7.9.1 if the deferred consideration is due under the contract but is not paid in full, the initial capital gains tax computation is revised and either a capital loss, or a reduced capital gain arises; 7.9.2 if the deferred consideration is in the form of loan notes which are QCBs, there is no tax relief available if they are not redeemed or are redeemed for less than their face value. The rationale is that gains and losses on QCBs are not subject to capital gains tax. At the point that the QCB is proved to be irrecoverable the taxable gain which has been heldover becomes payable; 7.9.3 if the deferred consideration is in the form of non-QCBs there has been no disposal as the non-QCBs effectively stand in the shoes of the original shares. Therefore if the non-QCBs are not redeemed, or are redeemed for less than their face value, the proceeds are reduced for tax purposes and either a capital loss, or a reduced capital gain arises. 7.10 As previously mentioned, if the Seller makes payments under the warranties or the tax covenant, these payments are deducted from the cash proceeds under the provisions of Section 49, TCGA. However, this is not possible if the Sellers receive shares or loan notes as consideration. 7.11 In this circumstance the relief is given via Extra Statutory Concession D52: this provides that such costs may be treated as consideration given for the shares or loan notes. 7.12 As an example, the shareholders in Barham Trading Limited sell their shares to Offord Holdings Limited in exchange for £1 million of loan notes which are nonqualifying corporate bonds. The shares have a base cost of £100,000. A claim under the tax covenant is made and £50,000 is payable. Under the provisions of ESC D52 this payment is not deducted from the net proceeds as would have been the case with cash consideration: there are no proceeds as the consideration is in the form of non QCBs. Instead the payment under the tax covenant it is treated as consideration paid in order to acquire the loan notes. The base cost of the loan notes therefore increases from £100,000 to £150,000 for tax purposes.
8Earn Out Consideration
8.1 Earn outs are a common feature of corporate transactions: they provide a bridge between the Sellers’ perception of value and the value that the Buyer is able to identify by reference to the performance of the company to date. A very common form of earn out is for additional consideration to be payable by the Buyer to the extent that specified profit hurdles are cleared in the two or three years after Completion.
8.2 The taxing of earn outs has placed considerable challenges on the tax system, and various amendments to TCGA have been required in response to these challenges.
8.3 The basic position of earn outs was determined by the 1980 case of Marren v Ingles. This stated that the earn out right was additional consideration given for the shares, in the form of a separate asset. Therefore a disposal of shares in a company for cash
54
Made with FlippingBook Learn more on our blog