Earn-out rights- employment income risk

Guidance issued by HMRC in 2003 following the introduction of FA 2003 and the new securities legislation in ITEPA 2003 clarified the position on whether an earn-out right could be taxed as employment income2. It states that the following are considered to be the key indicators in determining whether an earn-out is further sale consideration rather than remuneration—

•   (i)     the sale agreement demonstrates that the earn-out is part of the valuable consideration given for the securities in the old company.

•   (ii)     the value received from the earn-out reflects the value of the securities given up.

•   (iii)     where the vendor continues to be employed in the business, the earn-out is not compensation for the vendor not being fully remunerated for continuing employment with the company.

•   (iv)     where the vendor continues to be employed, the earn-out is not conditional on future employment, beyond a reasonable requirement to stay to protect the value of the business being sold.

•   (v)     where the vendor continues to be employed, there is no personal performance targets incorporated in the earn-out.

The following factors may also be relevant—

•   (i)     negotiations between the seller and buyer as to the level of the earn-out in relation to the value of the consideration given for securities in the old company.

•   (ii)     any clearance that might have been obtained under TCGA 1992 s 138 and TCGA 1992 s 707 demonstrating the bona fide nature of the transactions, and the level of the earn-out linked to profitability or other key performance indicators of the business.

•   (iii)     evidence that future bonuses were commuted into purchase consideration would indicate that the earn-out was, at least partly, remuneration rather than consideration for the disposal of securities.