CGT treatment of non-cash consideration on a share sale
Background commercial issues
If you sell your shares in private company, you may not be paid in cash fully on completion. Buyers want to defer payment for a variety of reasons. The payment you receive may be in the form of any or all of these:
- shares in the purchasing company (so it would be a share for share exchange);
- deferred consideration under some form of earn out arrangement; and/or
- payment in the form of loan notes.
The tax treatment for each of these gives rise to different issues.
We will look at each of these in turn. But first we will at look how the capital gain will be calculated and when any Capital Gains Tax (CGT) will be due for payment.
How will the capital gain be calculated in the UK?
An individual selling shares in his or her company will be liable to pay CGT on the gain (or deemed gain) arising on a sale.
Tax is calculated on the value of the consideration received less:
- the acquisition cost (the base cost);
- incidental costs associated with purchase and sale (for example, legal fees); and
- any capital losses in the same year or carried forward from a previous year.
You will only have to pay CGT on the gain above your tax-free allowance (assuming not set off against other capital gains in the year).
The rate of tax payable is usually 20% or 28% for gains on property but can be reduced down to 10% if you qualify for Entrepreneur’s Relief as we discuss.
When is the Capital Gain Tax payable?
For the sale of shares in trading companies the CGT is payable by 31 January in the year following the end of relevant tax year. So for gains in the tax year 2020/21, the CGT would be payable by 31 January 2022. The rules for the timing of payment of tax on property transactions are different.
CGT liability for Consideration Shares
There are a number of issues to think about if the consideration for some or all of the shares being sold is shares in the buyer company (the Buyer).
If there is a CGT liability, then provided that:
- the Buyer will hold more than 25% of the ordinary share capital of Company; or
- as a result of the offer to buy shares the Buyer will control the Company or hold the greater part of the voting rights in the Company,
you have a choice on when you pay the CGT on the gain arising on the exchange of your shares for consideration shares. You can either:
- defer payment of the tax and pay the CGT when your shares in the Buyer are eventually sold; or
- if you qualify for Entrepreneurs’ Relief (ER), you may elect to pay CGT on the gain now and pay tax at the rate of 10% now (rather than 20% if ER did not apply).
Why pay CGT sooner rather than later?
Our client asked the question many ask which is why pay CGT on the total planned consideration for the tax year of disposal knowing that further consideration could be received in the future and payment of CGT could be spread?
The advantage of paying CGT now and claiming ER is that:
- the rules relating to ER may change in future; and
- depending on the circumstances post completion, you may no longer qualify for ER if you can no longer satisfy the relevant tests.
There are anti avoidance rules to prevent abuse which we explained.
We recommended applying to HMRC for clearance. HMRC does not charge for this and a HMRC clearance does provide some certainty. However, this can only be done before completion of the transaction takes place. Our client took our advice.
CGT Liability for Deferred Consideration
The CGT liability for deferred consideration payable under an earn-out or similar arrangement is calculated on the estimated value of the deferred consideration to be received post completion.
The treatment of the deferred consideration for CGT purposes depends of whether the amount of the deferred consideration is regarded as “known or ascertainable” or is “unascertainable” deferred consideration.
Deferred consideration could be paid in the form of cash, shares or loans.
Known or Ascertainable Deferred Consideration
Where the amount is known (eg a number of known annual instalments) that can be included in the calculation of the total consideration paid on completion.
You can claim a refund from HMRC if it turns out later that you have overpaid CGT because you did not actually receive the full amount of the deferred consideration.
The advantage of paying the CGT for the amount of the deferred consideration at the time you pay the CGT for the completion consideration is that you may be able to claim ER on the full amount because you satisfied the ER tests at the time of completion.
If CGT is payable later on the deferred consideration, you might not be able to satisfy the relevant test for ER – for example, you may not still hold 5% of the shares of the Company and/or may no longer be an employee/director.
Unascertainable Deferred Consideration
This is slightly more complicated.
If the amount of the deferred consideration is not ascertainable because it depends on what happens in the future (so, for example, a percentage based on future profits of the company that was sold), then the right to receive that future amount is treated as an asset (which has to be valued).
Then, when that part of the consideration is actually received it is treated as consideration not for the original shares but for the right to receive that deferred consideration. If there are several occasions on which future payment is received – eg because there is a % paid for profits in each several years – there will need to be a calculation of CGT for each payment of deferred consideration that is received.
The other issue is that if the CGT liability arises post completion, you may not be able to satisfy the tests to obtain ER.
CGT liability for Loan Notes
From a CGT perspective, you will be liable for the total amount outstanding on the Loan Notes at completion. However, if they are not redeemed in full, it would be possible to claim a refund of CGT paid to the extent that the consideration was not received.
Interest paid on the loan note falls outside the CGT calculation. Income tax would be payable on loan notes where the income is not compounded with the capital sum.
The Share Purchase Agreement
The share purchase agreement will always need review to make sure you are in the best position. The ability of the buyer to pay is important along with security. Another important area is to make sure if disputes over the deferred consideration arise they can be resolved quickly and outside of court.