Playing a Longer Game: How Deferred Consideration and Earn-outs Shape Deal Pricing

Playing a Longer Game: How Deferred Consideration and Earn-outs Shape Deal Pricing

Tax in the Deal 2026

Overview

In any M&A transaction, the headline purchase price is rarely the whole story.

Buyers facing volatile markets, stretched valuations, and political and technological uncertainty are increasingly reaching for deferred consideration mechanisms (such as earn-outs, retentions, and contingent payments) to avoid overpaying. For sellers, these structures can bridge valuation gaps and unlock deals that might otherwise collapse.

However, deferred consideration structures are often subject to rules that recognise value not yet received, and the structure of consideration, while primarily a commercial choice, carries real tax consequences.

In this article, we discuss the tax treatment of deferred consideration on a share sale, comparing capital gains tax (CGT), employment taxes, and stamp duty. We focus on the UK rules, but the issues raised are generally applicable across other jurisdictions. In particular, the characterisation of deferred consideration as capital or income and the timing of tax liabilities should be carefully considered in all cases, as outcomes may vary between jurisdictions and requirements for valuation advice may differ.

The article does not cover reinvestment and rollover structures common in private equity transactions, where outgoing shareholders retain a stake in the business. These have their own tax implications and will require specialist advice.

Known or Unknown: Ascertainable and Unascertainable Consideration

One key element of the UK tax rules is the distinction between two concepts: 'ascertainable' and 'unascertainable' consideration.

  • Ascertainable consideration: is consideration the amount of which is known at completion of the sale (Completion). Deferred consideration can be ascertainable, but not yet ascertained, if it is capable of being calculated as at the date of Completion, even if the calculation has not yet occurred. Where deferred consideration is ascertainable, its full amount is included in the disposal proceeds at Completion.

  • Unascertainable consideration: is consideration the amount of which cannot be determined at the date of Completion. This is typically because the amount of the consideration is determined by future events (such as the financial performance of a company).

A Case Study

To illustrate these rules in practice, consider the following case study. Two founder-shareholders, Abigail and Bea, sell their trading company, AbBea Limited, to a private equity buyer looking to scale the business.

Abigail and Bea are both directors of, and both hold 50 ordinary shares each in, AbBea Limited. However, they hold their shares in different ways:

  • Abigail holds her shares through her personal holding company (Abi HoldCo), whilst
  • Bea holds her shares directly.

The buyer wants Abigail and Bea to continue working in the business and to retain shares in the acquisition structure. Although those shares would likely be 'employment-related securities', we assume they were acquired for 'unrestricted market value' and that both founders have entered 'section 431 elections', ensuring no UK employment tax is payable on the growth in value of the shares.

The consideration package agreed is:

  • Each founder is entitled to consideration of £5 million each (the Initial Purchase Amount) payable at Completion (as defined in the share purchase agreement (SPA)).

  • The deal is to be priced according to the net asset value of AbBea Limited, determined by a set of accounts prepared as at the date of Completion (the Completion Accounts). The SPA provides for a post-Completion 'true-up' of the consideration (the Adjustment Amount) calculated in accordance with the Completion Accounts. The Adjustment Amount is to be paid shortly after Completion.

  • £1 million of the total consideration is to be retained by the buyer (the Retention Amount) in respect of a risk that HM Revenue and Customs (HMRC) challenges an historic claim for Research & Development (R&D) tax relief by AbBea Limited. The Retention Amount will be payable 24 months after Completion, provided the R&D claim is not successfully challenged by HMRC.

  • An 'earn-out' is to be payable to Abigail (via Abi HoldCo) and Bea provided they remain employed by the business (the Earn-out Amount) post-Completion. The earn-out entitles Abigail and Bea to be paid an additional £5 for every £1 of Earnings Before Interest, Taxes, Depreciation, and Amortisation (EBITDA) above a threshold of £10 million in financial year 2027 (FY2027), and £15 million in financial year 2028 (FY2028).

"Deferred ascertainable consideration … can create real cash flow issues for sellers, resulting in tax falling due before the consideration is actually received."

Hannah Manning, Head of Tax

Chargeable Gains: Payable Now, Payable Later

The tax treatment of each of the four component parts of the total consideration package differs for Abigail and Bea.

  • The Initial Purchase Amount will be taxed differently for each shareholder.

    • For Abigail and Abi HoldCo, the Substantial Shareholding Exemption (SSE) should be available to Abi HoldCo, exempting the entire gain arising on the disposal of the AbBea Limited shares, provided the conditions are met. Abigail (holding via Abi HoldCo), therefore, does not pay any CGT on the Initial Purchase Amount. She will instead be taxed when the value is extracted from Abi HoldCo in the future, whether by dividend or liquidation.

    • For Bea, her portion of the upfront consideration will be subject to CGT at 24% (for higher and additional rate taxpayers for 2026/27). Reliefs might be available for Bea which could mean that the applicable CGT rate is lower, including where the conditions for Business Asset Disposal Relief (BADR) are met. 

  • Where the Completion Accounts show that an Adjustment Amount is payable by the buyer, it will be treated as additional consideration on top of the Initial Purchase Amount.

    The Adjustment Amount is 'ascertainable' consideration (that is, capable of being calculated at Completion) and is therefore brought into account for tax at the same time, and in the same way, as the Initial Purchase Amount.

    • For Abigail and Abi HoldCo, this is great news because the additional Adjustment Amount consideration (paid to Abi HoldCo) will also benefit from the SSE.

    • For Bea, the Adjustment Amount is also brought into account for CGT at her applicable rate (and subject to available reliefs, including BADR) in the same way as the Initial Purchase Amount.


    This should not cause difficulties for Bea, provided the Completion Accounts are finalised before her tax payment date. Tax is generally due when she submits her self-assessment return: if Completion occurs in September 2026, an online return (and any tax owed) would be due by 31 January 2028.

    Conversely, if the Completion Accounts show an Adjustment Amount is payable by the sellers to the buyer, it reduces the Initial Purchase Amount and, therefore, the gain on disposal.

    • For Abigail and Abi HoldCo, this has no practical impact because the availability of the SSE is unaffected and the gain, albeit smaller, remains exempt from tax.

    • For Bea, the Initial Purchase Amount will need to be adjusted to take account of her payment of the Adjustment Amount to the buyer. However, again assuming that the Adjustment Amount is known before she needs to submit her self-assessment tax return, this should be relatively straightforward.


    In short, the Adjustment Amount is ascertainable deferred consideration, will be taxed in the same way, and at the same time, as the Initial Purchase Amount, and is unlikely to produce difficulties for Abigail, Abi HoldCo or Bea.

  • Like the Adjustment Amount, the Retention Amount is also 'ascertainable' consideration.

    The retention provisions mean Abigail and Bea are denied part of their consideration until the Retention Amount is released (if it is released at all). It is ascertainable not because it can be calculated at Completion, but because the amount (£1 million) is known; what is unknown is whether it will ever be paid, since payment depends on HMRC failing to successfully challenge the R&D claim within two years.

    Unfortunately for the sellers, even though it has not yet been received, the full Retention Amount must be brought into account for tax on the assumption that the contingency will be met.

    • For Abigail and Abi HoldCo, the total consideration brought into charge to tax is extended to include the Retention Amount. The effect is that the tax point precedes the receipt of the consideration it relates to. Practically, for Abi HoldCo, this is not an issue because, assuming the SSE applies, the whole gain, even inflated by the Retention Amount, is exempt from corporation tax on chargeable gains.

    • For Bea, the same acceleration of tax charge applies but this has real consequences. The deemed receipt of the Retention Amount before it is actually received (at the earliest in September 2028) creates a 'dry' tax charge. Bea must file her 2026/27 self-assessment return, with CGT owed, by 31 January 2028.


    The key point is that deferred ascertainable consideration of this sort can create real cash flow issues for sellers, resulting in tax falling due before the consideration is actually received.

    From Bea's perspective, a preferable alternative would be for the full amount of the Retention Amount to be paid at Completion, with the sellers indemnifying the buyer for any tax, interest, and penalties arising from a successful HMRC challenge to the R&D claim. This would ensure Bea receives all taxable consideration at Completion and can pay the resulting tax when it becomes due. The effect on Abi HoldCo would be neutral (the SSE would still apply) but whether the buyer would also agree to forgo the retention would be a matter for commercial negotiation.

    Under this alternative, any indemnity claim following a successful HMRC challenge would be treated as an adjustment to the total consideration, and Bea would be able to claim a tax repayment reflecting the reduced consideration proceeds (provided she makes the claim within the applicable time limit).

  • The 'earn-out' is 'unascertainable' consideration because the amount payable can only be determined by reference to future EBITDA performance of AbBea Limited in FY2027 and FY2028.

    The CGT treatment of unascertainable consideration creates two separate tax charges. The principle here is that the 'right' to receive the Earn-out Amount is a valuable asset received at Completion, which is then disposed of when payment is actually made.

    • First Tax Charge – The right: At Completion, Abi HoldCo and Bea pay tax on the market value of the right to receive future consideration; the 'right' forms part of the consideration received.

      The tax depends on the value of the right. This is a valuation question, based on the probability that AbBea Limited meets the EBITDA targets and the likely quantum of the Earn-out Amount. The sellers would be prudent to seek professional valuation advice when filing their returns, though there is no obligation to do so.

      Let's assume the right is valued at £1 million at Completion. Each of Abi HoldCo and Bea is taxable on their share (£500,000) as additional disposal consideration, inflating their chargeable gains in the year of Completion.

      • For Abigail and Abi HoldCo, there should again be no practical impact because the SSE will exempt this additional amount from tax in the same way as the other three elements of consideration.

        For Bea, just as with the Retention Amount, the CGT charge on the additional consideration deemed to have been received (the market value of the right to a future payment) has been accelerated to the year of Completion. Depending on the precise timing of earn-out calculations, payments, and tax return filing dates, Bea may have to pay CGT on this amount before she actually receives payment of the Earn-out Amount – this will be the case in respect of any Earn-out Amount payable in respect of FY2028.

    • Second Tax Charge – The Earn-out Amount: The second tax point for CGT arises when the Earn-out Amount is actually paid. At this point, the 'right' to receive it is 'disposed of', and a second chargeable gains event occurs.

      Assume the earn-out is triggered: £2 million is earned in respect of FY2027 and a further £2 million in respect of FY2028, giving each shareholder a total Earn-out Amount of £2 million paid shortly after the end of FY2028. Each realises a gain of £1.5 million on disposal of the earn-out right (£2 million received less the £500,000 value of the right at Completion).

      • For Abigail and Abi HoldCo, the £1.5 million gain will not qualify for SSE. This is because the SSE applies to the disposal of shares, but not a contractual right to receive earn-out proceeds. Abi HoldCo will need to bring the gain into account for the purposes of corporation tax on chargeable gains.

      • For Bea, the £1.5 million gain will become subject to CGT, and payable by 31 January in the year after the end of the tax year in which the Earn-out Amount is paid.

      What if the earn-out is not triggered? In this case, the right will have proved to be worthless, and the total consideration received at Completion will have been overstated.

      • For Abigail and Abi HoldCo, there is no practical consequence because the SSE exempted the value of the right at Completion. Although tax returns will need amending, no entitlement to a tax repayment arises.

      • For Bea, it will be necessary to amend her Completion-year tax return to reduce her disposal proceeds and reclaim the CGT paid on the £500,000 of value given to the earn-out right.

    These differences raise two interesting points.

    First, shareholders may have divergent views on how to value the earn-out right. A shareholder entitled to SSE (like Abi HoldCo) may prefer a higher valuation to maximise the exempt amount, with little downside if the earn-out is not triggered. An individual shareholder (like Bea) may prefer a lower valuation to minimise the 'dry' tax charge on deemed consideration.

    Second, an individual shareholder may wish to defer the 'dry' CGT liability until the earn-out is paid. A mechanism exists for this (effectively 'holding over' the tax charge until a future disposal) where the earn-out is structured as a right to receive loan notes rather than cash. This can further complicate commercial negotiations between parties. In addition, the conditions to be met are strict, with targeted anti-avoidance rules in play, making professional advice essential.

A Word on Options

Our example does not address option holders, but deferred consideration paid to individuals who are subject to employment taxes (for example on the exercise of non-tax-advantaged options) can produce harsh results. The market value of earn-out and deferred consideration rights must be taken into account when calculating the gain arising when the options are exercised, but there is no mechanism to claim a tax refund if the consideration is not (for whatever reason) subsequently paid.

It is possible that a CGT loss may be created in these circumstances, but this will be of limited use unless an individual has other capital gains in the current or future tax years against which to set it off. Care is needed when options are involved.

Employment Tax: Capital Earn-out or Income Bonus?

Beyond CGT, there is the risk that an earn-out is characterised not as consideration for shares, but as a reward for ongoing employment. This is ultimately a question of fact and circumstance, but earn-outs frequently display characteristics that place them in an employment tax grey area.

HMRC guidance identifies key indicators to help distinguish between consideration (capital) and reward (income), including:

  • Whether the value received from the earn-out reflects the value of the shares sold;

  • Where a seller continues to be employed in the business, whether the earn-out is compensation for the seller not being fully remunerated for their employment with the company;

  • Whether the earn-out is conditional on future employment beyond a reasonable requirement to simply stay on to protect the value of the business; and

  • Whether non-employee sellers receive the earn-out on the same terms as continuing employee sellers.

In our case study, participation in the earn-out is conditional on Abigail and Bea remaining employed through to the end of FY2028. Provided the earn-out is properly documented in the SPA as consideration for the shares, payable proportionately to their shareholdings, and not a substitute for market-rate salary, it should be treated accordingly.

The link to continued employment does, however, risk the capital treatment being challenged. Removing that link entirely is preferable, though not always commercially possible. In our case study, the earn-out's relatively short duration and other factors pointing towards share consideration provide a reasonable argument against employment income treatment even if the link is retained. The position can be further complicated if a buyer asks sellers to indemnify it for any employment taxes arising.

Given that leaver provisions and the earn-out itself were buyer requirements, Abigail and Bea would need to consider carefully any indemnity request in our case-study.

Employment tax liabilities can also arise under other anti-avoidance provisions (for example, where only some shareholders (particularly employees or directors) are entitled to an earn-out). In such cases, there is an argument that those recipients are receiving above market value for their shares, with the excess treated as employment income.

Stamp Duty

Deferred consideration is also treated differently for stamp duty purposes, and to complicate matters, the stamp duty rules differ from the CGT rules.

Stamp duty is a UK transfer tax which, very broadly, applies to instruments which effect the transfer of shares. In UK company law, a transfer of the legal title to shares in a UK company takes effect when the transferee is registered in the company’s register of members as the holder of the shares, but this can only happen once the instrument of transfer has been 'stamped'. In relation to the transfer of shares, a stock transfer form (STF) is the stampable instrument of transfer. Stamp duty is chargeable at 0.5% of the value of the 'chargeable consideration' for a transfer, rounded to the nearest £5.

Stamp duty is assessed by reference to the facts and circumstances known at the date the instrument of transfer is executed. 

  • A 'contingency principle' determines how different types of unascertainable future consideration is assessed. Consideration payments:

    • subject to a stated maximum are charged on that maximum;

    • subject to a stated minimum are charged on that minimum;

    • falling between a stated minimum and maximum are charged on the maximum;

    • which are a stated figure subject to variation (up or down) are

    • which are wholly unquantifiable attract no stamp duty at all.

  • For consideration that is 'ascertainable but not yet ascertained', HMRC operates a 'wait and see' procedure. Under 'wait and see', a buyer submits the STF with an estimated stamp duty payment and commits to settle any additional duty once the actual consideration (and stamp duty liability) figure is determined.

    In our case study, there will be two STFs, one for each seller, and so stamp duty will apply to each of those as follows:

    • The Initial Purchase Amount: The 'upfront' consideration of £5 million payable to each shareholder (total £10 million) is a fixed and unconditional amount.

      Stamp duty, at 0.5%, is due on the total consideration paid in respect of each transfer. £25,000 will be payable in respect of each transfer (total £50,000) by the buyer.

    • The Adjustment Amount: The Adjustment Amount is capable of calculation at Completion in principle, but the precise figure will not be known until the Completion Accounts are agreed. 

      Wait and see applies. The buyer submits the STFs with an estimated duty payment and undertakes to return them once the Completion Accounts are agreed, paying any further duty at that point. Interest runs on unpaid duty from 30 days after execution of the STF, so a reasonable upfront estimate is always prudent.

    • The Retention Amount: The amount of this deferred consideration is fixed and known (£1 million) but whether it is paid at all depends on a future contingency. 

      The contingency principle applies: a maximum of £1 million is stated, so duty is charged on that maximum. Additional stamp duty of £5,000 (£2,500 per STF) is payable. If the contingency is not met, and the Retention Amount is not paid, no refund of stamp duty is available.

    • The Earn-out Amount: The earn-out operates by reference to the future performance of AbBea Limited, measured by reference to EBITDA. The Earn-out Amount is entirely variable. There is no stated maximum, no guaranteed minimum, and no baseline target figure.

      The contingency principle applies: the Earn-out Amount is wholly unquantifiable, so no stamp duty is chargeable, irrespective of whether it is ultimately paid. There is no stamp duty equivalent to the CGT rule treating the earn-out right as additional consideration at Completion.

  • Stamp duty for share transfers is set to change materially in 2027. Draft legislation introducing a new Securities Transfer Tax (STT) has been published for inclusion in Finance Bill 2027. STT will replace stamp duty and Stamp Duty Reserve Tax entirely.

    The contingency principle does not survive in STT. Instead, STT replaces both the contingency principle and 'wait and see' with a single mechanism (that looks a lot like 'wait and see'). Where consideration cannot be determined at the 'charging time', STT is initially charged on a reasonable estimate and redetermined when the exact amount becomes known.

    This may produce a fairer outcome because tax will neither be overpaid (as with the Retention Amount if the contingency fails) nor avoided altogether (as with a wholly unquantifiable earn-out). However, it does create an ongoing obligation to track earn-outs and other deferred consideration amounts, and to account for updated STT liabilities as such amounts are finally determined and paid.

As our case study illustrates, the structure, drafting, and timing of deferred consideration provisions can produce very different tax outcomes, and selling shareholders may have divergent views on what constitutes an optimal structure.

The tax consequences cut both ways: sellers can face accelerated charges, cash flow mismatches, and recharacterisation risk; buyers can face unexpected payroll obligations and irrecoverable stamp taxes.

None of this is to say that the tax tail should wag the transaction dog; it never should. But in a market where deferred consideration is increasingly common, it pays to assess the tax treatment of all the parties involved at an early stage, preferably before the structure and terms of the deal are signed-off. 

Authors

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Claudia French
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Hannah Manning

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