New legislation has been introduced which aims to end the confusion surrounding the tax treatment of employee entitlements in business acquisition transactions. The new provision will generally allow the vendor of a business a tax deduction for employee entitlements transferred to the purchaser, such as holiday pay, at the time the business is transferred.

The new legislation is found in the Taxation (Relief, Refunds and Miscellaneous) Bill 2001.

The reasons given for the change
The Privy Council decision in CIR v NZ Forest Research Institute Ltd [2000] 3 NZLR 1 confirmed the Commissioner of Inland Revenue's stance, that where a business and its employees are transferred and the purchaser later pays leave to employees accrued from periods before the purchase of the business, those payments are treated as capital i.e. part of the purchase price of the business. The purchaser thus does not obtain a deduction when the employee entitlements are eventually paid and in many cases the vendor is also unable to obtain a deduction.

Transaction structures overcoming this uncertainty include:
> The vendor pays employee entitlements prior to transfer of the business and the vendor is entitled to a tax deduction for that payment.
> The vendor pays the employee entitlements to a trustee which holds the funds on each employee's behalf. The trustee pays the employee entitlements when they fall due. The vendor's payments to the trustee are tax deductible as they are treated as paid directly to employees.

Each of these is commercially inconvenient. The new legislation will mean that transactions will no longer need to be
structured in this way. The legislation will deal with this issue.

Sale of business between associated persons
If the sale is between associated persons, the vendor will not qualify for a deduction. The purchaser will however be able to claim deductions for amounts that would have been deductible had the business not been sold, as they are paid. This treatment seems to allow the purchaser to take a deduction as if the business had not been sold, and appears to produce the result sought by the taxpayer in the Forest Research Institute case, but only in this circumstance.

Employee entitlements qualifying for deduction
The employee entitlements included are holiday pay, long service leave, retiring allowances and redundancy payments.

What if the amount paid out to employees differs from the provision transferred
It is a requirement that both the purchaser and the vendor agree on the amount of the employee entitlement provisions to be transferred.

When the employee entitlement provision is understated, the purchaser will be able to claim a deduction for the balance when it is paid.

When the employee entitlement provision is overstated, the excess will be treated as gross income in the hands of the
purchaser at the time generally accepted accounting practise requires an adjustment to be made in the financial accounts of the business.

ect on Purchase Price
As the tax-adjusted cost to the vendor should take account of paying this provision, the purchase price could be reduced by 33% of the employee entitlements (assuming that the vendor is a company).

Recommendations
The key outcome remains a denial of deduction to the purchaser in most cases. It may not always be beneficial for the vendor to take the deduction e.g. because of existing tax losses etc. The outcome will not please everybody.

Advice should be sought by those involved in a business sale or acquisition to ensure clauses contained in agreements for sale and purchase reflect the new legislation. Submissions on the Taxation (Relief, Refunds and Miscellaneous Provisions) Bill closed on 15 February 2002 and the new rules will apply from the date of enactment.

The contents of this document are for information purposes only and should not be acted upon without specific legal advice. KPMG Legal does not accept any liability other than to its clients and only then in relation to specific requests for advice.KPMG Legal is an independent law firm.

For more information please contact our Mergers & Aquisitions team.

Please contact:
Rob Noakes at rnoakes@kpmg.co.nz,
Martin Dalgleish at mdalgleish@kpmg.co.nz
Ross O'Neill at rsoneill@kpmg.co.nz.

Web site: KPMG Legal: Corporate Advisory / M &A