On 23 April 2015 the Government released exposure draft legislation to amend the income tax law to change the capital gains tax (CGT) treatment of ‘earnout arrangements’.

Broadly, as a result of the proposed amendments:

  • capital gains and losses arising in respect of eligible earnout rights will be disregarded; and
  • financial benefits received under eligible earnout rights will affect the capital proceeds and cost base of the underlying asset or assets to which the earnout arrangement relates.


An earnout arrangement is an arrangement commonly used in the sale  of a business or the sale of assets of a business. It involves the buyer and seller agreeing that additional consideration may later be payable or repayable for the sale. The amount paid or repaid is calculated by reference to the future performance of the business or the related business in which the assets are used.

The sale of a business or the assets  of a business will generally give rise to capital gains or losses to which the CGT rules apply. There has however been some uncertainty as to how earnout arrangements should be treated for the purpose of calculating the capital gain or loss.

The Commissioner of Taxation issued Draft Taxation Ruling TR 2007/D10 expressing the view that an earnout right or rights are a separate CGT asset.

However in 2010 the former Government announced that it would amend the tax law to provide ‘look-through’

CGT treatment to qualifying earnout arrangements.  The current Government announced in 2013 that it would proceed with the announced but unenacted measure.

The draft legislation gives effect to the above Government announcements.

Eligible look-through earnout rights

The proposed look-through CGT treatment will only apply to look-through earnout rights. An earnout right is only a look- through earnout right if:

  • the right is created under an arrangement involving the disposal of a business or its assets;
  • the future financial benefits provided under the right are linked to the future economic performance of the asset or a business in which the asset is used;
  • the right does not require financial benefits to be provided more than four years after the disposal occurs; and
  • the earnout rights are created as part of arrangements entered into on an arm’s- length basis.

A right will also be a look-through earnout right if it is a right to receive certain financial benefits provided for ending a right that is a look through earnout right.

Look-through approach

There are two key aspects to the look- through approach.

  • Disregard the right: if a right is a look- through earnout right, any capital gain or loss arising in respect of the creation or cessation of that right will be disregarded. Similarly, the value of the right will not be taken into account in determining the capital proceeds on the disposal by the seller or the cost base or reduced cost base on the acquisition by the buyer of the relevant asset.
  • Adjust the capital proceeds and the cost base for subsequent financial benefits: the value of any consideration subsequently paid or repaid in relation to such a right is included in the capital proceeds of the disposal by the seller and the cost base and reduced cost base on the acquisition by the buyer of the asset. It follows that a taxpayer’s capital gain or loss may change in subsequent tax years, requiring an amendment to a tax return for a previous tax year.

To give effect to the look-through approach, an array of special rules have been implemented with the intention of ensuring that the look-through approach does not disadvantage taxpayers or impose unnecessary compliance and administrative costs. These special rules relate to the time periods for amending tax returns, making CGT choices, interest payments and the treatment of capital losses.