Earn-outs
Austria, Hungary and Slovakia
An "earn-out" can be structured as a future entitlement to shares or loan notes or as payments of deferred and/or contingent cash consideration. Future entitlement to shares may include allocations of sweet equity as discussed in Part 2. Often an earn-out is contingent on certain future events or performance metrics. The way an earn-out is structured will affect how and when it will be taxed in your hands.
Some points to be aware of are set out below.
- Large values of deferred or contingent consideration can trigger significant tax charges on completion of the sale (regardless of when, or if, such amounts are eventually paid). Accordingly, careful consideration should go into the drafting of these provisions and the mechanisms for calculating any future amounts as described in the transaction documents.
- A seller's entitlement to earn-out consideration should ideally be linked only to the performance of the company (and not to any individual) and should not be conditional on any individual's ongoing employment (among other things) to maximise the likelihood that it is treated as investment income rather than employment income. However, in the case of sellers still assuming, after the closing, senior management functions in the target company or any of the buy-side companies controlling the target company, face a high risk that the earn-out amount is fully taxed as employment income under the wage tax rules rather than the capital gains rules.
Czech Republic
An "earn-out" can be structured as a future entitlement to shares or loan notes or as payments of deferred and/or contingent cash consideration. Future entitlement to shares may include allocations of sweet equity as discussed in Part 2. Often an earn out is contingent on certain future events or performance metrics. The way an earn out is structured will affect how and when it will be taxed in your hands.
If earn-out clauses are agreed to in M&A transactions, it is advisable to pay particular attention to the tax consequences.
Some points to be aware of are set out below.
- Large values of deferred or contingent consideration can trigger significant tax charges on completion of the sale (regardless of when, or if, such amounts are eventually paid). Accordingly, careful consideration should go into the drafting of these provisions and the mechanisms for calculating any future amounts as described in the transaction documents.
- A seller's entitlement to earn out consideration should ideally be linked only to the performance of the company (and not any individual) and should not be conditional on any individual's ongoing employment (among other things) to maximise the likelihood that it is treated as investment income rather than employment income. However, in the case of sellers still assuming, after the closing, senior management functions in the target company or any of the buy-side companies controlling the target company, face a high risk that the earn-out amount is fully taxed as employment income under the wage tax rules rather than the capital gains rules. It is particularly important to structure earn-outs correctly for tax reasons, see Part 3 for further details.
Poland
An "earn-out" can be structured as a future entitlement to shares or loan notes or as payments of deferred and/or contingent cash consideration. Future entitlement to shares may include allocations of sweet equity as discussed in Part 2. Often an earn-out is contingent on certain future events or performance metrics. The way an earn-out is structured will affect how and when it will be taxed in your hands.
Some points to be aware of are set out below.
- Large values of deferred or contingent consideration can trigger significant tax charges on completion of the sale (regardless of when, or if, such amounts are eventually paid). Accordingly, careful consideration should go into the drafting of these provisions and the mechanisms for calculating any future amounts as described in the transaction documents.
- A seller's entitlement to earn-out consideration should ideally be linked only to the performance of the company (and not any individual) and should not be conditional on any individual's ongoing employment (among other things) to maximise the likelihood that it is treated as capital gain rather than employment income. However, in the case of sellers still assuming, after the closing, senior management functions in the target company or any of the buy-side companies controlling the target company, they face a risk that the earn-out amount is fully taxed as employment income under the employment tax rules rather than the capital gains rules. Details of the earn-out structure are of key importance here.