How is an earn-out taxed on a business sale?
Answered 17 March 2026
Taxation of Earn-Outs on a Business Sale
Earn-outs can give rise to tax under two distinct regimes — Capital Gains Tax (CGT) and, where the vendor is also an employee, potentially Income Tax/NIC under the employment-related securities rules. The two analyses are entirely separate.
What the Law Says
1. Definition of an Earn-Out Right (CGT)
TCGA 1992 s.138A defines an "earn-out right" as so much of any right conferred on a seller as:
- constitutes the whole or part of the consideration for the transfer of shares or debentures ("old securities");
- consists of a right to be issued with shares or debentures of another company ("new company");
- is such that the value or quantity of those shares/debentures is unascertainable at the time the right is conferred; and
- is not capable of being discharged otherwise than by the issue of those shares/debentures.
The value/quantity is "unascertainable" only if it is referable to matters relating to the business or assets of a relevant company, and those matters are uncertain because they concern future business or assets.
2. Ascertainable vs. Unascertainable Deferred Consideration
Where consideration is ascertainable (even if contingent or payable by instalments), TCGA 1992 s.48 applies: the full amount is brought into account as consideration for the disposal at the outset, without discount for postponement or risk of irrecoverability. If any part subsequently proves irrecoverable, an adjustment is made on a claim.
Where consideration is unascertainable, s.48 does not apply (Marson v Marriage 54TC59). Instead, following Marren v Ingles 54TC76:
- The right to receive future unascertainable payments is a "chose in action" — an incorporeal asset chargeable to CGT;
- At the time of the original disposal, the consideration includes the market value of that right;
- When the future amounts are later received, they are capital sums derived from an asset within TCGA 1992 s.22, triggering a second CGT event on the chose in action.
3. The s.138A "Notional Security" Treatment (Earn-Out Satisfied in Shares)
Where the earn-out right meets the s.138A definition (i.e. can only be satisfied by an issue of shares/debentures), it is automatically treated as a security of the new company (a "notional security"), unless the seller elects otherwise. The effect is that the share exchange rules of TCGA 1992 s.135 apply — no immediate CGT charge arises on the earn-out right itself; instead, the gain is deferred until the notional security is ultimately converted into actual shares.
Critically, if the deferred consideration could be paid in cash or shares at the purchaser's option, the right does not qualify as an earn-out right under s.138A(1)(d) and the notional security treatment is unavailable.
4. Losses on Earn-Out Rights
If earn-out performance targets are not met, the vendor may receive less than the value attributed to the right at the time of the original disposal, resulting in an allowable CGT loss on the disposal of the chose in action/notional security.
TCGA 1992 ss.279A–279D allow individuals (not companies) to elect to carry back such losses to the year of the original disposal, provided a chargeable gain arose in that year on the original asset. However, this election is not available for earn-out rights treated as securities under s.138A.
HMRC Guidance / Practice
5. What Constitutes an Earn-Out
HMRC describes a typical earn-out as arising where there is difficulty agreeing a fair value, so part of the consideration is left unascertained — usually a right to deferred cash, loan notes, or shares dependent on the future performance of the acquired business.
6. The Critical CGT/Income Tax Distinction: Capital vs. Remuneration
Where the vendor is also an employee who continues working post-sale, HMRC will scrutinise whether the earn-out is genuine sale consideration (CGT) or disguised remuneration (Income Tax/NIC). The two regimes are entirely separate and the employment income analysis under Part 7 ITEPA 2003 has no bearing on the CGT rules.
HMRC's key indicators that an earn-out is sale consideration rather than remuneration include:
- The sale agreement demonstrates the earn-out is part of the consideration for the old securities;
- The value reflects the value of the securities given up;
- It is not conditional on future employment (beyond a reasonable requirement to protect business value);
- There are no personal performance targets;
- Non-employees receive the earn-out on the same terms as continuing employees;
- No evidence that future bonuses were reclassified as purchase consideration.
Where the earn-out is partly deferred consideration and partly remuneration, an apportionment on a just and reasonable basis is required.
7. Employment-Related Securities Charges
Where the vendor is an employee and the earn-out involves securities, various ITEPA 2003 Part 7 charges may potentially arise:
-
Put/call option structures (Chapter 3D / s.446Y): A charge could arise where shares are disposed of for more than market value at exercise. However, if the earn-out is shown to be consideration for the disposal of securities rather than employment value, the market value of the securities is treated as equal to the consideration received, eliminating the income tax charge.
-
Securities options (Chapter 5 / s.471): Where the earn-out is a right to acquire securities subject to conditions, it may be a securities option. Employees continuing in the business are deemed to have acquired it "by reason of employment" (s.471(3)); former employees may also be caught (s.471(4)). Again, if the earn-out is shown to be sale consideration, no income tax charge arises.
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Restricted/forfeitable securities (Chapter 2): Where earn-out securities are forfeitable and vest on performance conditions, they may be employment-related securities under s.421D(2) ITEPA, potentially triggering a charge under s.426. If shown to be sale consideration, the value of the old securities is treated as equal to the unrestricted market value of the new securities, eliminating the charge.
Summary Table
| Earn-Out Type | CGT Treatment | Income Tax Risk |
|---|---|---|
| Cash only (unascertainable) | Chose in action valued at disposal; second CGT event on receipt | None (unless recharacterised as remuneration) |
| Shares only (s.138A qualifies) | Notional security — gain deferred via s.135 share exchange | Potential ITEPA Part 7 charge if vendor is employee |
| Cash or shares (s.138A does not apply) | Chose in action — market value at disposal; s.22 on receipt | As above |
| Earn-out = disguised remuneration | CGT on genuine capital element only | Income Tax + NIC on remuneration element |
Citation sources
Part II General Provisions relating to computation of gains and acquisitions and disposals of assets Chapter III Computation of gains: General provisions Miscellaneous provisions Consideration due after time of disposal. 48 1 In the computation of the gain consideration for the disposal shall be brought into account without any discount for postponement of the right to receive any part of it and, in the first instance, without regard to a risk of any part of the consideration being irrecoverable
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