Taxation of Earnouts

From our November 2010 issue

Treasury is currently undertaking consultation in relation to new legislation to overhaul the taxation of earn-out arrangements.

An earn-out is broadly a right to ongoing payments from the purchaser after the sale of a business or asset. Such payments are generally based on the earnings or revenues of the business or asset after sale, and typically represent a form of deferred consideration on disposal of the business/asset i.e. as the ongoing payments are contingent on performance, the total consideration paid to the vendor is generally intended to be based on the profitability of the business.

This consultation was initiated as a result of the Commissioner’s draft ruling on earnouts, which sets out the Commissioner’s draft view that where a disposal is subject to an earn-out right, the consideration on disposal constitutes the cash amount as well as the “market value” of the earn-out right, and the excess of this consideration over cost base is taxed as a gain to the vendor at the time of the disposal.

The treatment set out in the ATO’s draft ruling requires vendors to pay tax on an amount that they have not yet received (or may never receive) and potentially miss out on the CGT discount in relation to earn-out payments.

The new legislation is intended to prevent this outcome, and will apply from the date of Royal Assent. Taxpayers intending to dispose of or acquire an asset or business that is subject to an earn-out arrangement should consult their tax advisor in order to identify challenges and opportunities posed by the planned reform of these rules.

NOTE
Taxpayers intended to acquire or dispose of a business or asset subject to an earn out payment should seek advice from their tax advisor as to the tax consequences of such an earn-out.

 

 

 

 

 

This information is for guidance only and is not intended as specific advice to any reader. Professional advice should be obtained before acting on any information contained herein. The publisher accepts no responsibility for loss occasioned to any person or organisation as a result of action or the refrain of action as a consequence of the contents of this publication.