Elephant traps on a company sale – Income Tax

Elephant traps on a company sale – Income Tax

Article 1 covered events that can lead to a loss of BADR.  This article looks at three common risk areas that could give an unexpected income tax charge on a company share sale.


If the selling shareholders remain employed post-sale, there is a risk that HMRC will tax an earn-out as employment income under PAYE with NIC, rather under CGT if it appears to them that the earn-out is really employment income for ongoing services.

Red-flags in earn-out clauses include:

  • earn-outs only being paid to the employed shareholders;
  • below-market rate salaries;
  • targets based on personal performance targets; and
  • the earn-out being dependant on continued employment, “beyond a reasonable requirement to stay to protect the value of the business being sold“.

Preferential share pricing

If employed shareholders receive a higher price per share on a disposal than the other shareholders, which is not justified by different share class rights, HMRC can assess the excess payment as employment income with tax under PAYE with NIC.  The employing company is obliged to operate PAYE and should collect the tax and NIC from the selling shareholder, there are significant further costs if this is not dealt with on time.

Sweet Equity

If an employee/director receives new shares and pays less than market value, the under value is subject to income tax and possibly NIC.  Sweet equity deals or ratchets in favour of management need careful review.

Transactions in Securities rules

These anti-avoidance rules often present a problem on Newco acquisition structures where there is a partial exit of the major shareholders for cash or loan notes, and they are retaining a material shareholding percentage in Newco going forward.

HMRC can use these rules to tax cash proceeds as a dividend, subject to income tax, rather than CGT. This could mean significantly higher tax rates, particularly if the client expected to pay 10% under BADR.

There is a safe harbour from these rules where the selling shareholder group retains less than 25% going forward.  Also advance HMRC clearance can be sought for deals falling outside of the safe harbour to give certainty to the shareholders.

This can be a deal-breaker and it is crucial that vendor’s expectations are managed and that advance HMRC clearance is considered early in the sale process.

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