How can I calculate CGT on earn out?

How can I calculate CGT on earn out?

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I have a client who has sold shares in the business. Part of the consideration is dependent upon future results. I need a step by step guide to preparing the CGT computations. Can anyone recommend where I might find this? Many thanks in advance.
Robert Hammond

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By andymeeson
12th Jul 2005 09:23

Good point, Clive
I recall that in the early years of Marren v Ingles, the Revenue was very keen to assess "capped" deferred consideration at full s.48 level. The current wording of CG14889 does therefore appear to be a softening of attitude.

I can't help thinking, though, that the sentence is crying out for a "necessarily" - i.e. "the presence of a maximum amount to be paid does not [necessarily] imply...", since in a number of circumstances I believe the implication truly is there.

Perhaps it's all down to how the deal is structured, and how the function of the maximum is expressed. If the real starting point is the cap, with performance shortfalls potentially bringing it down, that seems to me to deserve s.48 treatment.

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By User deleted
11th Jul 2005 16:18

Unascertainable deferred consideration
Regarding the use of a cap that fixes the maximum contingent consideration, has there been a change of mind by IR as it was my previous understanding that a cap on the contingent consideration would mean that the maximum sum was assessable "up front"? However, IR manual states "The presence of a maximum amount to be paid does not imply that the consideration is ascertainable in the maximum" (CG14889).

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By andymeeson
11th Jul 2005 09:39

Not really complex, merely awkward...
First thing: is the future consideration truly unquantifiable? If there is a fixed minimum (a "collar"), then that part is deemed to be received on day one, and only any excess is a true earn-out. It's even worse if there's a fixed maximum (a "cap"), since in principle everything up to the cap is initially deemed to be received on day one regardless of the fact it may never be received. (TCGA 1992 s.48)

Once you've separated out the part (if any) that's truly unquantifiable, this is treated as the receipt, on day one, of a right (a "chose in action") whose value forms part of the consideration for sale (Marren v Ingles).

This is where the tricky bit comes in. Valuing the right, with suitable discounts for the likelihood of reaching any particular targets and further discounting for delay, is a job for a specialist valuer (HMRC will inevitably put the case to Share Valuation).

Depending on how well the valuation was done, there will be either a gain or a loss when the earn-out crystallises (at which point there is a disposal of the chose in action). If a loss, it can by concession be carried back against the original gain.

That's the outline. I don't believe a true step-by-step guide can be done: the whole thing is too dependent on circumstances. really, there's no substitute for either proceeding from basic principles or taking guidance from someone who has done one.

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