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How New Laws May Impact Your Use of an Earnout Right when Buying or Selling a Business.

New legislation was introduced on the 25th February 2016, affecting look-through earnout rights from the 24th April 2015 onwards. It changes the capital gains tax (CGT) treatment on these earnout rights. If you have bought or sold a business after this date using an earnout right, it is valuable to look into what effect these changes may have on you.

Firstly, it is important to determine whether a right is a “look-through earnout right”. The following points, as listed by the ATO, list the criteria

  • it is created on or after 24 April 2015
  • the right is to future financial benefits, which cannot be reasonably ascertained at the time the right was created
  • the right was created under an arrangement involving the disposal (CGT event A1) of a CGT active asset of the seller
  • all financial benefits under the right are provided within five years, from the end of the income year in which the CGT event occurred
  • the financial benefits are contingent and relate to the future economic performance of the CGT asset or a business for which it is expected that the CGT asset be an active asset; and
  • the parties dealt at arm’s length.

Put in simple terms, the new law means capital gains and losses are now disregarded in relation to look-through earnout rights. Part of the cost base or reduced cost base of the underlying assets is increased by any financial benefit provided under a look-through earnout right for the buyer. For the seller, financial benefits received increase the capital proceeds for the underlying asset.

Understanding these changes and how they make effect you can be a complicated task, which is why we are here to help. For help regarding CGT and Earnout Rights, contact YML today.

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