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Capital Gains Manual

Deferred consideration: shares and securities: rights partially qualify

TCGA92/S138A

This example illustrates the effect of an earn-out right being treated as a security by TCGA92/S138A if a customer sells shares and receives an immediate issue of shares and the right to receive an unascertainable deferred amount of shares.

NOTE From 6 April 2008 only companies and other concerns within the charge to Corporation Tax may be able to claim indexation allowance, see CG17207.

FACTS

In year 0 V Ltd acquires all the shares in T Ltd for £100,000.

In year 10 V Ltd sells the shares in T Ltd at arm’s length to P Ltd.

The consideration is

  • 80,000 shares in P Ltd at market value of £2.25 each (total £180,000), and
  • 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 V Ltd 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 section 138A.

COMPUTATIONS

A) COST OF SHARES IN P LTD

Apportioned cost      
       
       
cost x shares  
    -–-–-–-–-–-–-–  
    shares + ‘right’  
       
£100,0000 x £180,000  
    -–-–-–-–-–-–-–-—- £37,500 at year 0
    £180,000 + £300,000  
       
Indexed rise to year 10      
£37,500 x 0.250     9,375
      -–-–-—-
Indexed pool of expenditure     £46,875
      -–-–-—-

 

B) COST OF NOTIONAL SECURITY = RIGHT TO DEFERRED CONSIDERATION

Apportioned cost      
       
       
£100,000 x £300,000  
    -–-–-–-–-–-–-–-—- £62,500
    £180,000 + £300,000  
       
Indexed rise to year 10      
£62,500 x 0.250     £15,625
      -–-–-—-
Indexed pool of expenditure     £78,125
      -–-–-–-–

 

C) COMPUTATIONS WHEN DEFERRED CONSIDERATION RECEIVED

Notional security Cost of right Indexed pool of expenditure  
       
       
As at year 10 £62,500 £78,125  
       
Indexed rise to year 11      
£78,125 x 0.025   £1,954  
    -–-–-—-  
    £80,079  
Attributable to 73,000 shares      
in P Ltd issued in year 11      
  £202,940    
  -–-–-–-–-–-–-—- £43,298 £55,476
  £202,940 + £90,000    
  -–-–-—- -–-–-–-–  
Remainder at year 11 £19,202 £24,603  
       
Indexed rise to year 12      
£24,602 x 0.025   £615  
    -–-–-–-—  
    £25,218  
Attributable to 47,000 shares      
In P Ltd issued year 12 £19,202 £25,218  
       

 

D) SHARES IN P LTD

P Ltd Shareholding No of shares Qualifying Indexed pool of
       
    expenditure expenditure
As at year 10      
(see computations at A) 80,000 £37,500 £46,875
  -–-–-— -–-–-–-– -–-–-—-
Indexed rise to year 11      
£46,875 x 0.025     £1,172
      -–-–-—-
      £48,047
Additional 73,000 shares      
acquired year 11      
(see computations at C) 73,000 £43,298 £55,476
  -–-–-— -–-–-–-– -–-–-—-
Pool at year 11 153,000 £80,798 £103,523
  -–-–-—- -–-–-–-– -–-–-–-–
Indexed rise to year 12      
£103,523 x 0.025     £2,588
      -–-–-–-–
      £106,111
Additional 47,000 shares      
acquired year 12      
(see computations at C) 47,000 £19,202 £25,218
  -–-–-—- -–-–-–-— -–-–-–-—
Pool at October 1993 200,000 £100,000 £131,329
  -–-–-—- -–-–-–-— -–-–-–-—

 

EXPLANATION

The statutory reasons for the method of computation are:

A. COST OF SHARES IN P LTD

V Ltd has acquired shares in P Ltd and a `notional security’ under section 138A.  These are treated as two classes of shares or debentures.  Together they form the `new holding’ under TCGA92/S127 as applied by TCGA92/S135(3).

If the shares in P Ltd are not quoted the apportionment should be made by reference to market values at the date of a disposal of all or part of the new holding.

C. RIGHT TO UNASCERTAINABLE DEFERRED CONSIDERATION

The part satisfaction of the right to deferred consideration is a part disposal of the right.  But because of section 138A 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 unascertainable deferred consideration is described at CG14950.

D. SHARES IN P LTD

The shares in P Ltd which are acquired go into the TCGA92/S104 holding of shares of the same class.  The base cost and indexed pool of expenditure is calculated in accordance with A and B above.