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Capital Gains Manual

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Deferred consideration: shares and securities: example

This example illustrates the computation where only part of the deferred consideration has to be satisfied by an issue 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 the taxpayer acquires all the shares in T Ltd for £100,000.
  • In year 10 the taxpayer sells all the shares in T Ltd at arm’s length to P Ltd.

The consideration is the right to two payments of deferred consideration, the amount depending on the future profits of T Ltd. Fifty per cent of the amount will be satisfied in shares of P Ltd, with the remaining fifty per cent to be satisfied in any combination of shares or cash at the vendor’s request.

The market value of the right to receive deferred consideration at the time of disposal is agreed by Shares and Assets Valuation at £800,000.

In year 11 the taxpayer receives shares in P Ltd to the value £680,000 (200,000 shares at £3.40 each) in part satisfaction of the right to deferred consideration. The market value of the remainder of the right is agreed by Shares and Assets Valuation to be £300,000.

In year 12 shares in P Ltd to the value £350,000 (100,000 shares at £3.50 each) are issued in full satisfaction of the remainder of the right to deferred consideration.

TCGA92/S138A applies to the fifty per cent of the consideration which could be received only in the form of shares. It cannot apply to the fifty per cent of the consideration that may be received in cash even if the cash alternative is not taken up. TCGA92/S138A (1)(d) requires that the right may only be satisfied by the issue of new securities if it is to be an earn-out right to which TCGA92/S138A can apply.

COMPUTATIONS

A) IMMEDIATE CHARGEABLE GAIN

50 per cent of the value of the right to £400,000    
       
receive deferred consideration      
       
Less apportioned cost      
       
Cost x ‘right’ S138A does not apply  
    -–-–-–-–-–-–-–-–-–-–-–-–-–-–-–-–-–-–-–-–-–-–-–-–  
    ‘right’ S138A does not apply + ‘right’ S138A does apply  
       
£100,000   £400,000  
    -–-–-–-–-–-–-–-–-—- £50,000
    £400,000 + £400,000  
      -–-–-–-—
      £350,000
Less indexation £50,000 x 0.250 £12,500    
      -–-–-–-—
Chargeable gain     £337,500
  -–-–-–-—    

B) COST OF NOTIONAL SECURITY UNDER SECTION 138A

cost £100,000 - £50,000 £50,000
   
indexed rise to year 10 12,500
  -–-–-—-
Indexed pool of expenditure at year 10 £62,500
  -–-–-—-

C) COMPUTATIONS WHEN DEFERRED CONSIDERATION RECEIVED

i) 50 per cent not covered by Section 138A

Year 11 consideration received      
       
(50 per cent of £680,000)     £340,000
Less apportioned cost      
£400,000 x £340,000  
    -–-–-–-–-–-–-–-–-–-–-—- £277,551
    £340,000 + (50% of £300,000)  
      -–-–-–-—
Unindexed gain     £62,449
Less indexation £277,551 x 0.025 £6,939    
      -–-–-–-—
CHARGEABLE GAIN YEAR 11     £55,510
      -–-–-–-—
       
Year 12 consideration received      
(50 per cent of £350,000)     £175,000
Less cost £400,000 - £277,551 £122,449    
      -–-–-–-—
Unindexed gain     £52,551
       
Less indexation £122,449 x 0.051      
(increase year 10 to year 12)     £6,245
      -–-–-—
CHARGEABLE GAIN YEAR 12     £46,306
      -–-–-—-

ii) 50 per cent covered by Section 138A

NOTIONAL SECURITY

Notional security   Cost of Indexed
       
    right pool of
      expenditure
As at year 10   £50,000 £62,500
       
Indexed rise to year 11      
£62,000 x 0.025     £1,563
      -–-–-—-
      £64,063
Attributable to 50 per cent      
of shares in P Ltd issued      
in year 11 (100,000 shares)      
  £340.000    
  -–-–-–-–-–-–-–-–-— £34,694 £44,452
  £340,000 + £150,000    
    -–-–-—- -–-–-—-
Remainder at year 11   £15,306 £19,611
       
Indexed rise to year 12      
£19,611 x 0.025     £491
      -–-–-–-–
      £20,102
      -–-–-–-–
Attributable to 50 per cent      
of shares issued in      
year 12, 50,000 shares   £15,306 £20,102

D) SHARES IN P LTD

P Ltd Shareholding No of Qualifying Indexed pool of
       
  Shares Expenditure Expenditure
Year 11 acquired on part disposal.      
Section 138A did not apply. (See C(i)) 100,000 £340,000 £340,000
       
Year 11 acquired on part disposal      
with Section 138A applying. (See C(ii)) 100,000 £34,694 £44,452
  -–-–-–-– -–-–-–-– -–-–-–-–
Pool at year 11 200,000 £374,694 £384,452
       
Indexed rise to year 12      
£384,452 x 0.025     £9,612
      -–-–-–-–
      £394,064
Year 12 acquired on disposal of      
remainder of right.      
Section 138A does not apply. (See C(i)) 50,000 £175,000 £175,000
       
Year 12 acquired on disposal of      
remainder of right.      
Section 138A applies. (See C(ii)) 50,000 £15,306 £20,102
  -–-–-–-– -–-–-–-— -–-–-–-—
Pool at year 12 300,000 £565,000 £589,166
  -–-–-—- -–-–-–-— -–-–-–-—

EXPLANATION

A) IMMEDIATE CHARGEABLE GAIN

There is an immediate chargeable gain on the proportion of the right to receive deferred unascertainable consideration which does not fall within TCGA92/S138A. The disposal consideration is the value of that part of the right (supplied by Shares and Assets Valuation).

C)i) CHARGEABLE GAINS ON RECEIPT OF DEFERRED CONSIDERATION

There is a disposal or part disposal of the `right’ when the deferred consideration is received in satisfaction or part satisfaction of the `right’. The cost of the right to receive deferred unascertainable consideration is the value which has been brought into the computation of the immediate chargeable gain. CG14970 explains this in more detail.

D) SHARES IN P LTD

All of the shares in P Ltd which are acquired go into the same pool. The shares to which TCGA92/S138A did not apply go into the pool at market value at the date of acquisition. The shares to which TCGA92/S138A did apply go into the pool with the base cost (and indexation) which has been calculated as if there was no disposal of the original shares.