On 4 June, draft tax legislation was introduced to Parliament that will alter the treatment of asset transfers and the extent to which feasibility expenditure is tax-deductible.
Currently, there is no standard practice for how price is attributed to assets being transferred, if you enter into a sale and purchase agreement for transferring assets. At one end of the scale, the parties may list the assets being transferred on a line by line basis and agree specific values for each one. At the other end, a single price may be agreed between the parties, with no allocation to the assets at all.
If the purchase price allocation does not have enough detail, problems can arise when each party takes a tax position.
Take for example, the sale of a business that comprises a number of different assets, including a truck. The truck cost $350k and with depreciation is now valued at $150k. The sale and purchase agreement includes a price for the business as a whole but does not include a specific value for the truck. After settlement, the parties are independently preparing their tax returns and need to account for the sale and purchase. The vendor knows the truck is not in great condition and takes the view it was worth $100k and claims a loss on disposal of $50k. Meanwhile, the purchaser thinks it is in great condition and values it at $250k, providing a future depreciable cost base of $250k. There is a gross difference between the parties of $150k. The two parties have won, but IRD has lost.
To avoid this outcome, the draft legislation prescribes a tiered approach:
If the parties agree a purchase price allocation, it must be followed by both.
If the parties do not agree an allocation, the vendor is entitled to determine it. The vendor must notify both the purchaser and IRD of the allocation within two months of the change in ownership of the assets. However, the allocation to taxable property (depreciable property, revenue account property, financial arrangements) cannot lead to additional losses 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 the vendor and IRD.
If no allocation is made by either party, the vendor is treated as selling for market value and there is a risk the purchaser is deemed to acquire certain property
Irrespective of the values determined by the parties, IRD may challenge them if they consider they do not reflect market value. In this sense, there is no change to the current landscape. Although it should no longer be driven by a mismatch between the parties. There is also less risk of this occurring other than in scenarios where ‘debatable’ values are adopted.
If no allocation is made, the purchase price allocation rules will apply to transactions with a total purchase price of $1 million or more, or an allocation to taxable property of $100k or more. The rules will apply to sale and purchase agreements entered into from 1 April 2021.
A second change is ‘feasibility expenditure’, i.e. costs incurred to decide whether to proceed with a particular venture or purchase of an asset. For context, prior to 2016, feasibility expenditure was generally tax deductible up until the point the decision was made whether to proceed or not. This changed due to the Supreme Court’s decision in Trustpower Limited v Commissioner of Inland Revenue.
Trustpower had incurred costs to acquire resource consents before deciding whether to commit to potential power generation projects. Trustpower treated this expenditure as deductible. The Supreme Court determined the expenditure was non-deductible due to the underlying projects being capital in nature. A subsequent Interpretation Statement from IRD confirmed the limited circumstances in which feasibility expenditure could be deducted.
To relax the outcome after the Trustpower decision, the new legislation proposes allowing deductions for feasibility expenditure in relation to new projects or assets, where there is no explicit denial of deductions.
With effect from the 2020-21 income year, expenditure incurred in working towards completing, creating or acquiring property that is abandoned will be deductible over a five year period, starting from the year in which a project is abandoned (being the earlier of when no further money is spent on the project or a formal decision is documented not to proceed).
The property needs to comprise depreciable property (if completed) or certain types of intangible property or revenue account property. There also needs to be a nexus between the expenditure and an existing income-earning process of the person. If an abandoned project later proceeds, income is triggered to reverse deductions claimed and ‘standard’ rules apply instead, e.g. depreciable property is depreciated.
The changes described above are logical. The first simplifies an area that has been problematic in practice and the latter goes some way to eliminating a frustrating outcome for affected businesses.
The comments in this article of a general nature and should not be relied on for specific cases. Taxpayers should seek specific advice.