Types of sale considerations to know before selling your business

This article looks at the tax issues you may encounter arising from the type of sale consideration you are offered.

Potential purchasers may offer consideration in numerous different forms other than upfront cash – many deals include a mix of cash and other consideration. This could include deferred consideration, loan notes, equity in the purchaser and earn-outs (which may either be cash or equity/securities based).

In the following examples it has been assumed that the entire sale consideration will be a capital receipt subject to capital gains tax. In situations where the sale shares are ‘Employment Related Securities’ (broadly shares held by officers/employees of the company), some sale consideration may be taxable to income tax. Earnout entitlements may also be subject to income tax where the vendor continues to be involved in the business post sale.
 

Cash

Cash forms taxable consideration at the date of disposal for capital gains tax purposes. No deduction should be made for any contingent liability of the person making the disposal by way of warranty or representation made on the disposal (e.g., for warranties included in a sale and purchase agreement).

If any of these contingent liabilities subsequently become enforceable, the enforced payment may then be deducted from the consideration received. If in the meantime the taxpayer has submitted their return, they have four years to make the appropriate claim for their capital gain to be recomputed.
 

Fixed deferred consideration

Consideration that is fixed, i.e., a future amount which may be paid and that is ascertainable at the date of disposal, is also included with the cash as one disposal for capital gains tax purposes.

If any amount of the deferred payments ultimately becomes not payable, then the vendors may adjust their capital gains tax computation accordingly. If in the meantime the tax return has been submitted, they will have four years from the date the consideration becomes irrecoverable to make the appropriate claim for their capital gain to be recomputed.
 

Cash earnouts

Where an entitlement to further consideration cannot be ascertained at the date of disposal, i.e., the vendor does not know how much he will receive when he originally signs the contract, it is ‘unascertainable’ for tax purposes.

The right to receive the unascertainable deferred consideration itself is valued and treated as part of the consideration at the date of disposal. In legal terms, this asset is called a 'chose in action'.

Essentially, an earnout right is itself a chargeable asset with an acquisition cost for capital gains tax purposes of the value placed on it as consideration for the disposal of the shares. As earn out payments are received these are chargeable to capital gains tax as capital sums derived from an asset, i.e., the earn out right.

Each tax year there will be a part disposal of the earn out right calculated by reference to the amount received during the respective year, less a proportion of the cost of the earn based on the amounts received and the expected future receipts of the earn out. This calculation needs to be performed each time an amount is received under the earn out and tax paid for the tax year accordingly. An earnout right does not qualify for Business Asset Disposal Relief (BADR) so gains arising in the future on it suffer tax at the normal full rates.
 

Shares and non-Qualifying Corporate Bond loan notes

Where consideration is paid in either equity or loan notes structured as non-Qualifying Corporate Bonds (QCB) in the purchaser, it is likely that the capital gain on this consideration will automatically roll-over into the new securities. Payment of tax on the gain is, therefore, deferred until the disposal of the new security.

Often this new holding will not qualify for BADR itself, which may lead to relief being lost. Where the shares in the company being sold would have qualified for the relief, it is possible to elect to disapply rollover such that the relief is obtained.
 

Qualifying Corporate Bond loan notes

Where consideration is paid in loan notes structured as Qualifying Corporate Bonds (QCB) in the purchaser, the capital gain on this consideration does crystalise. However, the assessment of the gain is deferred until the later sale of the QCB loan notes.

When the deferred gain does fall into charge, BADR will only be available if at that point and during the previous 24 months, the company to which the QCBs relate has been the individual’s personal company and they are an officer/employee of the group. As the relief on the deferred gain may be lost, it is possible to elect to disapply rollover such that the relief is obtained.
 

Equity/Security earnouts

Where consideration is paid by way of an earnout entitlement which will ultimately be satisfied by way of equity/loan notes in the purchaser, it is likely that the capital gain on this entitlement will automatically roll-over into the new securities when they are issued. Payment of tax on the gain is, therefore, deferred until the disposal of the new security.

Again, this new holding may not qualify for BADR itself, which may lead to relief being lost. Where the shares in the company being sold would have qualified for the relief, it is possible to elect to disapply rollover to get the relief on the immediate gain.
 

Final thoughts

The chargeable gains arising from these different forms of consideration may be taxable at different dates and can give rise to ‘dry’ tax liabilities on completion, that is a non-cash consideration which becomes taxable in the current tax year which may require other cash to be found to meet payment of the liability.

Consideration which is taxable in the future will be subject to the tax rates in force at the time, which may have changed from the rates currently in force. Additionally, the risks of amounts being taxed to income tax, under the Employment Related Securities legislation, need to be analysed and understood.

It is therefore important that vendors understand the tax position of the proposed sale consideration early in the negotiation process to ensure that it is in their best interests both commercially, and for tax purposes.

For advice or support on the topics covered above, please contact our Private Client team.