CG58075 - Deferred consideration: shares and securities: TCGA92/S138A does not apply: example
TCGA92/S138A
In this example the conditions for an earn-out right being treated as a security by TCGA92/S138A are not met - the deferred consideration could be satisfied either in shares or in cash. The right cannot be treated as a security even though the deferred consideration is actually satisfied in shares. The possibility of the receipt of cash means that the right is not an ‘earn-out right’ - section 138A(1)(d).
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.
In year 0 V Ltd acquires all the shares in T Ltd for £100,000.
In year 10 V Ltd sells all the shares in T Ltd at arm’s length to P Ltd.
The consideration is
- cash 500,000, and
- 80,000 shares in P Ltd at market value of £2.25 each (total £180,000), and
- the right to two payments of future consideration, the amount depending on future profits of T Ltd, to be satisfied either by the issue of shares in P Ltd, or in cash if P Ltd so decides. The market value of the right to deferred consideration at the time of disposal is agreed by Shares and Assets Valuation at £300,000.
The further consideration is paid in the form of shares. 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 at 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 quoted company. But the conditions for the earn-out right to be treated as a security by section 138A are not met.
COMPUTATIONS
A) IMMEDIATE CHARGEABLE GAIN
Cash consideration plus value of right to receive deferred payments (£500,000 + £300,000)
| Description | Multiply | Calcualtion/Amount | Amount |
|---|---|---|---|
| Consideration | - | - | £800,000 |
| Less apportioned cost | - | - | - |
| Cost | x | Cash + ‘right’ | - |
| - | - | -—————————— | - |
| - | - | Cash + ‘right’ + shares | - |
| £100,000 | x | £800,000 | - |
| - | - | -—————————– | £81,633 |
| - | - | £800,000 + £180,000 | - |
| - | - | - | -———— |
| Unindexed gain | - | - | £718,367 |
| Less indexation £81,633 x 0.250 | - | - | £20,409 |
| - | - | - | -———— |
| Chargeable gain year 10 | - | - | £697,958 |
B) COST OF SHARES IN P LTD
| Calculation | Amount |
|---|---|
| Cost £100,000 - £81,633 | £18,367 at year 0 |
| Indexed rise to year 10 | - |
| £18,367 x 0.250 | £4,592 |
| - | -———- |
| Indexed pool of expenditure | £22,959 |
| - | -———- |
This is the base cost and indexed pool of expenditure relating to the 80,000 shares in P Ltd acquired in year 10.
C) COMPUTATIONS WHEN DEFERRED CONSIDERATION RECEIVED
PART DISPOSALS OF RIGHT TO DEFERRED CONSIDERATION
| Description | Calculation | Amount | Amount |
|---|---|---|---|
| Year 11 – consideration received | - | - | - |
| (value of 73,000 shares in P Ltd) | - | - | £202,940 |
| Apportioned cost | - | - | - |
| £300,000 | x | £202,940 | - |
| - | —————- | - | £207,831 |
| - | £202,940 + £90,000 | - | - |
| Allowable loss | - | - | (4,891) |
Indexation can’t create or increase an allowable loss, see CG17700.
| Description | Amount |
|---|---|
| Year 12 – consideration received | - |
| (value of 47,000 shares in P Ltd) | £118,440 |
| Less cost £300,000 - £207,831 | £92,169 |
| - | -———— |
| Unindexed gain | £26,271 |
| Less indexation £92,169 x 0.051 | - |
| (indexation year 10 to year 12) | £4,701 |
| - | -———— |
| Chargeable gain year 12 | £21,570 |
| - | -———— |
D) SHARES IN P LTD
| Description | Shares | Qualifying Expenditure | Indexed pool of Expenditure |
|---|---|---|---|
| P Ltd Shareholding | No Of | Qualifying | Indexed pool of |
| - | Shares | Expenditure | Expenditure |
| As at year 10 | - | - | - |
| (see computations at B) | 80,000 | £18,367 | £22,959 |
| Indexed rise to year 11 | - | - | - |
| £22,959 x 0.025 | - | - | £574 |
| - | - | - | -———- |
| - | - | - | £23,533 |
| Acquired year 11 on part disposal | - | - | - |
| of right (see computations at C) | 73,000 | £202,940 | £202,940 |
| - | -——– | -———— | -———— |
| Pool at year 11 | 153,000 | £221,307 | £226,473 |
| Indexed rise to year 12 | - | - | - |
| £226,473 x 0.025 | - | - | £5,662 |
| - | - | - | -———— |
| - | - | - | £232,125 |
| Acquired year 12 on final disposal | - | - | - |
| of right (see computations at C) | 47,000 | £118,440 | £118,440 |
| - | -———- | -———— | -———— |
| Pool at October 1993 | 200,000 | £339,747 | £350,575 |
| - | -———- | -———— | -———— |
EXPLANATION
The existence of a cash alternative in the sale agreement means that the right falls outside the terms of section 138A. This applies whether or not shares are actually received in satisfaction of the right.
A. IMMEDIATE CHARGEABLE GAIN
There is an immediate chargeable gain on both the cash element and the value of the right to receive unascertainable deferred consideration.
B. COST OF SHARES IN P LTD
The normal rules of TCGA92/S135 apply to the immediate issue of shares in P Ltd in exchange for shares in T Ltd.
C. COMPUTATIONS WHEN DEFERRED CONSIDERATION RECEIVED
Even though the deferred consideration is actually received in shares section 138A does not apply.
A chargeable gain or allowable loss is calculated for the part disposal of the right to receive unascertainable deferred consideration. As section 138A does not apply the `right’ is not treated as a notional security and there is no exchange of securities.
D. SHARES IN P LTD
All of the acquired shares go into the same pool of shares. The 80,000 shares acquired in year 10 have their base cost (and indexation) calculated in accordance with the normal rules of section 135. The shares to which section 138A did not apply go into the pool at market value at the date of acquisition.