Deferred consideration in share sales and property transactions

Steve Eccleston, Managing Partner

The use of deferred consideration structures in share sales and property transactions may allow sellers to receive more by deferring a portion of the payment, possibly based on the future performance of the business or upon increases in property value which may help buyers bridge the valuation gap by offering a lower upfront payment.

Key points to consider

1. Commercial Considerations

Deferred consideration is worth considering but several commercial factors need to be taken into account by both parties. These include uncertainty around future performance and the availability of funds. Careful contractual drafting is essential to protect the interests of all involved. Engaging lawyers and tax advisers at an early stage is crucial to getting the structure right and avoiding delays.

2. Tax Treatment

In addition to the commercial aspects, it’s crucial to consider the tax treatment of deferred consideration structures. Although the terms of the deferred consideration will ultimately be determined by commercial negotiations, thinking about these and the tax treatment upfront can help prevent any unexpected surprises later, particularly when it’s time to submit the tax returns.

The capital gains tax position for sellers will depend on the specific facts of each case, and personal tax advice should be sought to reflect individual circumstances. That said, broadly, the capital gains tax treatment will hinge on whether the amount of deferred consideration payable (or potentially payable) is known or ascertainable at the time of the sale’s completion.

Known Deferred Consideration

If the deferred consideration amount is known (or ascertainable) at the time of completion, even if contingent on a future event, tax should (generally) be payable on the full consideration. For example, agreements to pay an additional sum in the future, such as

1. a £1million in six months or,
2. £10 million conditionally upon granting planning permission.

will be immediately taxable even though the seller may not have the funds and certainly will not have been paid! If the consideration later becomes irrecoverable, the seller can claim a refund for any overpaid tax but, that may leave significant cashflow issues

Practically speaking, it’s worth considering the timing of deferred consideration payments and whether the tax will need to be paid before the deferred consideration is received. Capital gains tax is generally payable by January 31 in the year following the tax year-end. In some cases, deferred consideration may be paid or found irrecoverable before the tax due date, reducing the immediate concern. However, if it is delayed, it is important to set aside some funds for tax payment…so hang on to some money!

Unknown Deferred Consideration

If the deferred consideration amount is unknown and cannot be determined at the time of completion, the tax treatment differs. For example, if deferred consideration depends on the business’s future performance (“an earn-out”) or upon the future value of land if planning is obtained, tax will not be payable immediately.

For example, provisions for payments of:-

1. 10% of gross income for the first year when income is anticipated at £10million or,
2. 10% of the value of land upon granting planning permission when land value is anticipated at £100 million.

would be likely treated as a separate taxable event for capital gains tax purposes delaying a tax payment but potentially creating other risks!

Accurately assessing the market value of the earn-out or additional land payment right at the time is crucial. A high guaranteed but deferred payment results in higher upfront tax, while a variable deferred payment carries the potential for a loss if the earn-out or land value increase doesn’t fully materialise.

Impact on Available Reliefs

Additionally, it is important to consider how deferred consideration structures could impact any available reliefs. For example, the sale of shares might qualify for business asset disposal relief (if conditions are met) and be taxed at a lower rate. However, an earn-out might not qualify for this relief. Speaking to lawyers and tax advisers early can help navigate these issues.

Tax Treatment for Employee/Director Shareholders

Similarly deferred consideration payable to employee/director shareholders, could be reclassified as employment income, which could be more expensive in terms of tax. The risks can be complex and fact-specific…so speak to the lawyer early in the process.

Conclusion

The use of deferred consideration structures as with many issues in significant property or corporate transactions have potential benefits to both buyers and sellers. There are complexities and not just in relation to the tax implications of these structures and in order to manage risks and maximise returns advice should be sought upfront and the team at Kuits who would really enjoy helping you!