Sunil Arora, Partner, Taxation co-authored an article with Mayank Sharma, Deputy Manager, Taxation for Taxmann on issues while taxing the earn-out consideration in M&A.
While structuring a M&A transaction, the element of purchase price that is contingent on the performance of the acquired business, over a specified time period following the closing is known as the Earn-Out Consideration. In theory, Earn-Outs are intended to bridge the gap between an optimistic seller and a sceptical buyer. This article discusses in detail whether earn-out is directly linked to transfer of shares and should therefore be taxed as capital gains or whether in cases where the exiting promoters are also employed in the business post sell-out and can therefore be taxed as salaries.
Also discussed in this article is the crucial role played by the timing of taxation of consideration and the various things to consider throughout the whole process. Sunil Arora and Mayank Sharma have also shared their opinions on the matter and with examples as to when they believe earn-outs can be taxed as salaries or as capital goods.
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