Appendix – Other countries’ requirements
For tax and accounting reasons, the parties are encouraged by their advisors to agree in their sale and purchase agreement on an allocation of this price across the business assets being purchased/sold.
For tax purposes the amount allocated to the asset is generally the allocation agreed by the parties. This is generally acceptable to the tax authorities because it’s recognised that there is a natural tension between the parties. There is an incentive for the vendor to allocate proceeds to CGT assets, and for the purchaser to maximise the amount allocated to plant and equipment which is depreciable.
However, the tax authorities can replace this allocation by a “market value consideration” under the market value substitution rule, if they do not consider the value to be a fair reflection of market value. This might arise, for example, if the parties are related. The Australian Tax Office has provided general guidance on assessing market value for various tax purposes.
If the parties cannot agree an allocation, they can apply to the Commissioner for Taxation for a private binding ruling on an acceptable market value.
In some cases, the sale and purchase agreement sets out the price for each asset, a value for the inventory and any goodwill. If there is no agreement then the purchaser has to determine how to allocate, and these amounts should coincide with the amounts the seller determined when reporting the sale. The amount allocated should be its fair market value.
While purchasers and sellers will have their own preferences as to how the purchase price is to be allocated, both parties must ensure that any allocation is reasonable and based on the actual value of the assets included in the deal.
Anti-avoidance rules in the Income Tax Act give the Canada Revenue Agency the authority to impose its own allocation of the purchase price such that the consideration paid is a reasonable reflection of the actual value in the circumstances. These are designed to overcome non-arms-length allocations.
Where there is genuine bargaining between the buyer and seller the CRA will accept the parties’ allocation as prima facie proof that an allocation is reasonable. Accounting valuations may vary from allocations for tax purposes.
Companies are required to complete a purchase price allocation for all transactions involving a change of control to determine the purchaser’s basis and the seller’s gain or loss. Section 1060 of the Internal Revenue Service (IRS) Code provides detailed procedures for completing the allocation. This can vary from the accounting standards allocation through the exclusion of certain transaction costs, deferred taxes and accrued liabilities, and how assumed debt is measured.
For tax law the assumed value of the property transferred is fair market value which is defined as the price at which property would exchange between a willing buyer and willing seller. Where the parties have agreed the allocation, or their fair market value, they are bound to use it for tax purposes unless the IRS determines that such an allocation, or fair market value, is not appropriate.
There are prescriptive valuation requirements, such as when assets are acquired at bargain prices. For tax purposes the consideration paid is allocated amongst the net assets acquired based on a class system of asset categories in a process known as the residual method. If the aggregate purchase price allocable to a particular class of assets is less than the aggregate fair market value of the assets within the class (as would be the case with a bargain purchase), each asset in the class is allocated an amount in proportion to its fair market value, with nothing allocated to a junior class (goodwill is the most junior class).
For tax purposes, it is necessary to apportion the total consideration of the transaction among the assets acquired. The parties to the transaction are encouraged by their advisers to specify the allocation in the sale and purchase agreement. That allocation is normally acceptable for tax purposes, provided it is commercially justifiable.
Two statutory rules impact on the allocation. The first stipulates that the open-market value of trading stock must be substituted in calculating the profits of the seller unless the purchaser acquires the stock for their own trade. The second requires that the purchaser’s cost of acquisition and the seller’s disposal proceeds for capital allowance purposes be calculated through a just apportionment of the total consideration. Since 1 April 2014 the buyer of a building that contains fixtures can only claim plant and machinery allowances if the expenditure is pooled before the sale. The seller and the buyer must either formally agree a value for fixtures within two years of transfer or start formal proceedings to agree the value within that time. If the two parties cannot agree an apportionment, either can apply to the first-tier tribunal to decide the value of the fixture(s).