Buyers and sellers must be aware of Irish ‘earn-out’ tax implications

Irish tax rules around earn-outs can give rise to some unexpected and sometimes harsh results, according to legal experts Robert Dever and Gerry Beausang of Pinsent Masons, writing in the Irish Tax Review.

An earn-out is a contractual mechanism used in M&A deals where part of the purchase price is contingent upon the future performance of the business being sold. Essentially, it allows sellers to “earn” additional payments based on the business achieving specific financial or operational milestones post-transaction. This mechanism can be particularly useful when there is a disagreement on the valuation of the business, as it aligns the interest of both buyers and sellers by tying part of the payment to the business’s future success. Earn-outs typically involve setting performance targets, such as revenue, profit, or other key performance indicators (KPIs), that the business must achieve within a specified period after the sale. If these targets are met, the seller receives additional payments. This structure can benefit both buyers, by mitigating the risk of overpaying, and sellers, providing an opportunity to benefit from future growth of the business.

However, sellers should approach earn-outs with a degree of caution. They will typically seek certain protections regarding the running of the business during the earn-out period, to ensure that revenue is not diverted from the target company in a manner that could compromise a seller’s ability to achieve the relevant performance target.

Earn-outs can also give rise to significant tax issues for both buyers and sellers.

For sellers, the Irish Capital Gains Tax (CGT) rules on earn-out arrangements can lead to unexpected consequences. One of the most notable issues arises where the earn-out is subject to a maximum cap. In those circumstances, CGT must be paid by the sellers on the full amount of the earn-out at the time of the share sale regardless of the likelihood of that amount ultimately being paid by the buyer.  

“The operation of the Irish CGT rules can be particularly harsh where the sellers find themselves liable for a substantial CGT liability on amounts they have not yet received. The rules can also potentially result in some sellers losing out on certain tax reliefs or exemptions,” said Dever.

One common strategy to mitigate these issues is to structure the transaction so that the sellers retain some of their shares in the target company, disposing of them later as part of a ‘put and call’ option agreement. This creates multiple capital disposals for CGT purposes. However, buyers may resist allowing sellers to maintain a minority shareholding, especially if those shares carry divided participation or voting rights. In addition, buyers may prefer to avoid the complexity that would be involved in putting in place a shareholders agreement.

Dever said: “The complexity may further increase when there is a mix of individual and corporate sellers, particularly if some are not tax resident in Ireland. In such cases, it may be challenging to agree on a structure that optimises the tax position for all parties. Non-Irish-resident sellers, who may not be subject to Irish CGT on the sale of their shares, may also resist changes to the deal structure that could negatively impact their tax position in their home jurisdiction”.

Earn-out arrangements can also raise difficulties for the buyer, in particular complicating the calculation of chargeable consideration, which affects the stamp duty liability and timing of the payment. 

Beausang said: “The tax treatment of earn-outs can be complex in practice for both sides. For this reason, we always recommend that sellers obtain appropriate tax structuring advice at an early stage of the deal so that this can be communicated to the buyer. In our experience, this maximises the chances that any commercial concerns the buyer may have can be allayed.”