Election to carry back earn out loss

If you sell a business which includes an earn-out arrangement, e.g. the sale price is wholly or partly deferred and paid depending on the profits made by the purchaser’s company after the sale, you must estimate the value of the final proceeds in your capital gains tax calculation. If you receive less than the estimated amount, the difference is a capital loss that you can claim for the year in which you sold your business instead of the year you received the payment. 

When can you make a claim?

The legislation allowing you to elect to treat a loss resulting from an earn-out as arising for the year in which you sold your business is contained in s.279A Taxation of Chargeable Gains Act 1992.

• the election applies to the whole amount of the loss, i.e. you cannot elect to carry back just part of it
• if more than one loss arises from the earn-out a separate election is required for each loss
• the time limit for the election is one year from the normal filing date for the return in which the loss arose. For example, an election for a loss arsing in 2022/23 from the sale of a business in 2019/20 must be made by 31 January 2025
• there is no time limit on how far the loss can be carried back
• the sale of the business must have resulted in a capital gains tax (CGT) liability for the year in which you are electing to carry back the loss
• if the loss is not completely used against the gain from the sale of your business, it can be carried forward. The unused loss cannot be used against capital gains from the sale or transfer of other assets. It can only be set against gains arising on the disposal of the sale of the business
• if the gain on the original disposal was deferred under the EIS or VCT reinvestment relief rules, the loss will be used against the deferred gain when it comes back into charge.

Example

In March 2024 Bob accepted an offer for his business of £600,000 on completion of the contract and an amount equal to 30% of the business’s profits for the three years ended 31 March 2025, 2026 and 2027. A payment for each year will be made after each year’s accounts are finalised. The profits are estimated at £200,000 for each. If all goes well Bob will receive another £180,000. Therefore, in 2023/24 Bob owed CGT on £780,000 (£600,000 + £180,000).

When the accounts for 2025 are finalised in July that year they showed a profit of £250,000, i.e. £50,000 more than originally estimated. The buyer pays Bob 30% of this as agreed, i.e. £75,000, whereas the original estimate was £60,000. As long as there’s no reason to think that the original estimate of profits for the next two years is wrong he’ll have to pay CGT on the extra £15,000 for 2025/26.

Proceeds from sale agreed in March 2024  £600,000

Proceeds based on profits for 2025, 2026 and 2027 £180,000 (i.e. £200,000 x 3 x 30%)

Total proceeds     £780,000

Less cost of business to Bob          Nil

Capital gain     £780,000

Revised position after 2025 accounts agreed:

Proceeds based on profits for 2025, 2026 and 2027 £195,000 (i.e. £250,000 + (£200,000 x2))

Less cost of proceeds:

Equal to the amount of gain taxed in March 2024   £180,000

Gain taxable for year in which 2025 accounts approved   £15,000

You must make an election in writing as part of your tax return for the year in which the earn-out loss arose or as a standalone claim. Send it to the tax office which deals with your tax return. The election must include a calculation of the loss.