CG58055 - Deferred consideration: shares and securities: example

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 the consideration received is an immediate payment of cash 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

  • cash £500,000, 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. IMMEDIATE CHARGEABLE GAIN

Description Action Calculation Amount
Cash received - - £500,000
Less apportioned cost - - -
Cost x Cash -
- - -—————- -
- - Cash + right -
£100,000 x £500,000 -
- - -————————- £62,500
- - £500,000 + £300,000 -
Unindexed gain - - £437,500
Less indexation £62,500 x 0.250 - - £15,625
- - - -———-
CHARGEABLE GAIN YEAR 10 - - £421,875
- - - -———-

B. COST OF NOTIONAL SECURITY = RIGHT TO DEFERRED CONSIDERATION

Description Action Calculation Amount
Apportioned cost - - -
£100,000 x £300,000 -
- - -————————- £37,500
- - £500,000 + £300,000 -
Indexed rise to year 10 - - -
£37,500 x 0.250 - - £9,375
- - - -——–
Indexed pool of expenditure - - £46,875
- - - -——–

C. COMPUTATIONS WHEN DEFERRED CONSIDERATION RECEIVED

Calculation Notional security Cost of Indexed pool of
- - right expenditure
- As at year 10 £37,500 £46,875
- Indexed rise to year 11 - -
- £46,875 x 0.025 - 1,172
- - - -——–
- - - 48,047
- Attributable to 73,000 shares in - -
- P Ltd issued in year 11 - -
202,940 - - -
———————– - 25,979 33,286
202,940 + 90,000 - -——– -———
- Remainder at year 11 11,521 £14,761
- Indexed rise to year 12 - -
- 14,761 x 0.025 - £369
- - - -———-
- - - £15,130
- Attributable to 47,000 shares - -
- in P Ltd issued year 12 £11,521 £15,130

D. SHARES IN P LTD

P Ltd Shareholding No of shares Qualifying Indexed pool
- - expenditure of expenditure
73,000 shares acquired - - -
year 11 - - -
(see computations at C) 73,000 £25,979 £33,286
- -———— -———- -———-
Pool at year 11 73,000 £25,979 £33,286
Indexed rise to year 12 - - -
£33,286 x 0.025 - - £833
- - - -———-
- - - £34,119
Additional 47,000 shares - - -
acquired year 12 - - -
(see computations at C) 47,000 £11,521 £15,130
- -——– -———- -———-
Pool at October 1993 120,000 £37,500 £49,249
- -———- -———– -———-

EXPLANATION

The statutory reasons for the method of computation are

A. CASH RECEIVED

The cash received is treated as a part-disposal of the old holding of T Ltd shares under TCGA92/S128(3). The apportionment of the base cost of the old holding is made on the basis of market value at the date of disposal (section 128(4) and TCGA92/S129).

B. COST OF THE NOTIONAL SECURITY UNDER section 138A

The notional security forms the ‘new holding’ under TCGA92/S127 as applied by TCGA92/S135(3).

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. Section 127 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 at the base cost computed in accordance with C above.