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CG58060 | 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 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 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

  • 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 costMultiplyDescriptionAmount
costxshares-
---——————–-
--shares + ‘right’-
£100,0000x£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 costMultiplyDescriptionAmount
£100,000x£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 securityCost of rightIndexed 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 ShareholdingNo of sharesQualifyingIndexed pool of
--expenditureexpenditure
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 11153,000£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 1993200,000£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 CG14950.

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.