IHT and Earn-Outs: The Inheritance Tax Trap When You Sell Your Business for Deferred Consideration
Selling your business for an earn-out eliminates BPR permanently. The right to receive future consideration — whether a contingent earn-out, a fixed deferred payment, or a loan note — is an estate asset valued at discounted present value. If you die before all the money arrives, your estate pays IHT on money you haven't received yet. Planning must start at completion, not after the first payment.
Types of Deferred Consideration and Their IHT Treatment
Contingent earn-out linked to future profits
The right to receive an earn-out payment contingent on the target company's future profits is an asset of the seller's estate at the date of death. It is valued on an open market basis: what a hypothetical buyer would pay for the right to receive the expected future earn-out payments, discounted to present value. The valuation requires: (1) an assessment of the likely level of future profits (based on current trading and projections); (2) a discount rate reflecting the risk that the earn-out conditions may not be met; (3) a time-value-of-money discount for the period before payments are due. HMRC will accept a professional valuation — typically from a corporate finance adviser or accountant. Where it is genuinely impossible to value the earn-out at the date of death (because the contingency is entirely uncertain), an estimated nil value may be appropriate — but this requires strong evidence and HMRC will scrutinise it.
Fixed deferred payment (certain but delayed)
A right to receive a fixed sum on a specific future date is an asset of the seller's estate, valued at the present value of that future sum (i.e. the fixed sum discounted at an appropriate rate for the time remaining until payment). Example: a business sale completes on 1 January 2025 with £500,000 payable in 3 years (January 2028). If the seller dies in June 2026, the remaining deferred consideration is discounted from January 2028 to June 2026 — at, say, 5%: approximately £500,000 × (1/(1.05^1.58)) ≈ £471,000. HMRC accepts present value calculations — the discount rate should reflect the creditworthiness of the buyer and the market at the date of death.
Loan notes issued as consideration
Vendor loan notes (VLNs) issued by the buyer as consideration for a business sale are assets of the seller's estate at their face or market value (if traded or redeemable on demand, face value; if illiquid or dependent on buyer's credit, a discount may apply). Loan notes are not qualifying business property for BPR — they are a debt owed to the seller, not a business interest. If the seller holds loan notes at death, they are in the IHT estate at full market value (subject to any credit risk discount). Planning for loan note holders: using the loan notes to make gifts (PETs) to start the 7-year clock; reinvesting redeemed loan notes in BPR-qualifying assets; taking out life cover to meet the IHT bill.
Shares in the buyer received as consideration
Where a business is sold for shares in the acquiring company (a share-for-share exchange), the seller holds quoted or unquoted shares in the buyer at the date of death. Quoted shares are valued at mid-market price. Unquoted buyer shares may qualify for BPR if the buyer is a qualifying trading company and the seller has held the shares for 2 years (BPR does not require the original business to have been owned for 2 years — the 2-year clock restarts from the date of acquisition of the buyer's shares). This is a significant planning point: in a share-for-share exchange, BPR qualification restarts from the date of the exchange — unlike a cash sale where BPR is permanently lost.
Frequently Asked Questions
Is BPR available on the right to receive earn-out consideration?
No — once the underlying business (or shares) have been sold, BPR no longer applies to the right to receive the sale consideration. BPR requires the asset to be qualifying business property — a sole trader's business, a partnership interest, or shares in a qualifying unquoted company. After a sale, the seller holds a contractual right to receive money (not qualifying business property) or loan notes (a debt, not qualifying business property). The BPR that applied to the original shares is lost on the sale. The earn-out right, fixed deferred consideration, or loan notes are all ordinary estate assets subject to IHT at 40% above the NRB. This is the major IHT disadvantage of a trade sale versus keeping the business — the BPR shelter is eliminated the moment the sale completes.
How does HMRC value an earn-out right in the seller's estate?
HMRC values the earn-out right at its open market value at the date of death — the price a hypothetical willing buyer would pay for the right to receive the expected future earn-out payments. The valuation is a present value calculation: (1) estimate the expected earn-out payments based on the company's trading performance up to the date of death and projected forward to the earn-out end date; (2) apply a risk discount reflecting the probability that the earn-out conditions may not be fully met; (3) apply a time-value discount for the period until the earn-out is received. HMRC's IHT Manual at IHTM20000 deals with deferred consideration. Where the earn-out amount is genuinely incapable of reasonable estimation (e.g. because the company is in severe difficulty or the earn-out period has barely started), HMRC may accept a lower value — but this requires detailed evidence.
What if the earn-out pays out at a different amount from the IHT valuation — is there relief?
If the earn-out right was included in the estate at an estimated value, and the actual earn-out received turns out to be less (or nil), there may be a claim for relief: under s149 IHTA 1984 (grossing up and fall-in-value relief) and the post-death event reporting rules, where a right to receive deferred consideration is subsequently discharged at less than the value included in the IHT account, a corrective account can be filed to reduce the IHT charge. Conversely, if the earn-out pays more than the IHT valuation, HMRC can seek additional IHT on the higher value. Executors should keep records of all earn-out payments received post-death to reconcile against the IHT account.
Can a business seller plan for the IHT on deferred consideration?
Yes — several planning strategies are available to business sellers facing IHT on deferred consideration: (1) Use the sale proceeds (or early redemptions of loan notes) to make gifts as PETs — starting the 7-year clock immediately. The sooner gifts are made post-sale, the longer the 7-year window. (2) Reinvest redeemed consideration in BPR-qualifying assets — AIM shares or EIS investments can qualify for BPR after 2 years, rebuilding the IHT shelter. (3) Take out life cover (written in trust) to pay the IHT that will arise if death occurs before the 7-year clock runs on gifts. (4) If the buyer offers shares (not cash), consider a share-for-share exchange rather than a cash sale — the buyer's shares may qualify for BPR after 2 years if the buyer is a qualifying trading company. (5) Make use of the annual exemption (£3,000/year) and normal expenditure out of income exemption from investment income on retained cash.
How does the earn-out interact with CGT?
The CGT position on an earn-out is separate from (but concurrent with) the IHT position. For CGT: the initial sale of shares triggers CGT on the proceeds received at completion (and any up-front loan notes). The right to receive earn-out consideration is a 'right to unascertainable consideration' under TCGA 1992 s48 — typically treated as an asset acquired at the date of the sale, to be brought into the CGT computation when the earn-out is ultimately quantified (the 'look-through' treatment). On death, the earn-out right passes to the deceased's estate at market value — the estate takes a new CGT base cost equal to the probate value, eliminating any latent CGT gain in the right itself. Business Asset Disposal Relief (BADR) — if applicable — applies to the sale at completion; it does not extend to the earn-out payments as they arise (they are treated as additional sale consideration for the original disposal, which was either within BADR or not).
What happens to the IHT position if the seller dies during the earn-out period?
If the seller dies during the earn-out period: (1) the IHT estate includes the right to receive the outstanding earn-out payments, valued at the date of death (present value of expected future receipts); (2) IHT is charged on this value in the usual way as part of the estate; (3) the executors receive the earn-out payments as they fall due — reporting any material variation from the IHT valuation; (4) the earn-out right passes to the beneficiaries under the will (or intestacy) — they do not inherit it free of IHT (there is no BPR or other relief); (5) the executors should model the IHT exposure on the earn-out right and consider whether life cover existed to meet the bill. The practical problem: the earn-out cash may not arrive for months or years after probate is granted, yet IHT is due within 6 months of death. The estate may need to borrow or use other assets to pay the IHT before the earn-out is received.
Sold Your Business? Update Your Will and Start Your IHT Planning Now
A business sale changes your IHT position dramatically. The will you had when the business provided BPR shelter may not be right for a cash-and-loan-note estate. Update your will with a WillSafe kit — and take specialist IHT advice on post-sale gifting and investment.
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