Who this is for: For founders who have received or are negotiating an earnout offer and want to understand how the deferred consideration is taxed.
An earnout is a portion of the sale price that is contingent on the future performance of the business. It is common in trade sales and MBOs where the buyer and seller cannot agree on a fixed price.
The tax treatment of an earnout depends on how it is structured. If it is structured as a capital payment, it is taxed as CGT at 20% (or 10% with BADR). If it is structured as employment income, it is taxed as income tax at 45% plus NICs.
When earnouts become income
An earnout is treated as employment income when it is conditional on the founder remaining employed by the business after the sale, or when it is structured as a bonus payment linked to performance targets that the founder is responsible for achieving.
HMRC's position is that if the earnout is in substance a payment for the founder's continued services, it is employment income regardless of how it is labelled in the sale agreement.
When earnouts remain capital
An earnout is treated as a capital payment when it is genuinely contingent on the performance of the business as a whole, not on the founder's individual contribution, and when the founder is not required to remain employed to receive it.
The distinction is not always clear. HMRC scrutinises earnout arrangements carefully, particularly where the founder remains as an employee or director after the sale.
The numbers
| Earnout amount | Capital treatment (20% CGT) | Income treatment (45% IT + NICs) | Difference |
|---|---|---|---|
| £500,000 | £100,000 tax | £225,000+ tax | £125,000+ |
| £1,000,000 | £200,000 tax | £450,000+ tax | £250,000+ |
| £2,000,000 | £400,000 tax | £900,000+ tax | £500,000+ |
The earnout structure is agreed at heads of terms. The tax treatment follows from the structure. Changing the structure after the deal is signed is rarely possible.
What the planning looks like
The earnout structure must be designed before heads of terms are agreed. The key decisions are: whether the earnout is conditional on the founder's continued employment, how the performance targets are defined, and whether the earnout can be structured as a loan note (deferring the CGT charge to the year of receipt).
Your Exit Architecture
The structure has to be in place before the buyer is in the room. Not during the process. The Capital Architecture maps your exit route, the qualifying window, and the exact steps required to make the transaction tax-free. It is delivered within 48 hours of your intake call.
The Capital Architecture includes your exit route analysis, the SSE qualifying window, and the full implementation roadmap. Delivered within 48 hours.
The Structure That Determines the Treatment
The tax treatment of an earnout is determined by the structure that was in place before the transaction, not by the negotiation at the point of sale. The Growth layer (a holding company with the right share class structure) creates the conditions under which earnout proceeds can be received as capital rather than income.
The Expansion layer is what ensures the holding company was properly constituted, that the share classes were correctly designed, and that the earnout mechanism was structured from the outset to receive the proceeds at the lowest possible tax rate. The founders who receive earnout proceeds as capital built the right architecture before the buyer made their offer.