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Capital Gains Manual

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Deferred consideration: shares and securities: example

This example illustrates the effect of TCGA92/S138A if the taxpayer receives an immediate issue of debentures, which are QCBs, and an unascertainable deferred amount of shares and debentures, which are also 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 the shares in T Ltd at arm’s length to P Ltd.

The consideration is

  1. debentures of P Ltd to the value of £300,000
  2. the right to a payment of deferred consideration, the amount depending on future profits of T Ltd, to be satisfied only by an issue of shares in or debentures of P Ltd.

The market value of the right to deferred consideration at the time of disposal is agreed by Shares and Assets Valuation at £250,000.

In year 11 shares in P Ltd to the value of £169,000 (44,591 shares at £3.79 each) and debentures in P Ltd to the value of £86,000 are issued in full satisfaction of the right to deferred consideration.

All of the debentures issued are QCBs.

All of the conditions are satisfied and the earn-out right is treated as a security by TCGA92/S138A.

COMPUTATION

A. COMPUTATION OF HELD OVER CHARGEABLE GAIN

Market value of part of original holding      
       
( = value of the debenture) £300,000    
Apportioned cost      
£100,000 x £300,000  
    -–-–-–-–-–-–-–-–-—- £54,545
    £300,000 + £250,000  
  -–-–-–-–    
Unindexed gain £245,455    
Indexation £54,545 x 0.250 £13,637    
  -–-–-–-—    
Held over gain £231,818    
  -–-–-–-—    

B. COST OF NOTIONAL SECURITY

Cost £100,000 - £54,545 £45,455
   
Indexed rise to year 10  
£45,455 x 0.250 £11,364
  -–-–-—-
Indexed pool of expenditure £56,819
  -–-–-—-

C. COMPUTATIONS WHEN DEFERRED CONSIDERATION RECEIVED

i) Computation of held over gain on debenture

Market value of part of notional security        
         
( = value of the debenture) £86,000      
Apportioned cost        
£45,455 x £86,000    
    -–-–-–-–-–-–-–-–-— £15,330  
    £86,000 + £169,000    
Indexation (year 0 to year 11)        
£15,330 x 0.281 £4,308 £19,638    
      -–-–-—- -–-–-–-–
Held over gain   £66,362    
    -–-–-–-–    

ii) Computation of cost of shares issued

Cost £45,455 - £15,330 £30,125
   
Indexed rise to year 11  
£30,125 x 0.281 £8,465
  -–-–-—-
Indexed pool of expenditure £38,590
  -–-–-—-

EXPLANATION

A. IMMEDIATE ISSUE OF QCBS

A chargeable gain is calculated in respect of the debenture received which is a QCB. This gain is held over until the debenture is disposed of (TCGA92/S116 (10)). This is often when the debenture is redeemed.

B. 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.

C. COMPUTATION WHEN DEFERRED CONSIDERATION RECEIVED

When shares and QCBs are received in satisfaction of the right

  • the issue of shares is treated as a conversion of securities within TCGA92/S132 under subsection (3)(d) of TCGA92/S138A
  • 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.