Guidelines for allocating the purchase price of a business

This article provides guidance on how the price paid for a business can be reasonably allocated to the assets of the business. This allocation will often need to take into account the competing demands of the buyer and the seller. For simplicity, the authors have assumed the vendor and the purchaser are private companies and that the purchaser is acquiring the business and not shares in a holding company.

Most commonly the price paid for a business will be expressed as an undissected lump sum amount based on a multiple of maintainable earnings. The allocation of the purchase price to the business assets does not affect the price paid but does, however, have important taxation consequences for both the vendor and the purchaser.

From the vendor’s perspective, the price they received for disposing of the business to the purchaser may comprise their capital proceeds for CGT purposes (if the thing disposed of is a CGT asset) or ordinary income (if the thing disposed of is not a CGT asset but a revenue asset), with each having differing tax treatment. In some instances, vendors may be advantaged in having the purchase price allocated to CGT Assets as they may avail themselves of concessional tax treatment available to taxpayers who make capital gains (such as the 50% discount (not available to companies) and the small business CGT concessions, which apply to “active assets”). The vendor may also prefer to allocate proceeds to CGT assets if they are pre-CGT assets or if the vendor has available capital losses. On the other hand, allocation of the purchase price to revenue assets may be potentially less advantageous.

The purchaser on the other hand may want to maximise the amount allocated to plant and equipment, which is depreciable and minimise the amount allocated to goodwill which is not depreciable (but is a CGT Asset). A purchaser will also prefer to allocate as much as possible to intangible assets, which can be amortised, rather than goodwill. Under IFRS (which is not mandatory for private companies) goodwill cannot be amortised but is instead subject to an annual impairment review. 1

It is important to note, that for tax purposes, the value of an asset being transferred will generally be the amount allocated to that asset and agreed by the parties. However, it is possible that this amount may be replaced by a “market value consideration” under the market value substitution rule. This may occur where the sale of business is between related parties. A capital gain on the disposal of an asset is calculated by deducting the cost base of that asset from the price at which it is disposed. If the sale is to a related party and the value allocated to an asset is less than its market value, a market value will be substituted for tax purposes in respect of the disposal.

In addition, the allocation of the purchase price to goodwill and other assets will determine the “dutiable value” of those assets for stamp duty purposes, which is payable on sales of businesses in most states and territories in Australia. Where a business is making sales in several states there may be duty on goodwill. The duty payable is generally based on gross sales generated in those states over 3 years preceding the transaction.

The purchase price allocation will depend on the valuation method used for each asset. The company accounts of the vendor should contain a book value for each asset being transferred. Valuations may be based on book value, market value, written down value, realisable value, cost, income or some other method. Values may be agreed by the parties or obtained from an independent valuer. There is frequently a tension between a vendor’s desire to transfer an asset at book value (which may not give rise to a gain) and market value.

The table below lists typical preferences of a vendor and a purchaser regarding purchase price allocation in certain circumstances. It lists some of the reasons behind those preferences. The table is for illustrative purposes only and is not intended to be comprehensive or accurate in all circumstances. Readers should seek advice in relation to the particular circumstances of their transaction.

Purchase price allocation:

Asset	Vendor’s Preference	Purchaser’s Preference
Plant and Equipment	LESS will not be taxed under the CGT regime and therefore ineligible for CGT concessions often transferred at written down value	MORE Purchase price allocation may determine the depreciation cost base for the asset going forward
Stock	LESS Will not be taxed under the CGT regime and therefore ineligible for CGT concessions	LESS for commercial reasons the Purchaser will want to reduce the price paid for stock eg discount for slow moving/dead stock purchaser will want a stocktake and agreement on a formula for discounting the stock
Intellectual Property	LESS Will not be an ‘active’ asset if it is a depreciable asset for tax purposes	MORE Purchase price allocation may determine the depreciation cost base for the asset going forward.
Records	$1	$1
Land (and buildings	NEUTRAL Market value relatively easy to determine.	NEUTRAL stamp duty payable on transfer of land in all states and territories the value of the business sale and the value of the land sale may be aggregated for stamp duty purposes the relevant stamp duty authority may require independent valuations be conducted
Fixtures and fittings	LESS May not be an ‘active’ asset if it has been depreciated for tax purposes.	MORE Purchase price allocation may determine the depreciation cost base for the asset going forward.
Motor Vehicles	NEUTRAL may not be an ‘active’ asset if it has been depreciated for tax purposes vehicles depreciate so vendor not concerned about capital gain market value relatively easy to determine	NEUTRAL Purchase price allocation may determine the depreciation cost base for the asset going forward stamp duty payable in all states and territories
Goodwill	MORE May be a CGT Asset/Active Asset and may be eligible for CGT concessions.	LESS goodwill not depreciable stamp duty payable on goodwill in some states and territories purchaser would prefer if goodwill higher in states where duty not payable

 

A vendor and a purchaser should ensure that the purchase price allocation they agree is included in the Business Sale and Purchase Agreement.  This could be in a schedule that forms part of the agreement or in a clause in the body of the agreement.  Both parties are then bound to use the allocation in their tax returns and this avoids problems with inconsistent values being lodged.

On occasion there will be a transfer of business between two consolidated entities.  For example a purchaser company may acquire another company, consolidate for tax purposes and then transfer the target’s business out of the target into the purchaser.  An ACA allocation process will need to take place to determine the value of the assets being transferred.  As a consequence, it may be that depreciable items are stepped up in value on a once off basis.

In conclusion, it is important for Vendors and Purchasers and their counsel and advisors in a sale of business to understand the competing preferences of Vendors and Purchasers in purchase price allocation.  It is important that the purchase price allocation is agreed and included in the terms of the Business Sale and Purchase Agreement.

Also, it should be noted that an application can be made to the Commissioner for Taxation for a private binding ruling on an acceptable market value for tax (for a cost).  This may be useful if the parties are otherwise unable to reach agreement.

NOTES:

GST is not considered in this article since most vendors seek to satisfy the conditions of a GST free sale of a going concern.

Readers should note that Part IVA of the Income Tax Assessment Act (Cth) 1936 contains anti-avoidance provisions, breach of which can lead to substantial penalties.

1 For further discussion on intangibles and purchase price allocation see Deloitte publication entitled “Valuing intangible assets”, January 2006.