CG58055 | Deferred consideration: shares and securities: example
From HM Revenue & Customs · Capital Gains Manual
TCGA92/S138A
This example illustrates the effect of an earn-out right being treated as a security by TCGA92/S138A if a customer sells shares and the consideration received is an immediate payment of cash and the right to receive an unascertainable deferred amount of shares.
NOTE From 6 April 2008 only companies and other concerns within the charge to Corporation Tax may be able to claim indexation allowance, see CG17200C.
In year 0 V Ltd acquires all the shares in T Ltd for £100,000.
In year 10 V Ltd sells the shares in T Ltd at arm's length to P Ltd.
The consideration is
cash £500,000, and
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 V Ltd 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 section 138A.
COMPUTATIONS
A. IMMEDIATE CHARGEABLE GAIN
| Description | Action | Calculation | Amount |
|---|---|---|---|
| Cash received | - | - | £500,000 |
| Less apportioned cost | - | - | - |
| - | - | - | - |
| Cost | x | Cash | - |
| - | - | ----------------- | - |
| - | - | Cash + right | - |
| - | - | - | - |
| £100,000 | x | £500,000 | - |
| - | - | -------------------------- | £62,500 |
| - | - | £500,000 + £300,000 | - |
| Unindexed gain | - | - | £437,500 |
| Less indexation £62,500 x 0.250 | - | - | £15,625 |
| - | - | - | ----------- |
| CHARGEABLE GAIN YEAR 10 | - | - | £421,875 |
| - | - | - | ----------- |
B. COST OF NOTIONAL SECURITY = RIGHT TO DEFERRED CONSIDERATION
| Description | Action | Calculation | Amount |
|---|---|---|---|
| Apportioned cost | - | - | - |
| - | - | - | - |
| £100,000 | x | £300,000 | - |
| - | - | -------------------------- | £37,500 |
| - | - | £500,000 + £300,000 | - |
| - | - | - | - |
| Indexed rise to year 10 | - | - | - |
| £37,500 x 0.250 | - | - | £9,375 |
| - | - | - | --------- |
| - | - | - | - |
| Indexed pool of expenditure | - | - | £46,875 |
| - | - | - | --------- |
C. COMPUTATIONS WHEN DEFERRED CONSIDERATION RECEIVED
| Calculation | Notional security | Cost of | Indexed pool of |
|---|---|---|---|
| - | - | ||
| - | - | - | - |
| - | As at year 10 | £37,500 | £46,875 |
| - | - | - | - |
| - | Indexed rise to year 11 | - | - |
| - | £46,875 x 0.025 | - | 1,172 |
| - | - | - | --------- |
| - | - | - | 48,047 |
| - | Attributable to 73,000 shares in | - | - |
| - | P Ltd issued in year 11 | - | - |
| - | - | - | - |
| 202,940 | - | - | - |
| ----------------------- | - | 25,979 | 33,286 |
| 202,940 + 90,000 | - | --------- | ---------- |
| - | - | - | - |
| - | Remainder at year 11 | 11,521 | £14,761 |
| - | - | - | - |
| - | Indexed rise to year 12 | - | - |
| - | 14,761 x 0.025 | - | £369 |
| - | - | - | ----------- |
| - | - | - | £15,130 |
| - | Attributable to 47,000 shares | - | - |
| - | in P Ltd issued year 12 | £11,521 | £15,130 |
D. SHARES IN P LTD
| P Ltd Shareholding | No of shares | Qualifying | Indexed pool |
|---|---|---|---|
| - | - | ||
| 73,000 shares acquired | - | - | - |
| year 11 | - | - | - |
| (see computations at C) | 73,000 | £25,979 | £33,286 |
| - | ------------- | ----------- | ----------- |
| Pool at year 11 | 73,000 | £25,979 | £33,286 |
| - | - | - | - |
| Indexed rise to year 12 | - | - | - |
| £33,286 x 0.025 | - | - | £833 |
| - | - | - | ----------- |
| - | - | - | £34,119 |
| Additional 47,000 shares | - | - | - |
| acquired year 12 | - | - | - |
| (see computations at C) | 47,000 | £11,521 | £15,130 |
| - | --------- | ----------- | ----------- |
| Pool at October 1993 | 120,000 | £37,500 | £49,249 |
| - | ----------- | ------------ | ----------- |
EXPLANATION
The statutory reasons for the method of computation are
A. CASH RECEIVED
The cash received is treated as a part-disposal of the old holding of T Ltd shares under TCGA92/S128(3). The apportionment of the base cost of the old holding is made on the basis of market value at the date of disposal (section 128(4) and TCGA92/S129).
B. COST OF THE NOTIONAL SECURITY UNDER section 138A
The notional security forms the ‘new holding’ under TCGA92/S127 as applied by TCGA92/S135(3).
C. RIGHT TO UNASCERTAINABLE DEFERRED CONSIDERATION
The part-satisfaction of the right to deferred consideration is a part-disposal of the right. But because of section 138A it is treated as a conversion of securities within TCGA92/S132. Section 127 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 unascertainable deferred consideration is described at .
D. SHARES IN P LTD
The shares in P Ltd which are acquired go into the TCGA92/S104 holding of shares at the base cost computed in accordance with C above.