Stamp duty implications for corporate transactions

Stamp duty applies to transfer documents transferring stock or marketable securities.  For a UK company, that would be the stock transfer form. The rate of stamp duty is 0.5% of the total consideration for the transfer, rounded by to the nearest £5.

This rate is applied to the ‘stampable’ consideration – being cash, stock or marketable securities or the assumption of debt. The amount of stamp duty payable will vary depending on how the consideration is structured and the way that the consideration is calculated.

Generally, the consideration for the sale of a company’s shares is calculated using one of two mechanisms – completion accounts and locked box.

The buyer and seller may also choose to include an earn-out in the pricing structure. An earn-out is a deferred consideration payment, typically dependent on the performance of the company being sold (the target) after completion.

The choice of consideration mechanism will depend on several legal and commercial issues. This includes the nature of the seller and their need for a clean-cut exit, the amount of cash the buyer has at disposal, and whether the parties consider the accounts on the completion date reflect the value of the target.

Completion accounts

This mechanism involves an adjustment to the agreed purchase price for the target made at completion. The adjustment is calculated using accounts drawn up shortly after completion that refer to the position of the target at the date of completion.

Where the consideration is determined using completion accounts, the total price paid for the target is typically split into two payment – one before and the other after the completion accounts have been finalised. Consequently, the charge to stamp duty is also split into two parts.

Prior to finalising the completion accounts, the full consideration amount remains subject to adjustment, and it can take time for any adjustment to be finalised. However, a buyer cannot register its legal ownership in the target unless and until it has received a stamped stock transfer from HMRC. Consequently, at completion, to the extent that the consideration is ascertainable whilst not yet ascertained, HMRC allow for stamp duty to be provisionally paid on the estimated value of the consideration and provide a provisionally stamped stock transfer form allowing for the target’s books to be written up. HMRC will require an undertaking that the stock transfer forms will be returned once the final adjustment is known.

The provisional stamp duty payment is calculated on the agreed estimated price and should be paid within 30 days of completion of the sale of the target. Once the completion accounts have been finalised and any price adjustment agreed, the final payment, based only on the adjustment, is paid alongside the resubmission of the stock transfer forms for final stamping.

If there has been an upwards price adjustment, additional stamp duty will be payable, and interest may be payable on this amount. If there has been a downwards price adjustment, the total stamp duty payable will have reduced, and the buyer is entitled to a refund from HMRC on the difference in the overpayment.

Why use a ‘completion accounts’ mechanism from a commercial perspective?

Completion accounts are usually preferred by a buyer because they allow for greater certainty as to the target’s financial position at completion.

Where the consideration for a sale is determined by reference to completion accounts, the parties agree to a preliminary purchase price based on estimated figures. This amount is paid on the date of completion. Typically, the buyer then prepares ‘completion accounts’ and assesses whether a price adjustment, upwards or downwards, is required. Any adjustment will be reviewed by the seller, with an opportunity for disagreement and discussion. The agreement for sale will have prescribed how the completion accounts will be drawn up and any price adjustment made, and funds may have been set aside in anticipation.

Locked box

Using this mechanism, the parties agree a price by reference to a set out accounts, whether or not specifically drawn up for this purpose, at a date prior to completion. There may be certain adjustments for events from that date to completion, but there is no post-completion adjustment.

The locked box mechanism typically results in a straightforward stamp duty calculation. The amount paid at completion is not subsequently adjusted and the stamp duty charge is applied to such amount, subject to any additional consideration elements such as an earn-out as described below. The stamp duty should be paid, and stock transfer forms submitted to HMRC, within 30 days of completion.

Why use a ‘locked box’ mechanism from a commercial perspective?

The locked box mechanism is commonly used in transactions where the seller has a greater ability to dictate the terms of the sale. This is common in private equity transactions. Typically, a seller will prefer the locked box mechanism over a completion accounts transaction, since the former increases the certainty of the consideration payment.

The buyer and seller agree on a fixed price using a set of accounts that are drawn up as at a date prior to completion. In contrast to completion accounts deals, under a ‘locked box’ mechanism, the price will not be adjusted post completion and is fixed on an agreed date - the ‘locked box date’. Generally, only certain agreed adjustments relating to the period between the locked box date and completion will be allowed.

Earn-out

Generally, an earn-out constitutes a payment, or a series of payments, based on the future profits and performance of the target. Although the earn-out is paid after completion, the stamp duty charge applies as at completion with no subsequent adjustment in the event that the earn-out is not in fact paid. 

Stamp duty is applied to the earn-out mechanism on what HMRC refers to as a contingency basis. This means as follows: 

• If there is a maximum earn-out: The stamp duty charge will be calculated on the basis that this maximum was reached.
• If there is a minimum earn-out: The stamp duty charge on the earn-out would be calculated on the basis that this is the earn-out consideration, even if the total consideration received under the earn-out is ultimately higher.
• If the earn-out is subject to both a stated maximum and a stated minimum: The stamp duty charge would be calculated on the maximum.
• If the earnout is estimated but could vary up or down: Stamp duty is charged as if there was no variation of the estimate.

To the extent that the earn-out payment is wholly unquantifiable, and not subject to any of the above, then the earn-out should not be considered to have value for the purposes of calculating the ‘stampable’ consideration. No stamp duty is therefore payable in respect of it, even if it is subsequently paid.

In contrast to stamp duty payable under a completion accounts structure, under an earn-out, it is not possible to recover any excess stamp duty paid to HMRC. The risk of a stamp duty overpayment is borne by the buyer in return for obtaining certainty regarding the “earn-out” element of the consideration for the target.

Why use an ‘earn out’ mechanism?

Earn-out provisions are usually included in transactions where the buyer and seller cannot agree a value upfront and so the value gap is breached by deferring an element of the consideration and making it variable, based on the post-completion performance of the target.