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HMRC internal manual

Employment Related Securities Manual

HM Revenue & Customs
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Securities Options: earn-outs: potential liability under Chapter 5

When an earn-out takes the form of a right to acquire securities at some time in the future subject to conditions, it will, for the purposes of Chapter 5, be a securities option. However, where the purchaser of a company has the choice of paying the earn-out in cash or securities, then it may not be a securities option. (See ERSM110025.)

Employees in receipt of such securities options may continue to work for the business or cease their employment. Employees who continue to work for the business will have acquired a securities option from their prospective employer and ITEPA03/S471(3) deems this to be ‘by reason of employment’. Employees who cease to work at the time the business is sold may also be deemed to have acquired an employment-related securities option by virtue of ITEPA03/S471(4).

For both categories there will be a potential liability to Income Tax and NIC on the receipt of the earn-out securities. However, where it can be shown that the earn-out is further consideration for the disposal of securities rather than value obtained by reason of employment, the value of securities exchanged for the earn-out will be taken to be equal to the value of the securities acquired under the earn-out itself. There will then be no liability to Income Tax arising.

This guidance is only applicable to the computation of employment income under Chapter 5 Part 7 ITEPA 2003 and has no bearing on the rules for Capital Gains Tax.