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Taxation Annual Rates for 2020–21 Feasibility Expenditure and Remedial Matters Bill

Purchase price allocation

PURCHASE PRICE ALLOCATION

(Clause 40)

Summary of proposed amendments

The proposed amendments tighten the rules that govern how parties to a sale of two or more assets with different tax treatments (a “mixed supply”) allocate the total price between the assets, for income tax purposes. The amendments do not affect existing law relating to the determination of the price when the purchaser assumes any vendor liabilities. The objective of the amendments is to prevent an overall revenue loss when vendors and purchasers adopt different price allocations that minimise their own tax liabilities.

Application date

The proposed amendments would apply to agreements for the disposal and acquisition of property entered into on or after 1 April 2021.

Key features

The core elements of the proposal are:

  • If the parties agree an allocation, they must follow it in their tax returns.
  • If the parties do not agree an allocation, the vendor is entitled to determine the allocation, and must notify both the purchaser and the Commissioner of it within two months of the change in ownership of the assets. However, the vendor must allocate amounts to taxable property (depreciable property, revenue account property, financial arrangements) such that there is no additional loss on the sale of that property.
  • If the vendor does not make an allocation within the two-month timeframe, the purchaser is entitled to determine the allocation, and notify both the vendor and the Commissioner of it.
  • The Commissioner may challenge an allocation if she considers it does not reflect market values.
  • The purchase price allocation rules will not apply to a transaction if the total purchase price is less than $1 million, or the purchaser’s total allocation to taxable property is less than $100,000.

Background

When a bundle of assets is sold, and not all the assets have the same tax treatment for a party, that party must allocate the total transaction price between the various assets for tax purposes. The allocation determines the vendor’s tax liability from the sale, and the purchaser’s cost base for claiming deductions over time.

Under the current law, the parties are generally required to ascribe market values to the assets. However, market value is a range, and other than for trading stock there is no requirement for the vendor and purchaser to use the same market value. This means that the two parties can adopt different allocations which minimise their own respective tax liabilities and are therefore detrimental to the government’s revenue base overall. Such discrepancies have been identified in a number of large commercial property transactions and sales of going concern businesses, with the total revenue loss sometimes being in the millions of dollars.

The proposed amendments are designed to improve the integrity of the income tax rules by requiring consistency between the parties’ allocations, and to reinforce the existing requirement that the allocation be based on relative market values.

Detailed analysis

The purchase price allocation reforms are proposed to be implemented by two new sections in subpart GC of the Income Tax Act 2007.

Proposed section GC 20 applies when the vendor and purchaser (person A and person B) in a mixed supply have agreed an allocation to the property before filing their respective returns of income in relation to the transaction. The parties must file in accordance with the agreed allocation. There is no de minimis for this requirement, because a threshold would undermine the expectation that parties who have agreed an allocation should always adhere to that agreement.

Proposed section GC 21 applies when the vendor and purchaser have not agreed an allocation to the property before filing their returns of income in relation to the transaction. The objective of the section is to ensure that a single allocation is made, and that the allocation is followed by both parties when they file their tax returns.

The vendor is required, within two months after the change in ownership of the property, to determine the allocation, and must notify both the purchaser and the Commissioner of its allocation. Both the vendor and the purchaser must then file on the basis of that allocation.

In making the allocation, the vendor is subject to one constraint that over-rides the market value requirement: it must allocate amounts to taxable property such that there is no additional loss on the sale of that property. The vendor cannot, therefore, allocate to an item of depreciable property an amount that is less than its adjusted tax value (adjusted for a pro rata portion of the depreciation in the year of sale). This constraint is included to protect the purchaser from an unreasonably low allocation that might not be challenged by the Commissioner.

It is possible that in some cases, despite the obligation on it to do so, the vendor will not make an allocation. For example, it may be in liquidation and decide that making an allocation is not necessary for practical reasons. If the vendor fails to make an allocation within the two-month timeframe, the obligation to determine the allocation is transferred to the purchaser. The purchaser must notify both the vendor and the Commissioner of its allocation. Both the purchaser and the vendor must then file on the basis of that allocation. There is no constraint on the purchaser’s allocation other than the requirement for relative market values to be used.

Whether the allocation is agreed between the parties or made unilaterally by the vendor or the purchaser under section GC 21, the Commissioner has the power to require the parties to adopt a different allocation if she considers the allocation does not reflect relative market value.

It is not intended that parties have to allocate an amount to every individual item. It will be sufficient for the allocation to be made at the level of asset categories subject to particular income or deduction rules – for example, depreciable property, buildings, revenue account property, financial arrangements, land, and so on. This eliminates most of the scope for tax manipulation without imposing unrealistic compliance costs. Of course, more detailed allocations are also acceptable.

De minimis thresholds apply to the consistency rules outlined above. These thresholds are included so that parties to small transactions, in which the scope for tax manipulation is small, do not have to bear any extra compliance costs that might arise from being required to notify an allocation, or follow one notified by the other party. These de minimises only apply where the parties have not agreed an allocation; if the parties have agreed an allocation, they must file their returns on the basis of it, regardless of the transaction size.

The thresholds are a total sale/purchase price of $1 million and an allocation by the purchaser to taxable property of $100,000. If the transaction falls below either of the two thresholds, the proposed consistency requirements will not apply to the parties. Because the second threshold depends on the purchaser’s allocation, the vendor may require an undertaking from the purchaser before relying on it.

There is one other de minimis threshold, which applies to the Commissioner’s ability to replace an agreed or vendor’s allocation with a market value allocation. The Commissioner cannot challenge an allocation to an item of depreciable property if:

  • the original cost of the property to the vendor is less than $10,000;
  • the allocation to the property is no less than its adjusted tax value and no greater than its original cost; and
  • where there are multiple identical assets each with an original cost of less than $10,000, the total amount allocated to those assets is less than $1 million.

This de minimis is included to provide additional certainty to vendors that are adopting a simple method of ascribing values to low-value depreciable assets.

In the unlikely event that neither party makes an allocation, the vendor is treated as disposing of the property for its relative market value, and the purchaser is treated as acquiring the property for nil consideration. The effect of this is that the purchaser is unable to claim depreciation or other deductions in relation to the property until it has made an allocation, so it has an incentive to do so before it files its tax return.

There is a specific rule, which applies to both the vendor and purchaser, for allocations to agricultural, aquacultural and forestry improvements that are amortisable under sections DO 4, DO 12 and DP 3 respectively. In line with the existing law, the amount that must be allocated to these improvements is the diminished value amount under the relevant section. The vendor is obliged to provide this figure to the purchaser. If the diminished value cannot be determined, the purchaser is treated as acquiring the improvement for nil consideration, and therefore cannot claim deductions for it going forward.

Section EB 24, which requires the purchaser to use the vendor’s allocation for trading stock, will be redundant once the proposed purchase price allocation rules are implemented, and is therefore being repealed.