A fairly common feature on a sale of shares in a private company is an element of consideration which is delayed, either for a set period of time or based on certain conditions being met.
The tax impact of these innocuous looking payments can often be surprising and can lead to unwanted tax liabilities arising before any funds have been received. In most cases, the tax will be payable in the year following disposal, regardless of when the deferred proceeds are received.
In a recent case which Eaves and Co have been involved with following an HMRC enquiry, a sale was agreed with an element of the sale price becoming payable only when dividends were paid by the company in the future. No tax advice was sought at the time the sale was agreed.
HMRC had stated that the contract was unconditional and that the proceeds were simply deferred.
Our analysis was that the payments are contingent, as something has to happen (the payment of dividends) before the amounts are due. However, having established that the payments are contingent, we then have to determine whether the proceeds are ascertainable or not.
If the proceeds are ascertainable, they will be taxed in full as part of the proceeds of the disposal, despite the fact that they may not become payable until some time into the future. The position is more complex if the proceeds are unascertainable, as the value of the right to receive the funds in the future is taxed on the original disposal.
In this case, the chances of dividends being declared are thought to be low, and as such the right could potentially be valued at a substantial discount and therefore bring down the initial tax cost.
The distinction between ascertainable and unascertainable can be quite subtle, but the key is whether or not all the events that can affect the amount occur before the disposal. For example, where the proceeds are based on a percentage of future profits, this would be unascertainable as the future profits are not known at the date of the sale.
We successfully argued that the payments in this case are unascertainable, because whilst there is a limit on the maximum that can be received, there is no way to determine what dividends will be declared in the future.
HMRC confirmed that they accept our position, despite having previously argued that the payments were not even contingent. We have begun negotiations with HMRC as to the value of the potential right to future consideration and have begun with a low valuation due to the facts of the case and the likelihood that any funds will be received in the future. The downside to this is that any further receipts would be taxable without Entrepreneurs’ relief being available, however the cashflow benefits are thought to outweigh this drawback.
The key point is that taking tax advice at the time of the disposal would have prevented this unexpected tax treatment, and the contract could have been worded in order to provide a more clear outcome without the expense of negotiating with HMRC.