CG58060 | 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 receives an immediate issue of shares 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.
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
80,000 shares in P Ltd at market value of £2.25 each (total £180,000), 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) COST OF SHARES IN P LTD
| Apportioned cost | Multiply | Description | Amount |
|---|---|---|---|
| - | - | - | - |
| cost | x | shares | - |
| - | - | --------------------- | - |
| - | - | shares + ‘right’ | - |
| - | - | - | - |
| £100,0000 | x | £180,000 | - |
| - | - | -------------------------- | £37,500 at year 0 |
| - | - | £180,000 + £300,000 | - |
| - | - | - | - |
| Indexed rise to year 10 | - | - | - |
| £37,500 x 0.250 | - | - | 9,375 |
| - | - | - | ----------- |
| Indexed pool of expenditure | - | - | £46,875 |
| - | - | - | ----------- |
B) COST OF NOTIONAL SECURITY = RIGHT TO DEFERRED CONSIDERATION
| Apportioned cost | Multiply | Description | Amount |
|---|---|---|---|
| - | - | - | - |
| £100,000 | x | £300,000 | - |
| - | - | -------------------------- | £62,500 |
| - | - | £180,000 + £300,000 | - |
| - | - | - | - |
| Indexed rise to year 10 | - | - | - |
| £62,500 x 0.250 | - | - | £15,625 |
| - | - | - | ----------- |
| Indexed pool of expenditure | - | - | £78,125 |
| - | - | - | ------------ |
C) COMPUTATIONS WHEN DEFERRED CONSIDERATION RECEIVED
| Notional security | Cost of right | Indexed pool of expenditure | |
|---|---|---|---|
| - | - | - | |
| As at year 10 | £62,500 | £78,125 | |
| - | - | - | |
| Indexed rise to year 11 | - | - | |
| £78,125 x 0.025 | - | £1,954 | |
| - | - | ----------- | |
| - | - | £80,079 | |
| Attributable to 73,000 shares | - | - | |
| in P Ltd issued in year 11 | - | - | |
| £202, 940 | - | - | |
| ----------------------- | £43,298 | £55,476 | |
| £202,940 + £90,000 | - | - | |
| - | -------------- | ||
| Remainder at year 11 | £19,202 | £24,603 | |
| - | - | - | |
| Indexed rise to year 12 | - | - | |
| £24,602 x 0.025 | - | £615 | |
| - | - | ------------- | |
| - | - | £25,218 | |
| Attributable to 47,000 shares | - | - | |
| In P Ltd issued year 12 | £19,202 | £25,218 | |
D) SHARES IN P LTD
| P Ltd Shareholding | No of shares | Qualifying | Indexed pool of |
|---|---|---|---|
| - | - | expenditure | expenditure |
| As at year 10 | - | - | - |
| (see computations at A) | 80,000 | £37,500 | £46,875 |
| - | ---------- | ------------ | ----------- |
| Indexed rise to year 11 | - | - | - |
| £46,875 x 0.025 | - | - | £1,172 |
| - | - | - | ----------- |
| - | - | - | £48,047 |
| Additional 73,000 shares | - | - | - |
| acquired year 11 | - | - | - |
| (see computations at C) | 73,000 | £43,298 | £55,476 |
| - | ---------- | ------------ | ----------- |
| Pool at year 11 | 153,000 | £80,798 | £103,523 |
| - | ----------- | ------------ | ------------ |
| Indexed rise to year 12 | - | - | - |
| £103,523 x 0.025 | - | - | £2,588 |
| - | - | - | ------------ |
| - | - | - | £106,111 |
| Additional 47,000 shares | - | - | - |
| acquired year 12 | - | - | - |
| (see computations at C) | 47,000 | £19,202 | £25,218 |
| - | ----------- | ------------- | ------------- |
| Pool at October 1993 | 200,000 | £100,000 | £131,329 |
| - | ----------- | ------------- | ------------- |
EXPLANATION
The statutory reasons for the method of computation are:
A. COST OF SHARES IN P LTD
V Ltd has acquired shares in P Ltd and a `notional security' under section 138A. These are treated as two classes of shares or debentures. Together they form the `new holding' under TCGA92/S127 as applied by TCGA92/S135(3).
If the shares in P Ltd are not quoted the apportionment should be made by reference to market values at the date of a disposal of all or part of the new holding.
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. TCGA92/S127 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 of the same class. The base cost and indexed pool of expenditure is calculated in accordance with A and B above.