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HMRC internal manual

Employment Related Securities Manual

From
HM Revenue & Customs
Updated
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Securities Options: earn-outs: key indicators of earn-out being sale consideration

Key indicators in determining whether an earn-out is further sale consideration rather than remuneration are:

  1. The sale agreement demonstrates that the earn-out is part of the valuable consideration given for the securities in the old company
  2. The value received from the earn-out reflects the value of the securities given up.
  3. Where the vendor continues to be employed in the business, the earn-out is not compensation for the vendor not being fully remunerated for continuing employment with the company.
  4. Where the vendor continues to be employed, the earn-out is not conditional on future employment, beyond a reasonable requirement to stay to protect the value of the business being sold.
  5. Where the vendor continues to be employed, there are no personal performance targets incorporated in the earn-out.
  6. Non-employees or former employees receive the earn-out on the same terms as employees remaining.

The following factors may also be relevant:

  1. Negotiations between the seller and buyer as to the level of the earn out in relation to the value of the consideration given for securities in the old company.
  2. Any clearance that might have been obtained under Section 138 and Section 707 demonstrating the bona fide nature of the transactions, and the level of the earn-out linked to profitability or other key performance indicators of the business.
  3. Evidence that future bonuses were reclassified or commuted into purchase consideration would indicate that the earn-out was, at least partly, remuneration rather than consideration for the disposal of securities.

Where the earn-out is partly deferred consideration for the old securities and partly a reward for services or inducement to continue working for the business, then an apportionment of the value will need to be undertaken on a just and reasonable basis.

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