Taxation of Chargeable Gains Act 1992 section 138A

Use of earn-out rights for exchange of securities

Section 138A provides rules that allow earn-out rights — where the number or value of shares to be received as deferred consideration is not known at the time of a share sale — to be treated as securities, so that the normal share reorganisation rules can apply and no immediate tax charge arises.

• An earn-out right is a right to receive shares or debentures in the acquiring company as consideration for selling shares, where the number or value of shares to be issued cannot be determined at the date of the deal and the right can only be satisfied by issuing those shares or debentures.
• Where the conditions are met, the earn-out right is automatically treated as a non-qualifying-corporate-bond security of the acquiring company, and issuing shares or debentures to satisfy it is treated as a conversion of that security — deferring any capital gains tax charge until the shares or debentures actually received are eventually sold.
• A seller can elect out of this automatic treatment — choosing not to have the earn-out right treated as a security — by giving irrevocable notice to HMRC within two years of the end of the relevant accounting period (for companies) or by the first anniversary of 31 January following the tax year in which the right was conferred (for individuals).
• The deferred consideration is only regarded as unascertainable if its value or quantity depends on uncertain future matters relating to the business or assets of relevant companies in the transaction — and the rules for ascertainable deferred consideration under section 48 take priority where they apply.