Loan notes and CGT

Loan notes and CGT

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My client sold shares in his business in exchange for loan notes which are issued annually as part of an earn out deal.
HMRC have confirmed the transactions qualify as a business asset.

When working out the capital gain do I take the total acquisition cost (ie the cost of his shares) in year 1 or should it be spread over the earn out period?

Andrew

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By kenmoody
14th Dec 2007 11:28

It sounds as if ...
.. what your client has is a right to be issued with securities, known as a 'chose in action' - a right to have something done. That in itself is not a security and is a separate asset for CGT purposes, or would have been treated as such in the old days. Under the decision in Marren v Ingle you would then have to value the right as part of the consideration for the sale i.e. you CGT proceeds would be cash plus the value of the right. There would then be a further gain or loss when the further consideration is received.

S138A however now treats the earn out right as if it were a security so that it's like receiving part cash and part shares: you'd have to apportion part of the cost to the cash proceeds and under the part-disposal formula part to the shares. You will still have to put some value on the earn-out right for the purpose of apportionment, but you can't have a situation where if you overestimate the value you finish up with an unallowable loss.

Under s138A the earn out is capable of qualifying for BATR whereas without s138A it wouldn't as an earn out right is not a business asset.

However, with the abolition of taper relief there are circumstances where you wouldn't want s138A treatment - you can elect to disapply it - in order to crystalise taper before next April. The gain will arise when the loan notes issued under the earn-out are redeemed, but there won't be any taper after 5/4/2008.

Have fun!

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