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  • Earnout arrangements and CGT

    Earnout arrangements are a way of structuring the sale of a business to deal with uncertainty about its value. The contract for the sale of the business (or assets of the business) provides for an initial lump sum payment by the buyer and a right to subsequent financial benefits that are contingent on the performance of the business for a specified period after the sale.

    • In a standard earnout arrangement, the buyer agrees to pay the seller additional amounts if certain performance thresholds are met within a particular time. The seller holds the earnout right.
    • In a reverse earnout arrangement, the seller agrees to repay amounts to the buyer if certain performance thresholds are not met within a particular time. The buyer holds the earnout right.
    • Some earnout arrangements combine the features of both a standard earnout arrangement and a reverse earnout arrangement as both the buyer and seller may be obligated to provide financial benefits depending on performance.

    Legislation that became law on 25 February 2016 provides for look-through CGT treatment of certain earnout arrangements entered into on or after 24 April 2015.

    Generally, if you enter an earnout arrangement:

    • before 24 April 2015:
      • the earnout right or rights created under the arrangement are considered separate CGT assets and are dealt with accordingly for CGT purposes – this treatment is described in Draft Taxation Ruling TR 2007/D10
       
    • on or after 24 April 2015:
      • capital gains or losses associated with 'look-through earnout rights' are disregarded, and the financial benefits of the arrangement are instead applied to the capital proceeds or cost base of the underlying asset – this treatment is provided for in the 2016 legislation
      • if the earnout rights don't meet the conditions for 'look-through earnout rights' specified in the 2016 legislation, the law as described in TR 2007/D10 continues to apply until its withdrawal on 7 December 2016.
       

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      Last modified: 24 Jul 2017QC 52706