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CG58055 | Deferred consideration: shares and securities: example

From HM Revenue & Customs · Capital Gains Manual

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 CG17207.

FACTS

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

DescriptionActionCalculationAmount
Cash received--£500,000
Less apportioned cost---
CostxCash-
---—————--
--Cash + right-
£100,000x£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

DescriptionActionCalculationAmount
Apportioned cost---
£100,000x£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

CalculationNotional securityCost ofIndexed pool of
--rightexpenditure
-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---
———————–-25,97933,286
202,940 + 90,000--——–-———
-Remainder at year 1111,521£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 ShareholdingNo of sharesQualifyingIndexed pool
--expenditureof expenditure
73,000 shares acquired---
year 11---
(see computations at C)73,000£25,979£33,286
--————-———--———-
Pool at year 1173,000£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 1993120,000£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 CG14950.

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.