Deferred Consideration and Capital Gains Tax
- Taylor Keeble
- 7 minutes ago
- 3 min read
When selling an asset, understanding the date of disposal for capital gains tax (CGT) is essential. The disposal date is generally the date the contract to sell the asset is signed. If the contract is conditional, dependent on a specific event, the disposal date is the day all the conditions are fulfilled.
Correctly identifying the date of disposal matters because it determines in which tax year any gain will be taxed. The actual date of payment of the sale proceeds is less important, except in cases where the purchaser pays in instalments. In such situations, the seller may be able to spread the CGT payments over time rather than paying a large sum all at once.
CGT Instalments
When sale proceeds are payable in instalments, vendors may have the option to pay their CGT in instalments as well. Typically, CGT instalments are proportional to the amount of the payment received. For example, if a buyer pays the vendor in three equal annual instalments, the CGT can also be spread across those three years. There are limits to how long this can continue, and instalments are often structured to coincide with the dates the vendor is entitled to receive payment. The key benefit is that these payments are generally interest-free, giving vendors flexibility in managing their tax liability. This can be particularly helpful for smaller businesses or individuals who do not want to pay a large CGT bill immediately.
Earn-Outs — Ascertainable Consideration
An earn-out is a type of deferred consideration where part of the sale price depends on a future event. For instance, the additional payment could be linked to a company achieving a specific profit target or being listed on a stock exchange. When the future payment is fixed and can be determined at the time of sale, the entire sale price, including the immediate cash and the future payment, is treated as a single disposal for CGT purposes. This means the seller includes both the cash received now and the value of the future payment in the CGT calculation for the year the contract is signed.
Earn-Outs — Unascertainable Consideration
Sometimes, the additional payment cannot be determined at the date of sale. In these cases, the principle from Marren v Ingles comes into play. The key takeaway from this case is that the right to receive future consideration is considered a valuable asset in itself. Even though the exact amount is unknown at the time of sale, the seller has a right to a future payment, and this right must be included in the original CGT calculation by assigning it a reasonable value.
Later, when the future payment is made, the seller may realise a further gain or a loss, depending on whether the amount received is higher or lower than the initially assigned value. This ensures that the tax treatment reflects the economic reality of the transaction. Essentially, deferred consideration is treated as a separate asset, and its disposal can trigger a CGT event. If a loss arises on this right, special rules may allow it to be offset against the gain on the original asset, which could result in a CGT repayment.
Practical Examples
Consider a business sold for a combination of immediate cash and an earn-out tied to future performance. If the upfront cash is £500,000 and the earn-out is estimated at £200,000, the total proceeds considered for CGT would be £700,000. Later, if the earn-out turns out to be £250,000, the seller may have an additional gain on the disposal of the deferred right. Conversely, if the earn-out only amounts to £150,000, the seller could make a loss on the right to receive deferred consideration, which may be offset against earlier gains. These scenarios illustrate why valuing the right to future consideration is crucial and why the Marren v Ingles principle remains relevant today.
Speak to an Expert
Deferred consideration and earn-outs can be complex, and getting the timing and calculations right is essential for managing your tax liability. Small errors in valuation or timing can result in overpaying tax or missing opportunities to offset gains and losses.
Authored by: London Team
