CGT Earn-outs Omission

There exists a glaring omission in the new Capital Gains Tax rules - they did not address earn-outs. Thousands of entrepreneurs who sold their businesses in 2005/06 have until 31st January to sort out a CGT tax nightmare for which HMRC issued no guidelines whatsoever.

This affected those people who are receiving part of their payment for their business in shares or loan notes as an earn-out (deferred payment). They had to tell HMRC before the end of January whether they were paying the CGT immediately or deferring it until they are able to cash the shares/loan notes in. The consequences of making a wrong decision can be enormous.

Thanks to PKF (UK), who provided the following illustration of this problem:

• A qualifying business was sold in 2005/06, half for cash and half for an earn-out right in the form of loan notes redeemable in 2009.


• The owner had to pay 10% CGT on the cash part by 31 January 2007 but 18% on the other half of the proceeds received when a loan note matures after 5 April 2008.


• The owner can elect, by 31 January 2008, to treat the loan note proceeds as received in 2005/06 to get the 10% tax rate but will have to pay the tax now, long before he gets the final cash (and pay interest because the tax should have already been paid!).
• If the owner does make the election it cannot (currently) be revoked at a later date - for example, when the position on the new Entrepreneurs' relief is known.

In a further twist, the Institute of Chartered Accountants of Scotland have claimed that the government's latest CGT changes could have broken European law.

The EU law states that changes to tax legislation must provide a reasonable time period to claim the money. From the date of Alistair Darling's announcement, business owners had less than ten weeks to arrange their assets or even sell their businesses to protect some of the indexation relief accruing because of inflation.

Previous tax decisions made under European law have indicated that even by having a transitional period of three months would be insufficient. Icas called for the chancellor to defer implementation of the legislation for two years to give businesses enough time to rearrange their affairs.

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