CG58040 - Deferred consideration: shares and securities: example
This example illustrates the effect of an earn-out right being
treated as a security by TCGA92/S138A if a taxpayer sells shares
and receives an immediate issue of shares and the right to receive
a deferred unascertainable amount of shares.
All events take place on or after 26 November 1996.
Illustrative indexation factors have been provided for the purposes
of this example only. As regards the freezing of indexation
allowance for Capital Gains Tax purposes from 1998-99 onwards, see
CG50607.
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
- 80,000 shares in P Ltd at market value of £2.25 each
(total £180,000), plus
- the right to two payments of deferred consideration, the amount depending on future profits of T Ltd, to be satisfied only by an issue of shares in P Ltd.
The market value of the right to deferred consideration at the
time of disposal is agreed by Shares and Assets Valuation at
£300,000.
In year 11 shares in P Ltd to the value of £202,940
(73,000 shares at £2.78 each) are issued to the taxpayer in
part satisfaction of the right to deferred consideration. The
market value of the remainder of the right in year 11 is agreed by
Shares and Assets Valuation at £90,000.
In year 12 shares in P Ltd to the value of £118,440
(47,000 shares at £2.52 each) are issued in full satisfaction
of the remainder of the right to deferred consideration.
P Ltd is a company whose shares are quoted on the Stock
Exchange. All of the conditions are satisfied and the earn-out
right is treated as a security by TCGA92/S138A.
COMPUTATIONS
A) COST OF SHARES IN P LTD
| Apportioned cost | |||
| cost | x | shares | |
| --------------------- | |||
| shares + ‘right’ | |||
| £100,0000 | x | £180,000 | |
| ---------------------------- | £37,500 at year 0 | ||
| £180,000 + £300,000 | |||
| Indexed rise to year 10 | |||
| £37,500 x 0.250 | 9,375 | ||
| ----------- | |||
| Indexed pool of expenditure | £46,875 | ||
| ----------- |
B) COST OF NOTIONAL SECURITY = RIGHT TO DEFERRED CONSIDERATION
| Apportioned cost | |||
| £100,000 | x | £300,000 | |
| ---------------------------- | £62,500 | ||
| £180,000 + £300,000 | |||
| Indexed rise to year 10 | |||
| £62,500 x 0.250 | £15,625 | ||
| ----------- | |||
| Indexed pool of expenditure | £78,125 | ||
| ------------ |
C) COMPUTATIONS WHEN DEFERRED CONSIDERATION RECEIVED
| Notional security | Cost of right | Indexed pool of expenditure | |
| As at year 10 | £62,500 | £78,125 | |
| Indexed rise to year 11 | |||
| £78,125 x 0.025 | £1,954 | ||
| ----------- | |||
| £80,079 | |||
| Attributable to 73,000 shares | |||
| in P Ltd issued in year 11 | |||
|
| £202,940 | ||
| ---------------------------- | £43,298 | £55,476 | |
| £202,940 + £90,000 | |||
| ----------- | ------------ | ||
| Remainder at year 11 | £19,202 | £24,603 | |
| Indexed rise to year 12 | |||
| £24,602 x 0.025 | £615 | ||
| ------------- | |||
| £25,218 | |||
| Attributable to 47,000 shares | |||
| In P Ltd issued year 12 | £19,202 | £25,218 | |
D) SHARES IN P LTD
| P Ltd Shareholding | No of shares | Qualifying expenditure | Indexed pool of expenditure |
| As at year 10 | |||
| (see computations at A) | 80,000 | £37,500 | £46,875 |
| ---------- | ------------ | ----------- | |
| Indexed rise to year 11 | |||
| £46,875 x 0.025 | £1,172 | ||
| ----------- | |||
| £48,047 | |||
| Additional 73,000 shares | |||
| acquired year 11 | |||
| (see computations at C) | 73,000 | £43,298 | £55,476 |
| ---------- | ------------ | ----------- | |
| Pool at year 11 | 153,000 | £80,798 | £103,523 |
| ----------- | ------------ | ------------ | |
| Indexed rise to year 12 | |||
| £103,523 x 0.025 | £2,588 | ||
| ------------ | |||
| £106,111 | |||
| Additional 47,000 shares | |||
| acquired year 12 | |||
| (see computations at C) | 47,000 | £19,202 | £25,218 |
| ----------- | ------------- | ------------- | |
| Pool at October 1993 | 200,000 | £100,000 | £131,329 |
| ----------- | ------------- | ------------- |
EXPLANATION
The statutory reasons for the method of computation are:
- COST OF SHARES IN P LTD
The vendor has acquired shares in P Ltd and a `notional
security' under TCGA92/S138A. These are treated as two classes of
shares or debentures. Together they form the `new holding' under
TCGA92/S127 as applied by TCGA92/S135 (3).
If the shares in P Ltd are not quoted the apportionment
should be made by reference to market values at the date of a
disposal of all or part of the new holding.
- RIGHT TO DEFERRED UNASCERTAINABLE CONSIDERATION
The part satisfaction of the right to deferred consideration is a part disposal of the right. But because of TCGA92/S138A it is treated as a conversion of securities within TCGA92/S132. TCGA92/S127 applies with the necessary adaptations to the part disposal and part of the base cost of the notional security is transferred to the holding of shares in P Ltd.
The procedure for obtaining valuations of the right to deferred unascertainable consideration is described at CG14960+.
- SHARES IN P LTD
The shares in P Ltd which are acquired go into the Section 104 holding of shares of the same class. The base cost and indexed pool of expenditure is calculated in accordance with A and B above.
