules are intended to remedy this loophole. They apply to a “mixed supply” transaction - a single transaction which is a mix of taxable and non-taxable assets. They do not apply to sale of shares.
The best option is to agree the APP between the vendor and purchaser and include the split in the sale transaction agreement. This is then binding on both parties. The value is stated per asset class – trading stock, timber or timber rights, depreciable buildings, other depreciable property, and non-taxable property (e.g. land and goodwill).
The legislation allows the IRD to over-ride values at any stage (agreed or unilateral) if it considers values do not represent realistic market values. However, there is an exemption for low value depreciable property.
If the APP hasn’t been agreed and documented, the vendor has the first right to set the values unilaterally. This does not apply if the total sale is less than $1million or the only property is the sale of residential land/chattels for less than $7.5million.
The vendor must notify the purchaser and IRD of the allocation within three months of settlement date.
There are special rules to ensure that the value allocated to taxable assets (e.g. stock and depreciable assets) is not less than the vendor’s tax book value for that class. If this results in total allocated value exceeding the total sale price, the rules ensure allocation to non-taxable assets is reduced first, with any remaining excess being pro-rated to other property classes.
If the vendor fails to notify apportionment within the three-month timeframe, the purchaser then has three months to notify his unilaterally set values to the vendor and IRD. The purchaser cannot claim a deduction until this notification has occurred.
If neither party notifies a unilateral APP within time and there is no agreed APP before the date for filing the first party’s tax return, IRD can use either party’s values in both tax returns or set its own values.
The rules appear to give greater advantage to the vendor, therefore it is essential for purchasers to raise the APP question early. Even if the actual split can’t be included in the sale and purchase agreement, it can include a binding clause on how values will be determined and covenants stopping a unilateral APP.
Remember, talk to your tax advisor before signing any business property sale/purchase documentation.