ERSM80120 - 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 put his remaining shares on the acquirer;
- the purchaser has the right to call for 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 was previously published as FAQ 3D(b) and 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.
