From a tax perspective an earn-out right can be ascertainable (where the amount can be determined at the time of a transaction) or unascertainable (where the calculation of the amounts depends on events which have not taken place) and whichever category the earn-out falls into can have a big impact on the tax treatment.
If an earn-out is ascertainable, therefore the amount which a vendor would receive is fixed at completion, then the full cash amount is brought into the tax computation in the year of disposal.
This again, can cause cash flow complications for vendors if the earn-out does not pay out until after the CGT is due.
If an earn-out is unascertainable for tax purposes at the point of the disposal, a valuation will need to be made to estimate the value for the earn-out under the Marren V Ingles principle.
Under this principle, the right to receive future unascertainable consideration is a chargeable asset in itself and the value of the right is to be included as part of the original consideration.
This is applicable to both a cash and a securities element. This value is taxable in the year of disposal and forms the base cost for the disposal of the earn-out right in the future.
Complexity arises surrounding the value of the potential earn-out and the tax treatment if there is a loss on disposal of the right to receive future income.
Ross Stupart is a tax partner at RSM UK
