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Capital Gains Manual

Deferred consideration: shares and securities: TCGA92/S138A does not apply: example

TCGA92/S138A

This example illustrates the most common type of transaction.  The consideration to be received is immediate cash, immediate shares and 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

  • cash £500,000, and
  • 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 TCGA92/S138A.

COMPUTATIONS

A) IMMEDIATE CHARGEABLE GAIN

Cash received       £500,000
         
Less apportioned cost cost x cash  
      -–-–-–-–-–-–-–-–-–-—-  
      cash + shares + right  
         
  £100,000 x £500,000  
      -–-–-–-–-–-–-–-–-–-–-–-— £51,020
      £500,000 + £180,000 + £300,000  
        -–-–-—-
Unindexed gain       £448,980
less indexation 51,000 x 0.250       £12,755
        -–-–-—-
CHARGEABLE GAIN YEAR 10       £436,225
        -–-–-—-

 

B) COST OF SHARES IN P LTD

Apportioned cost      
       
       
£100,000 x £180,000  
    -–-–-–-–-–-–-–-–-–-–-–-—- £18,367 at year 0
    £500,000 + £180,000 + £300,000  
       
Indexed rise to year 10      
£18,367 x 0.250     £4,592
      -–-–-—-
Indexed pool of expenditure     £22,959
      -–-–-—-

 

C) COST OF NOTIONAL SECURITY = RIGHT TO DEFERRED CONSIDERATION

Apportioned cost      
       
       
£100,000 x £300,000  
    -–-–-–-–-–-–-–-–-–-–-–-–-— £30,613
    £500,000 + £180,000 + £300,000  
       
Indexed rise to year 10      
£30,613 x 0.250     £7,654
      -–-–-—-
Indexed pool of expenditure     £38,267
      -–-–-—-

 

D) COMPUTATIONS WHEN DEFERRED CONSIDERATION RECEIVED

Notional Security   Cost of right Indexed pool of expenditure  
         
         
As at year 10   £30,613 £38,267  
         
Indexed rise to year 11        
£38,267 x 0.025     £957  
      -–-–-—-  
      £39,224  
Attributable to 73,000 shares in        
P Ltd issued in year 11        
  £202,940      
  -–-–-–-–-–-–-–-–-— £21,208 £27,174  
  £202,940 + £90,000      
    -–-–-—- -–-–-—-  
Remainder at year 11   £9,405 £12,050  
Indexed rise to year 11        
£12,050 x 0.025     £302  
      -–-–-—-  
      £12,352  
Attributable to 47,000 shares in        
P Ltd issued year 12   £9,405 £12,352  
         

 

E) SHARES IN P LTD

P Ltd Shareholding No of shares Qualifying Indexed pool ,of
       
    expenditure expenditure
       
As at year 10      
(see computations at B) 80,000 £18,367 £22,959
       
Indexed rise to year 11      
£22,959 x 0.025     £574
      -–-–-—-
      £23,533
Additional 73,000      
shares acquired year 11      
(see computations at D) 73,000 £21,208 £27,174
  -–-–-–-– -–-–-—- -–-–-–-—
Pool at year 11 153,000 £39,575 £50,707
  -–-–-–-– -–-–-—- -–-–-–-—
Indexed rise to year 12      
£50,707 x 0.025     £1,268
      -–-–-–-–
      £51,975
Additional 47,000      
Shares acquired year 12      
(see computations at D) 47,000 £9,405 £12,352
  -–-–-–-– -–-–-–-– -–-–-–-–
Pool at year 12 200,000 £48,980 £64,327
  -–-–-–-– -–-–-–-– -–-–-–-–

 

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 (section 128(4) and TCGA92/S129).

B. COST OF SHARES IN P LTD

V Ltd has acquired shares in P Ltd and a `notional security’ under the terms of section 138A.  These are treated as two classes of shares.  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.

D. 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.  Section 127 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.

E. 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 B and C above.