ERSM110910 - Securities Options

Earn-outs: overview of liability

During the passage of the Schedule 22 Finance Act 2003 through Parliament the Paymaster General, Dawn Primarolo, said:

"A point to emphasise here is that the rules introduced by Schedule 22 seek to tax value obtained by reason of employment."

Where an earn-out operates entirely to cover further proceeds of sale, with no element of remuneration, then Income Tax and National Insurance Contributions (NICs) should not be payable.

But where an earn-out includes an element that passes value to a prospective employee of the acquiring company as reward for services over a performance period, then that remuneration element should be within the charge to Income Tax and NICs. The following paragraphs explain how the rules in Schedule 22 will be applied to achieve this policy intention and provide some guidance in identifying the divide between remuneration and capital.

The legislation

The relevant legislation can be found at

• ITEPA03/S420 (8) definition of "securities option"
• ITEPA03/S471 (2) applies securities option chapter to "prospective employment"
• ITEPA03/S471 (3) deems option acquired from employer to be 'by reason of employment'
• ITEPA03/S471 (4) deems option acquired by reason of holding employment-related securities to be 'by reason of employment'
• ITEPA03/S421B similar deeming provisions for securities themselves

Business sales

Where there is a sale of the goodwill and other assets of a business rather than a sale of the securities through which those assets are held the above guidance will apply with all appropriate amendments.