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Tax allocations in a ‘mixed’ sale

ALLOCATIONS OF DEPRECIABLE ASSETS IN A ‘MIXED’ SALE OF LAND AGREEMENT

In a so-called ‘mixed sale’, ie a sale involving land and other depreciable assets, (e.g. chattels, plant and equipment), the allocation of the total composite purchase between the building and the other depreciable assets can become an issue for income tax purposes.  In some sale and purchase agreements no allocation is specified, but in others the allocation is indeed specified.

In such sales, there is a natural tendency for a vendor to deflate the allocation of the total price to items such as chattels, plant and equipment in order to minimise or eliminate any depreciation recovery income on such sale.  Conversely the purchaser will generally seek to inflate the allocation of the price to maximise their ability to claim deprecation on such assets.

To remedy this possible mismatch of allocations between the tax positions of the vendor and the purchase, the Government has introduced new legislation in the Bill that will require the vendor and purchaser to follow the agreed allocation as per the sale and purchase agreement.  The new legislation applies to agreements for the acquisition or disposal of property entered into on or 1 July 2021.

Key elements of the Bill are as follows;

  • If the parties agree an allocation, they must follow it in their respective 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.   
  • 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.

What does this all mean?

  • With the re-introduction of depreciation allowances for buildings, this issue becomes particularly important.
  • Purchasers are likely advised to insist upon specific provisions in the sale and purchase agreement to provide for a fair allocation of the total purchase price to cover depreciable assets such as plant and equipment, chattels etc.
  • A failure to do this means that the allocation can be carried out unilaterally by the vendor, and whose interests favour keeping the allocation for such depreciable assets as low as is possible. 
  • Vendors will likely also insist upon such specific allocation provisions in the sale and purchase agreement because if the parties do not agree an allocation and the vendor then does not notify both the purchaser and the Commissioner of an allocation within two months of the change in ownership of the assets, the purchaser is entitled to determine the allocation, and notify both the vendor and the Commissioner of it. 
  • It is in the interests of the purchaser to make the allocation for such depreciable assets as high as possible, meaning a potentially higher deprecation recovery income liability for the vendor.
  • Where there is no allocation agreed to, the vendor would be advised to make the allocation and notify the Commissioner and the purchaser within the two month window period after the change in ownership of the sale assets. 

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