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Capital Gains Manual

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Deferred consideration: shares and securities: example

This example illustrates the effect of an earn-out right being treated as a security by TCGA92/S138A if a taxpayer sells shares and the consideration received is an immediate payment of cash and the right to receive an unascertainable deferred amount of shares.

All events take place on or after 26 November 1996. Illustrative indexation factors have been provided for the purposes of this example only. Indexation allowance does not apply to Capital Gains Tax disposals from 2008-09.

FACTS

  • In year 0 taxpayer acquires all the shares in T Ltd for £100,000.
  • In year 10 the taxpayer sells the shares in T Ltd at arm’s length to P Ltd.

The consideration is

  1. cash £500,000 plus
  2. the right to two payments of deferred consideration, the amount depending on future profits of T Ltd, to be satisfied only by an issue of shares in P Ltd.

The market value of the right to deferred consideration at the time of disposal is agreed by Shares and Assets Valuation at £300,000.

In year 11 shares in P Ltd to the value of £202,940 (73,000 shares at £2.78 each) are issued to the taxpayer in part satisfaction of the right to deferred consideration. The market value of the remainder of the right in year 11 is agreed by Shares and Assets Valuation at £90,000.

In year 12 shares in P Ltd to the value of £118,440 (47,000 shares at £2.52 each) are issued in full satisfaction of the remainder of the right to deferred consideration.

P Ltd is a company whose shares are quoted on the Stock Exchange. All of the conditions are satisfied and the earn-out right is treated as a security by TCGA92/S138A.

COMPUTATIONS

A. IMMEDIATE CHARGEABLE GAIN

Cash received     £500,000
       
Less apportioned cost      
       
Cost x Cash  
    -–-–-–-–-—-  
    Cash + right  
       
£100,000 x £500,000  
    -–-–-–-–-–-–-–-–-—- £62,500
    £500,000 + £300,000  
Unindexed gain     £437,500
Less indexation £62,500 x 0.250     £15,625
      -–-–-–-—
CHARGEABLE GAIN YEAR 10     £421,875
      -–-–-–-—

B. COST OF NOTIONAL SECURITY = RIGHT TO DEFERRED CONSIDERATION

Apportioned cost      
       
       
£100,000 x £300,000  
    -–-–-–-–-–-–-–-–-—- £37,500
    £500,000 + £300,000  
       
Indexed rise to year 10      
£37,500 x 0.250     £9,375
      -–-–-–
       
Indexed pool of expenditure     £46,875
      -–-–-–

C. COMPUTATIONS WHEN DEFERRED CONSIDERATION RECEIVED

Notional security Cost of Indexed pool of
     
  right expenditure
     
As at year 10 £37,500 £46,875
     
Indexed rise to year 11    
£46,875 x 0.025   1,172
    -–-–-–
    48,047
Attributable to 73,000 shares in    
P Ltd issued in year 11    
     
202,940    
-–-–-–-–-–-–-—- 25,979 33,286
202,940 + 90,000 -–-–-– -–-–-—-
     
Remainder at year 11 11,521 £14,761
     
Indexed rise to year 12    
14,761 x 0.025   £369
    -–-–-—-
    £15,130
Attributable to 47,000 shares    
in P Ltd issued year 12 £11,521 £15,130

D. SHARES IN P LTD

P Ltd Shareholding No of shares Qualifying Indexed pool
       
    expenditure of expenditure
73,000 shares acquired      
year 11      
(see computations at C) 73,000 £25,979 £33,286
  -–-–-–-— -–-–-—- -–-–-—-
Pool at year 11 73,000 £25,979 £33,286
       
Indexed rise to year 12      
£33,286 x 0.025     £833
      -–-–-—-
      £34,119
Additional 47,000 shares      
acquired year 12      
(see computations at C) 47,000 £11,521 £15,130
  -–-–-– -–-–-—- -–-–-—-
Pool at October 1993 120,000 £37,500 £49,249
  -–-–-—- -–-–-–-– -–-–-—-

EXPLANATION

The statutory reasons for the method of computation are

A. CASH RECEIVED

The cash received is treated as a part-disposal of the old holding of T Ltd shares under TCGA92/S128 (3). The apportionment of the base cost of the old holding is made on the basis of market value at the date of disposal (TCGA92/S128 (4) and TCGA92/S129).

B. COST OF THE NOTIONAL SECURITY UNDER TCGA92/S138A

The notional security forms the `new holding’ under TCGA92/S127 as applied by TCGA92/S135 (3).

C. RIGHT TO DEFERRED UNASCERTAINABLE CONSIDERATION

The part-satisfaction of the right to deferred consideration is a part-disposal of the right. But because of TCGA92/S138A it is treated as a conversion of securities within TCGA92/S132. TCGA92/S127 applies with the necessary adaptations to the part-disposal and part of the base cost of the `notional security’ is transferred to the holding of shares in P Ltd.

The procedure for obtaining valuations of the right to deferred unascertainable consideration is described at CG14950.

D. SHARES IN P LTD

The shares in P Ltd which are acquired go into the Section 104 holding of shares at the base cost computed in accordance with C above.