Specialist US UK Tax Services: Earn-Outs and Loan Notes

A US-connected founder who sells a UK company for cash plus an earn-out and loan notes is taxed twice on the same money, on two different clocks. HMRC generally taxes the deferred element when the right is created or when the notes are redeemed; the IRS taxes it as cash arrives under the installment method. That timing gap is what strands foreign tax credits.

This is the single most expensive structural problem we see on UK exits. It is not caused by aggressive planning or by anything the founder did wrong. It is caused by two mature tax systems recognising the same economic gain in different years, in different currencies, in different characters, and with foreign tax credit rules that were never designed to bridge the gap. Our Specialist US UK Tax Services team is engaged repeatedly on exactly this fact pattern, frequently after the completion accounts are already signed and, more often than founders expect, after several years of US returns were never filed at all. Jungle Tax prepares the returns that put the deal back into compliance and preserve as much credit as the law allows.

Why does a UK earn-out create a US tax problem at all?

On a typical UK private company sale, the founder receives three things: cash on completion, loan notes issued by the buyer (or by a newco in the buyer's group), and a contingent earn-out right tied to revenue, EBITDA or retention targets over the following one to three years. Commercially this is one transaction. For tax it is at least three separate assets, and each system slices them differently.

The UK asks a threshold question first: is the deferred amount ascertainable or unascertainable at completion? The US asks a completely different question: has the seller received at least one payment after the close of the tax year of disposition? Those two questions do not produce the same answer, and they certainly do not produce the same year.

Layer onto that the fact that the founder is a US citizen or green card holder, taxed by the IRS on worldwide income regardless of where they live, and you have a deal in which the UK tax may fall in 2026 while the matching US tax falls in 2027, 2028 and 2029 — or the reverse. Foreign tax credits are computed year by year. A credit that has nothing to sit against in the year it arises is, in practical terms, a payment made twice.

How does the UK tax an earn-out and loan notes on a company sale?

Ascertainable versus unascertainable deferred consideration

If the deferred amount is fixed at completion — say a further £2 million payable in twelve months, contingent only on the passage of time or on a condition that does not affect quantum — HMRC treats it as ascertainable. The full amount is brought into the disposal proceeds in the tax year of the sale, discounted only for the possibility of never being paid, not for the time value of money. The founder pays capital gains tax in the year of completion on money not yet received.

If the amount genuinely cannot be quantified at completion — a percentage of future EBITDA, an uncapped revenue multiple — the position follows Marren v Ingles. The right to receive the future payment is itself a separate chargeable asset, a chose in action. It is valued at completion, and that value forms part of the disposal proceeds for the share sale. When the earn-out is later paid, that is a second disposal: a capital sum derived from the chose in action, with the original valuation as its base cost. HMRC sets out the case law and the valuation approach in its Capital Gains Manual at CG14990.

This produces a well-known UK trap: if the earn-out right is valued at £1.5 million at completion, tax is paid on that £1.5 million immediately, and if the earn-out then pays only £400,000, the founder has a capital loss on the chose in action that may have no gain to shelter. Worse, the second disposal is a disposal of a chose in action, not of trading company shares, so Business Asset Disposal Relief is generally unavailable on it.

Loan notes: why QCB or non-QCB decides everything

Where part of the consideration is satisfied in loan notes, the classification of those notes is the most consequential drafting decision in the whole sale agreement, and it is usually made by the buyer's counsel for the buyer's reasons.

• Non-qualifying corporate bonds (non-QCBs) — typically loan notes with a foreign currency redemption right or other feature taking them outside the QCB definition. The share-for-securities reorganisation rules apply, so the notes step into the shoes of the shares: no gain arises on issue, the founder's original base cost carries across, and the gain crystallises on redemption or sale of the notes. Because the notes are securities, Business Asset Disposal Relief can, subject to conditions, remain available on encashment.
• Qualifying corporate bonds (QCBs) — sterling-denominated notes without those features. QCBs are not chargeable assets, so the gain on the shares is calculated at completion and held over, frozen, until the notes are redeemed. The frozen gain then crystallises. Critically, because QCBs are exempt assets, a fall in the buyer's creditworthiness that renders the notes worthless does not generate an allowable loss: the held-over gain remains chargeable even if the founder is never paid.

Where an unascertainable earn-out right is itself to be satisfied in loan notes or shares, TCGA 1992 s.138A can allow the earn-out right to be treated as a security, deferring the charge until the notes are disposed of, provided there is no cash alternative and the other conditions are met. HMRC's introduction to this area sits at CG58000. Advance clearance is customary and, in our experience, worth insisting on before signing.

When is the UK tax actually payable?

UK capital gains tax on a share sale is due by 31 January following the end of the tax year of disposal. Where consideration is payable in instalments over a period exceeding eighteen months, TCGA 1992 s.280 can allow HMRC to accept payment by instalments, broadly over up to eight years or until the final instalment is received, whichever is earlier. This is a relieving provision for cash flow only — it does not change the year in which the gain arises, and it does not change the year in which the tax is treated as paid or accrued for US foreign tax credit purposes in the way founders assume.

How does the US tax the same UK deal?

The IRS starts from IRC §453. If the founder receives at least one payment after the tax year of the sale, the installment method applies automatically unless an affirmative election out is made. Gain is recognised proportionately as principal is received, using a gross profit percentage. The mechanics, including the election-out procedure and its six-month relief window, are in IRS Publication 537, and the reporting is done on Form 6252.

Several US features have no UK analogue and routinely surprise founders:

• Contingent payment sales. Where the maximum selling price is not determinable, Treasury Regulation §15a.453-1(c) governs basis recovery. If there is a stated maximum price, basis is recovered by assuming that maximum is received. If there is no maximum price but a fixed period, basis is spread rateably over that period. If there is neither, basis is generally recovered rateably over fifteen years. A founder with an uncapped earn-out can therefore find US basis recovery stretched over a decade and a half while the UK has already taxed the whole thing.
• Imputed interest and OID. Loan notes and deferred payments carrying no interest, or interest below the applicable federal rate, are recharacterised in part as interest under §483 or the original issue discount rules. Interest is ordinary income taxed at rates up to the top marginal bracket, not at capital gains rates — and it is generally UK-source or US-source under different rules than the gain, which puts it in a different foreign tax credit basket.
• The §453A interest charge. Where the aggregate face amount of installment obligations outstanding at year end exceeds $5 million, an interest charge is imposed on the deferred tax liability. A founder deferring US tax on £12 million of loan notes is effectively paying the IRS interest for the privilege. The related pledge rule can also treat borrowing against the notes as a deemed payment, accelerating gain.
• No QSBS. Section 1202 qualified small business stock relief applies only to stock of a domestic C corporation. Shares in a UK limited company never qualify, no matter how small or how innovative the business.
• Net investment income tax. A 3.8% NIIT typically applies to the capital gain and to the interest element. Whether UK tax can be credited against NIIT has been litigated and remains contested; conservative return positions still generally assume no credit, which mechanically creates a residual US cost on an otherwise fully UK-taxed gain.

US versus UK: the same deal on two timetables

Deal element	UK / HMRC treatment	US / IRS treatment
Completion cash	Chargeable gain in the tax year of disposal	Gain recognised in year of sale via gross profit percentage
Ascertainable deferred cash	Included in year-of-sale proceeds in full, undiscounted for time value	Deferred until received under the installment method unless elected out
Unascertainable earn-out	Marren v Ingles: right valued and taxed at completion; second disposal on payment	Contingent payment sale; basis recovered under Reg. §15a.453-1(c), gain as cash arrives
Non-QCB loan notes	Reorganisation treatment; gain rolls into notes, crystallises on redemption	Installment obligation; gain recognised as principal is paid
QCB loan notes	Gain computed and held over at completion; crystallises on redemption; no loss if notes fail	Same installment analysis; a worthless note can produce a bad debt or loss position
Interest on notes	Savings income, income tax rates, possible withholding	Ordinary income; imputed under §483/OID if not adequately stated
Rate	Main CGT rates, with Business Asset Disposal Relief on a lifetime limit where conditions are met	Long-term capital gain rates plus 3.8% NIIT; ordinary rates on the interest strip
Payment timing	31 January after the tax year of disposal; s.280 instalments possible	With each year's return as payments are received; §453A interest charge above $5m

Why does the mismatch strand foreign tax credits?

The foreign tax credit under §901 is not a refund mechanism. It is a limitation calculation performed separately for each tax year and each income category under §904. To use a UK tax as a credit, the founder needs foreign-source income of the same category in the same year, and enough US tax on that income to absorb it.

Consider the classic sequence. The founder, a US citizen resident in London, sells in the UK tax year 2026/27. HMRC taxes the completion cash, the ascertainable deferred slice and the Marren v Ingles valuation of the earn-out right — a very large UK liability, all in one year. For US purposes the founder is on the installment method by default: only the completion cash is recognised in that year. The US tax in the sale year is a fraction of the UK tax. The excess UK credit goes into carryover.

Then the earn-out pays out over 2028 and 2029. Now the US recognises the bulk of the gain. But the UK already taxed it in 2026/27 and takes nothing further (or takes only a small second-disposal amount). There is no current-year UK tax to credit. The founder must reach back to the carryover — a credit that can be carried back one year and forward ten under §904(c), but only within the same income category and only against US tax on foreign-source income.

Three things then commonly go wrong:

• Category mismatch. The capital gain generally lands in the passive category; the interest strip on the loan notes lands in the passive category too, but ordinary earn-out amounts recharacterised as employment income (see below) land in the general category. Credits cannot cross baskets.
• Source mismatch. Gain on the sale of personal property, including shares, is sourced by reference to the seller's residence under §865. A founder who has moved back to the United States before the earn-out pays may find the later gain is US-source, meaning there is no foreign-source income in the numerator of the §904 limitation and the carryforward simply cannot be used. Treaty re-sourcing under the US–UK double tax treaty is the usual route out, and it must be claimed and disclosed, not assumed.
• Rate differential. Because long-term capital gains are taxed at preferential US rates, §904(b)(2)(B) requires an adjustment that shrinks foreign-source capital gain in the limitation fraction. The credit capacity is smaller than founders calculate on the back of an envelope.

The practical consequence: a founder who paid, say, 20% UK tax on the whole gain in year one can still owe meaningful US tax in years three and four, with an unusable pile of UK credits sitting in carryover that will expire in ten years unless other foreign-source passive income is generated. This is precisely the territory our cross-border tax planning and US UK tax accountants teams model before an election-out decision is locked in.

Is electing out of the installment method the answer?

Frequently, yes — and it is the single highest-value decision on the return. Electing out under §453(d) accelerates the entire US gain into the year of sale, deliberately matching the UK's front-loaded charge so that the UK tax and the US tax fall in the same year and the credit actually absorbs.

It is not automatic, and it is not always right. Electing out means paying US tax in year one on money the founder has not received, in a year when the sterling proceeds may not yet have been converted. It fixes the gross profit at a valuation that may prove wrong. It forecloses the deferral that a founder relocating to a lower-tax US state might otherwise want. And where the earn-out is genuinely unascertainable, valuing it for an election-out requires a defensible fair market value that both revenue authorities can be shown. The election must generally be made by the due date of the return, including extensions, with a limited six-month window to revoke by amended return — so this is a decision with a hard deadline attached, not something to revisit later.

Watch the character risk: is the earn-out consideration or employment income?

Both authorities can recharacterise earn-out payments as remuneration where they are conditioned on the founder's continued employment rather than purely on business performance. HMRC applies a well-established set of indicators; the IRS applies its own compensation analysis. If the earn-out is recast as employment income, the UK charge becomes income tax and National Insurance through PAYE, the US charge becomes ordinary income in the general category, and the entire foreign tax credit model has to be rebuilt. Deal documents that tie earn-out entitlement to a founder remaining in post are the ones that generate this exposure.

What if you leave the UK, or move to the US, before the earn-out pays?

Timing of residence is as important as timing of payment.

• Leaving the UK. The UK temporary non-residence rules can pull gains realised during a short absence back into charge on return. A founder who becomes non-UK resident, redeems loan notes abroad, and then returns within the relevant period may find the deferred gain taxed in the year of return.
• Arriving in the US. Becoming a US resident does not create a step-up in the basis of UK shares. It does change the source of subsequent gain under §865, which is the mechanism that strands credits. It also brings state tax into play: several US states do not recognise the federal installment method in the same way, and some assert taxing rights over installment payments attributable to a period of prior residence.
• Split-year and treaty tie-breakers. Where residence changes mid-year in either country, the treaty residence article and the UK split-year rules determine which system has the primary claim to which slice of the consideration. Getting this wrong is the difference between a clean credit and a double charge.

How is the sale year reported when US returns were never filed?

A significant minority of the founders who come to us in this position have never filed a US return. They were born in the US and left as infants, or they took a green card for a role a decade ago, or they simply believed that paying UK tax discharged the obligation. Then a nine-figure exit puts a very large, very visible number on a UK bank statement, and the buyer's US counsel starts asking about W-9s.

The route back is the IRS Streamlined Filing Compliance Procedures, and specifically the Streamlined Foreign Offshore Procedure for those resident outside the United States. It requires three years of delinquent or amended income tax returns, six years of FBARs, and a signed certification that the failure to file was non-willful. For eligible non-resident filers there is no miscellaneous offshore penalty; the US-resident version carries a 5% penalty on the highest aggregate balance of the unreported assets.

The sequencing question is the hard one. A streamlined submission that includes the sale year commits the founder to a position on the earn-out, the installment election, the valuation of the Marren v Ingles right and the foreign tax credit computation, all inside a package that is by definition under heightened scrutiny. A submission that ends before the sale year leaves the exit to be reported on a first-time current filing, which raises its own questions about why the earlier years exist. There is no universal answer; there is a right answer for each fact pattern, and it should be decided before anything is signed. Our IRS streamlined filing specialists take that decision as a discrete piece of work.

Which US forms does a UK exit actually generate?

• Form 6252 — installment sale income, filed every year an instalment is received.
• Form 8949 and Schedule D — the disposal itself, and any second disposal of an earn-out right.
• Form 1116 — foreign tax credit, computed by category, with carryback and carryover schedules that must be maintained year on year.
• Form 5471 — for the years the founder held the UK company, typically as a Category 4 or 5 filer, with a final-year filing on disposal. Penalties here start at $10,000 per form per year and are assessed automatically.
• FinCEN Form 114 (FBAR) and Form 8938 — the UK company shares, the loan notes and the escrow or retention accounts are all reportable assets. Loan notes issued by a foreign buyer are specified foreign financial assets.
• Form 8833 — where a treaty position, including re-sourcing, is relied upon.
• Form 8621 — if any part of the consideration or the founder's wider holdings involves a passive foreign investment company, including UK-domiciled funds used to park proceeds.

The five mistakes that cost the most

• Signing the SPA before modelling the US position. QCB versus non-QCB, cash alternative versus no cash alternative, capped versus uncapped earn-out — every one of these is negotiable at heads of terms and immovable after signing.
• Assuming the installment method is the default best answer. It is the default. It is frequently the worst answer for a US citizen taxed by the UK on a front-loaded basis.
• Ignoring currency. Gains are computed in sterling for HMRC and in dollars for the IRS, using different exchange dates. A movement in GBP/USD between completion and the final earn-out payment creates genuine US gain or loss that has no UK counterpart at all, including on the redemption of sterling loan notes.
• Failing to track credit carryovers. Excess credits that are not documented on a Form 1116 in the year they arise are extremely difficult to substantiate three years later when they are finally needed.
• Parking proceeds badly. Proceeds routed into UK investment funds or offshore bonds create PFIC and reporting problems that dwarf the original question. Coordinate the landing zone before the money moves, as part of a wider high net worth compliance plan.

What good looks like

A properly handled UK exit for a US-connected founder looks like this: the deferred consideration structure is stress-tested against both systems before heads of terms; the earn-out right is valued once, defensibly, on a basis both authorities can be shown; the installment election is modelled in both scenarios with the foreign tax credit carryforward projected across the full earn-out period; any historic non-compliance is remediated on a chosen, deliberate sequence rather than in a panic; and every year of the earn-out is filed consistently, with the credit position carried forward on the face of the return. Reference material across our other exit and cross-border topics is collected in our guides library.

If you have sold, or are selling, a UK company for cash plus an earn-out and loan notes — and particularly if US returns are outstanding — the window to fix the timing is narrow and largely defined by return due dates. Contact our cross-border team for a confidential consultation. We will review the sale agreement, model the US and UK charge year by year, and tell you plainly what the election-out decision is worth before the deadline closes it off.