On 1 July 2021, the way in which most vendors and purchasers of commercial property enter into agreements for sale and purchase changed, with the introduction of the new “purchase price allocation” (PPA) rules.
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The rules were introduced to ensure that vendors and purchasers allocate purchase prices consistently for income tax purposes, and to prevent the practice of “mis-matched” PPAs, where vendors and purchasers often adopted different positions in their tax return for the same transaction.
The rules apply to all commercial property transactions of land and buildings greater than $1.0m. They do not apply to transactions of bare land.
Where the rules apply, the vendor and the purchaser need to consider the allocation of the purchase price between the depreciable assets (building, fitout) and non-depreciable assets (land) when completing agreements for sale and purchase.
Vendors and purchasers should obtain accounting advice when negotiating agreements to ensure allocations that are appropriate for their position. In some cases, this may become part of the bargaining process when attempting to conclude an agreement.
To assist vendors and purchasers to address PPA when negotiating a sale, the ADLS / REINZ released addenda to be used with the standard agreement for sale and purchase of real estate, and for sales by tender.
The addenda, if included in the agreement, provides for two situations: where the PPA is agreed between the parties; and where it isn’t. If the PPA isn’t agreed at the date of the agreement then the addenda require the parties to agree it, and includes a process for doing so.
In the absence of an agreed position between the parties, or the adoption of the ADLS/REINZ addendum in their sale agreement, the rules enable the vendor to unilaterally set the PPA (provided they do so within the required statutory timeframe).
To avoid being exposed to a vendor’s unilateral allocation, purchasers should endeavour to negotiate and agree the PPA, or ensure the addendum is included, before entering into the agreement. Failing to do so could impact a purchaser’s tax position (for example, resulting in a lower than expected allocation for depreciable property).
The ADLS / REINZ have not released an addendum for auction sales.
The fact that at an auction the price isn’t known until the hammer has fallen does pose a challenge in relation to PPA. How can the purchase price allocation be agreed before the hammer has fallen?
From what we have seen in the market, most auction vendors are providing for PPA via the inclusion of a mechanism for completing the PPA once the price is known.
One way that this is being done is by specifying the amount to be allocated to the depreciable assets (buildings, fitout/chattels) in the auction terms, leaving the balance of the purchase price once known to be allocated to the land.
Another way that we have seen is to allocate the purchase price between land, buildings, fitout/chattels based on specified percentages.
Despite the new rules being in place for some time now, some vendors and purchasers are unaware of when and how they apply. That puts them in danger of an unintended or undesirable tax consequence.
We strongly recommend seeking tax and legal advice before entering into an agreement for sale and purchase to ensure you understand the tax and legal consequences of the PPA rules.
Cavell Leitch’s property team would be happy to assist you with any of your commercial property needs, and would work with your accountant to ensure your agreement is structured in a way that is as advantageous to you as possible.
You may be interested in our recent article: Due Diligence When Purchasing a Commercial Property.
If you are considering buying or selling a commercial property or have queries in relation to the PPA rules then please don’t hesitate to contact a member of Cavell Leitch’s property team today.