consideration and an earn out right resulted in the Sellers having aggregate consideration at Completion equivalent to the cash consideration plus the perceived value of the earn out right at that time. When the earn out was determined there was then a second capital gains tax computation, comprising the actual proceeds from the earn out right, less the base cost, which was the value taxed as at Completion.
8.3
This treatment triggered a number of potential problems for the taxpayer:
8.3.1 firstly, it was necessary to compute the present value of a future right when this value was contingent and reliant on the actual performance of the Company in the future The valuer’s art was therefore tested fully in such circumstances;
8.3.2 secondly capital gains tax crystallised at Completion on this element of the consideration although it had not been received;
8.3.3 thirdly, if the earn out realised a value which was greater than the present value perceived at Completion, there was a further capital gain in respect of the earn out right. This gain was not a gain on the disposal of the original shares but rather a gain on the disposal of the new earn out right. This therefore meant that certain reliefs, specifically taper relief, were not available in respect of this second gain; 8.3.4 fourthly, if the earn out realised a loss as the actual amount realised was less than the perception of the right at Completion, such loss could only be used in that year or be carried forward: it was not possible to carry such a loss back to be offset against the original gain which had been computed as at Completion. 8.4 The initial response from HMRC was Extra-Statutory Concession D27. This was then incorporated in legislation in the form of Section 138A, TCGA. This section deals with consideration that is both contingent and unascertainable. It is important to note that both qualities are required: if the earn out right is in the form of agreeing to pay an additional £100,000 if the aggregate profits in the two years after Completion exceed £250,000, then this is contingent but it is not unascertainable as the amount of the additional consideration is known. 8.5 Section 138A allows for a structure whereby the taxpayer agrees to receive the earn out consideration only in the form of a loan note. If this is done, the earn out right is also deemed to be a non-QCB loan note. 8.6 The shares in Kirton Trading Limited are sold to Kettleburgh Plastics Limited for consideration of £500,000, with further consideration of three times aggregate profits in excess of £200,000 in the first two years after Completion. The base cost of the shares is £1,200. The transaction is structured so that the earn out is to be settled by the issue of QCBs to the Sellers, with a redemption date 6 months after issue. The earn out right is agreed to have a value of £100,000 at Completion. The amount eventually payable under the earn-out is £270,000. 8.7 If the transaction is structured as set out above, the earn out is within Section 138A: this means that the Sellers receive for tax purposes a cash sum of £500,000 at Completion plus a deemed non-QCB, being the earn out right. (It is still necessary to value that right in order to apportion the base cost of the shares. However in most
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