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HMRC internal manual

Employment Related Securities Manual

HM Revenue & Customs
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Disposals for more than Market Value: Earn-out arrangements

An earn-out arrangement set up for the sale of a privately-owned business is frequently structured as;

  • an initial sale of some of the director’s shares;
  • further ‘put’ and ‘call’ options over the remaining shareholding. The put and call options operate so that:

    • the director has the right to sell (put) his remaining shares to the acquirer;
    • the purchaser has the right to buy (call) the same shares from the vendor; and
    • these options may be exercised on or after a certain period at a price dependent on the performance of the newly taken-over business.

There could be a potential charge under ITEPA03/S446Y when the put or call option is exercised, because the original shares may be disposed of for more than their market value at the time the option is exercised. However, where it can be shown that the earn-out is consideration for the disposal of securities rather than value obtained by reason of employment, the market value of the securities disposed of through the put & call options will be taken to be equal to the value of the consideration received (whether cash or securities) by the vendor. So there will not be a liability to Income Tax under Chapter 3D.

You may find the key indicators and other factors set out in ERSM110940 useful in examining this issue.

This guidance is only applicable to the computation of earnings under Chapter 3D Part 7 ITEPA 2003 and has no bearing on the rules for Capital Gains Tax.