29 September 2021

What is Purchase Price Allocation (PPA)?

When a business transaction occurs, a valuation of each asset acquired, and liability assumed is required in respect of each entity acquired. The transaction purchase price is then allocated to each asset (tangible and intangible) and liability at an amount consistent with its market value as at the date of the transaction, with any residual being allocated to goodwill. This process is known as the PPA and is required to be undertaken for both taxation and financial reporting purposes. In this article we focus on the requirements for taxation.

The completion of the PPA creates a ‘day-one’ balance sheet for each acquired entity, establishing new market values for each of the assets and liabilities acquired.

Typically, the PPA process has been the focus of the acquiring party following the completion of a transaction, but in this article we highlight the benefits of contemplating the PPA outcomes prior to completion of the transaction, with particular regard for new PPA rules introduced by the New Zealand (NZ) Inland Revenue Department (IRD) in relation to NZ based transactions.

Key benefits of considering the PPA outcomes prior to transaction completion

• New NZ PPA rules, which take effect from 1 July 2021, allow both the Vendor and Purchaser to have the ability to consider and agree potential PPA outcomes.

• Value attributed to certain depreciable intangibles[1] may be able to access tax deductions (per the new NZ PPA rules).

• Parties will gain a better understanding of the extent, value, economic life and amortisation profile of intangible assets acquired (which has impacts on future earnings per share calculations).

• Parties may be able to obtain an increase/ step-up in the market value of fixed assets, therefore setting a new, higher depreciable value and cost-base.

• Parties will gain an understanding of the potential residual value to be allocated to goodwill, therefore reducing potential future risk of goodwill impairment.

The vendor and purchaser have different objectives around asset allocations, driven by different tax consequences

The values determined as part of a PPA and allocation of the purchase price across the market value of business assets will have different tax implications for the vendor and purchaser. It has been possible for parties to determine and allocate different market values to the same assets, to maximise each party’s tax advantages. Whilst an acquirer will generally prefer to allocate greater value to depreciable items, for a greater tax advantage and lower value to non-deductible items such as residual goodwill. Conversely, the vendor would obtain greater tax advantage by selling depreciable assets at their (lower) book value and allocating more value to non-taxable capital items such as goodwill. This has caused opposing values and tax implications for vendors and purchasers in respect of business transactions.

Summary of the new NZ PPA rules

• In December 2019, IRD proposed prescriptive new PPA rules to address the above and the tax issues it viewed as detrimental to NZ’s tax base. The new PPA rules will require parties to agree to a consistent allocation of the purchase price based on market values, avoiding tax implications arising from opposing values determined by the vendor and purchaser.

• The new PPA rules apply to both businesses and commercial property (non-residential property) over $1 million, or where the acquirer’s total allocation to taxable property is more than $100,000 and to residential transactions of over $7.5 million. Generally, the rules do not apply to the sale of shares, but rather meet the definitions of a business or property transaction.

• The new PPA rules apply to contracts entered into from 1 July 2021.

PPA under the new NZ PPA rules

• Should the parties agree on market values and an allocation of the purchase price, they must adopt these market values and apply it in their respective tax returns.

• If the parties cannot agree on market values and the allocation of the purchase price, the vendor is entitled to determine the allocation, and must notify the acquirer and IRD of the allocation within three months of the completion date.

• If the vendor does not make an allocation within the three-month timeframe, the acquirer is entitled to determine the allocation, and must notify the seller and IRD within a further three months (within six months of settlement).

• If the acquirer does not make a notification within the further three month timeframe then:

• • The IRD may allocate amounts to each asset;

• • Any tax deduction that the vendor is entitled to may be denied until the following year’s tax return; and

• • Note – Where the IRD allocate an amount to each asset they may use an allocation made by either the vendor or acquirer notified after the three or six month timeframes, or based on market value subject to certain thresholds for low value depreciable assets, potentially creating an unfavourable tax position for the acquirer.

Application of the new PPA rules

The new PPA rules are a significant shift in the tax implications on commercial dealings between buyers and sellers and IRD has the power to challenge an allocation if it considers it does not reflect market value or is otherwise inappropriate.

Best practice approach:

• Try and agree a price allocation between the vendor and purchaser.

• Seek tax, independent and legal advice at the start of your transaction negotiations.

• Agree and document PPA allocations or valuation methodology early.

• Engage an independent valuer to determine market values of the assets being acquired and support the allocations agreed, to provide robust, defensible PPA outcomes and minimise the likelihood of challenge by IRD.

If you require assistance assessing the true potential of a transaction or market values associated with a liquidity event, get in touch with the Findex Corporate Finance team, who have deep experience in preparing PPA allocation reports and have assisted a significant number of listed and unlisted clients with their PPA requirements.

[1] Depreciable intangibles:

1 The right to use a copyright; 2 The right to use a design or model, plan, secret formula or process, or other like property or right; 3 A patent or the right to use a patent; 4 A patent application with a complete specification lodged on or after 1 April 2005; 5 The right to use land; 6 The right to use plant or machinery; 7 The copyright in software, the right to use the copyright in software, or the right to use software; 8 The right to use a trademark; 9 Management rights and licence rights created under the Radiocommunications Act 1989; 10 A consent granted under the Resource Management Act 1991 to do something that otherwise would contravene sections 12 to 15B of that Act (other than a consent for a reclamation), being a consent granted in or after - (a) The 1996–97 tax year, if the consent relates to sections 12 to 15 of that Act; or (b) The 2014–15 income year, if the consent relates to sections 15A and 15B of that Act; 11 The copyright in a sound recording, if the copyright was produced or acquired by the taxpayer on or after 1 July 1997, and copies of the recording have been sold or offered for sale to the public; 12 Plant variety rights granted under the Plant Variety Rights Act 1987 or similar rights given similar protection under the laws of a country or territory other than New Zealand; 13 A right to use plant variety rights granted under the Plant Variety Rights Act 1987 or a similar right under the laws of a country or territory other than New Zealand; 14 A design registration; 15 a design registration application; 16 industrial artistic copyright.