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Where Taxpayers and Advisers Meet

Valuation of Earnout right on company sale

simplytax
Posts:86
Joined:Wed Aug 06, 2008 3:34 pm
Valuation of Earnout right on company sale

Postby simplytax » Sat Dec 19, 2009 3:53 pm

How does HMRC expect to see a right to a cash earnout on a company sale valued ?

If the estimated amount expected at the time of sale completion was significantly higher than the current expectation when completing the tax return due to economic downturn, what is the valuation of the right to be based on ? the expectation and any forecasts at time of sale completion or the current expectation ? if the former that could result in paying over significant tax now knowing that there will be a significant loss to be claimed when actual earnout received and carried back to tax year of sale completion.

Its too late to go for a CG34 valuation to SAV at this point before submission of tax return by 31 January 2010 so how should valuation be reported in tax return ?

Any suggested format for arriving at valuation ?

Incredulum
Posts:2795
Joined:Thu Dec 03, 2009 5:35 pm

Re: Valuation of Earnout right on company sale

Postby Incredulum » Sun Dec 20, 2009 1:49 pm

Marren v Ingles. Contingent consideration.

I'm afraid that your valuation is based on the valuation at the time of sale. Valuation at time of submission of tax return is not - as I am sure you are well aware - relevant for anything!

You will end up with a capital loss when the earn out is finally paid.

If this is a company the loss cannot be carried back. If an individual you may well be able to carry the loss back.

simplytax
Posts:86
Joined:Wed Aug 06, 2008 3:34 pm

Re: Valuation of Earnout right on company sale

Postby simplytax » Sun Dec 20, 2009 5:55 pm

Thanks Incredulum for your comments. I suspect in the current economic climate this will be more common.

Any experience of how to value a "right" to earnout in cash ? Presumably there will be some forecasts and projections by the company prior to the sale completion date and one would have to factor in the potential risks of not achieving the projected EBIT and arrive at a % chance of achieving the projected EBIT and use that. With interest rates/inflation low at present then presumably little further discount for present value of receipts over next 3 years.

Cannot see any comment in HMRC SAV manual or in valuation reference books on approach to take.

Would be helpful if anyone has actually carried out such valuation or agreed one with HMRC to give heads up on the general approach they used and format.

Incredulum
Posts:2795
Joined:Thu Dec 03, 2009 5:35 pm

Re: Valuation of Earnout right on company sale

Postby Incredulum » Sun Dec 20, 2009 6:12 pm

Certainly is. Last one I dealt with the gain on the earn out was £20m. By the time we submitted 15 months later, the anticipated value was nil. (In fact, the hurdle was missed by about £20m.)

You should take the anticipated value and discount it back. If you are within the loss carry back rules, then I imagine you should be able to agree with the inspector to carry back the losses before they have arisen.

simplytax
Posts:86
Joined:Wed Aug 06, 2008 3:34 pm

Re: Valuation of Earnout right on company sale

Postby simplytax » Sun Dec 20, 2009 7:42 pm

Incredulum

Not sure I follow you.

Assume sale September 2008 and two earnout dates December 2010 and December 2012, but earnout at time of sale anticipated on EBIT figures which have since been revised down substantially in post sale forecasts. Sale and value of right to earnout require to be reported in 2008/09 TR by 31.1.10. The first earnout date is not until December 2010 and will fall into 2010/11 TR. The amendment window for 2008/09 TR is 31.1.11.

Can one avoid paying substantial tax on 31.1.10 on the value of right to earnout based on outlook at time of sale, knowing that expect a loss on the earnout when paid for 31.12.10 and 31.12.12 ? ie presumably the quantum of loss on earnout has to be established first before any claim under s279A TCGA may be made. If the loss for 31.12.10 earnout could be established before 31.1.11 amendment window expires for 2008/09 TR then that part affecting value of right could be amended, but not for the earnout due 31.12.12. ie perhaps could submit 2008/09 on 31.1.10 with assumption that a loss claim would be made for first earnout and finalise that by 31.1.11 but not for earnout due 31.12.12.

In your case are you saying that by the time you had to report the value of the right to earnout based on £20m that you were within time to establish the first earnout loss and make loss claim before tax due ?

mullet
Posts:3242
Joined:Fri Nov 06, 2009 9:26 am

Re: Valuation of Earnout right on company sale

Postby mullet » Sun Dec 20, 2009 9:51 pm

In your case are you saying that by the time you had to report the value of the right to earnout based on £20m that you were within time to establish the first earnout loss and make loss claim before tax due ?
Everything that can be claimed within a return should be claimed within a return if possible. So if the (full) gain and the loss on the Marren v Ingles right can be within the same return, then that is fine. It's all down to timing (not manipulation of timing, just working out what has to be reported or claimed in which return).

Incredulum
Posts:2795
Joined:Thu Dec 03, 2009 5:35 pm

Re: Valuation of Earnout right on company sale

Postby Incredulum » Mon Dec 21, 2009 10:24 am

It's very methodical.

You sell Sept '08. You calculate the earn out based on the value at that date - 30 September (don't forget to discount it). And submit your tax return and pay your tax. The earn out right is a "chose in action" (loosely translated as "thing"); it is a separate new asset that has been created - read Marren v Ingles if you wish.

Dec '10 you have your first earnout date. You calculate the loss based on proceeds minus base cost (calculated Sept '08), and submit your tax return. And if you are in the loss carryback regime, you carry back the loss.

You are not recalculating the Sept '08 gain by resubmitting the return, which, even if out of time, would allow HMRC to make a discovery assessment. You are instead calculating the gain/loss on the disposal of your chose in action ("thing") which happens in 10/11.



In my experience, HMRC will sometimes accept a preliminary claim to carry back a provisional amount of a loss, so as not to suffer the cashflow consequence of your taxable profit. You should talk to the inspector and see if he is happy to allow you to do this.


(My 20m gain was in a company, so outside the carry back regime; fortunately we had other losses.)


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