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Capital Gains Manual

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Deferred consideration: shares and securities: example

This example illustrates the operation of Section 138A TCGA 1992 if the deferred consideration is to be satisfied by an issue of QCBs. In the example the consideration to be received is immediate cash, immediate shares and an unascertainable deferred amount of debentures which are QCBs.

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 a 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

  1. cash £200,000, plus
  2. 80,000 shares in P Ltd at market value of £2.00 each (total £160,000), plus
  3. the right to two payments of future consideration, the amount depending on future profits of T Ltd, to be satisfied only by an issue of debentures which are QCBs by P Ltd.

The market value of the right to deferred consideration at the time of disposal is agreed by Shares and Assets Valuation at £90,000.

In year 11 QCBs in P Ltd to the value of £75,000 are issued to the taxpayer in part satisfaction of the right to deferred consideration. The market value of the remainder of the right at year 11 is agreed by Shares and Assets Valuation at £30,000.

In year 12 QCBs in P Ltd to the value of £32,000 are issued in full satisfaction of the remainder of the right to deferred consideration.

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 £200,000    
       
Less apportioned cost      
       
Cost x Cash  
    -–-–-–-–-–-–-–-–-–-–  
    Cash + shares + right  
       
£100,000 x £200,000  
    -–-–-–-–-–-–-–-–-–-–-–-–-–-—- £44,444
    £200,000 + £160,000 + £90,000  
  -–-–-–-—    
Unindexed gain £155,556    
Less indexation £44,444 x 0.250 £11,111    
  -–-–-–-—    
Chargeable gain year 10 £144,445    

B. COST OF SHARES IN P LTD

Apportioned cost      
       
£100,000 x £160,000  
    -–-–-–-–-–-–-–-–-–-–-–-–-–-—- £35,556 at year 0
    £200,000 = £160,000 = £90,000  
       
Indexed rise to year 10      
£35,556 x 0.250 £8,889    
  -–-–-—-    
Indexed pool of expenditure £44,445    
  -–-–-—-    

C. COST OF NOTIONAL SECURITY = RIGHT TO DEFERRED CONSIDERATION

Apportioned cost      
       
£100,000 x £90,000  
    -–-–-–-–-–-–-–-–-–-–-–-–-–-—- £20,000
    £200,000 + £160,000 + £90,000  
       
Indexed rise to year 10      
£20,000 x 0.250     £5,000
      -–-–-—-
Indexed pool of expenditure     £25,000
      -–-–-—-

D. COMPUTATIONS WHEN DEFERRED CONSIDERATION RECEIVED

Notional Security   Cost of Indexed pool of
       
  Right Expenditure  
As at year 10 £20,000 £25,000  
Indexed rise to year 11      
£25,000 x 0.025   £625  
    -–-–-—-  
    £25,625  
Attributable to debentures in £75,000    
P Ltd issued year 11 -–-–-–-–-–-–-–-—- £14,286 £18,304
  £75,000 + £30,000    
  -–-–-—- -–-–-—-  
Remainder at year 11 £5,714 £7,321  
Indexed rise to year 12      
£7,321 x 0.025   £183  
    -–-–-—-  
    £7,504  
Attributable to debentures in P Ltd issued year 12 £5,714 £7,504  

E. COMPUTATION OF HELD OVER GAIN ON DEBENTURE

Market value of part of notional security before    
     
exchange year 11 ( = value of debenture) £75,000  
Apportioned cost £14,286  
Indexation (year 0 to year 11) £4,018 £18,304
  -–-–-—- -–-–-—-
Held over gain   £56,696
    -–-–-—-
Market value of part of notional security before    
exchange year 12 ( = value of debenture) £32,000  
Apportioned cost £5,714  
Indexation (year 0 to year 12) £1,790 £7,504
  -–-–-— -–-–-—
Held over gain   £24,496
    -–-–-—-

EXPLANATION

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 SHARES IN P LTD

The vendor has acquired shares in P Ltd and a notional security under the terms of TCGA92/S138A. These are treated as two classes of shares. Together they form the new holding under TCGA92/S127 as applied by TCGA92/S135 (3).

C. RIGHT TO DEFERRED UNASCERTAINABLE CONSIDERATION

The right to the deferred consideration constitutes the new holding under TCGA92/S127 by virtue of TCGA92/S135 (3) and TCGA92/S138A.

D. AND E COMPUTATION OF THE HELD OVER GAIN

When QCBs are received in satisfaction of the right Section 116(10) applies to the exchange of the remaining part of the right to deferred consideration for the QCBs. The held over gain on the QCB is calculated by reference to the market value of the right.