Q. The recent Budget announced a change to the tax treatment of earn out rights. We are in the process of selling our business and we will receive a lump sum in consideration plus an earn out right which will be calculated over the following two years based on the revenue of the business.  What are the tax implications for us and are the recent changes favourable to us?

A. The changes announced in the budget should help to overcome the existing tax treatment of an earn out right based on a tax ruling issued by the Commissioner a few years ago. Under this tax ruling where you sell your business for a lump sum amount plus an earn out right, the deemed consideration for capital gains tax purposes is the lump sum amount plus a valuation of the earn out right at the date of the CGT event.

Sounds complicated? Yes it is. It added cost and uncertainty to the treatment of earn out rights under CGT.

The budget announcement provides a common sense solution to overcoming this problem created by the ATO interpretation. It proposes that where you receive an earn out right as part of the consideration on sale of the business, you will only declare the capital gain in the year of sale based on the actual consideration received. There will be no need to value or account for the earn out right at that time. Then in the following years any earn out payments received will be returned as a further capital gain, but against the original CGT event. On this basis if you are eligible you could continue to apply the CGT small business concessions.

This tax treatment is far more transparent. It allows you to return the capital gain as it is realised and you can continue to access the small business concessions against each payment.  This should produce a simpler CGT outcome for you in your sale. You may have to return parts of the capital gain over a number of years however you will only have to deal with the actual amounts you have received.