Earn-out and double taxation exemption under Spanish Corporate Income Tax
The ruling of Binding Tax Ruling V0062-26 issued by the Spanish Directorate-General for Taxes (Dirección General de Tributos, “DGT”) clarifies that the contingent portion of the consideration arising from the transfer of shares or equity interests may also benefit from the exemption under Article 21 of Law 27/2014 of 27 November, on the Spanish Corporate Income Tax Act (Ley del Impuesto sobre Sociedades, “LIS”), in the same way as the fixed portion, even where it accrues in a subsequent financial year.
What is an earn-out or “contingent payment”?
Where a company sells its shareholding in another business, the agreed purchase price often includes a variable component. In other words, this is a payment that depends on the occurrence of certain uncertain future events or the fulfilment of specific conditions.
In mergers and acquisitions (“M&A”) transactions, it is common to agree that part of the price is conditional upon the future performance of the business, such that the seller will only receive this additional amount if certain conditions are met. These conditions typically include a specified level of EBITDA, a minimum turnover threshold, the achievement of strategic contracts, etc.
This mechanism is particularly common where buyer and seller cannot agree on the company’s valuation, with the seller expecting higher future performance than the buyer is willing to price in at completion. The earn-out seeks to bridge this valuation gap.
Further information on this type of clause can be found in the following articles on our blog: “Risk mitigation in M&A: W&I, insurance and earn-out clauses” and “Earn-out clauses in share and equity purchase agreements”.
Where the seller is a legal entity, the taxation of this variable consideration is governed by the LIS, and the tax treatment is closely linked to its accounting treatment.
The tax base in Spanish Corporate Income Tax
Article 10 of the LIS establishes that the starting point for the taxable base in Corporate Income Tax is accounting profit, determined in accordance with commercial accounting rules and adjusted where required by specific tax adjustments under the LIS.
This means that, unless a specific tax rule provides otherwise, the key determinant for the taxation of an earn-out is its accounting recognition.
At this point, the key question arises: when should the selling company recognise, for accounting purposes, the income corresponding to the contingent consideration?
When does accounting income arise?
The Spanish General Chart of Accounts (Plan General de Contabilidad, “PGC”) conditions the recognition of any income on whether its amount can be measured reliably.
The issue is that, by its very nature, an earn-out depends on uncertain future events over which the seller typically has no control, since management of the business has already been transferred to the buyer. This is why International Accounting Standards, particularly IAS 37 on provisions, contingent liabilities and contingent assets, are relevant.
IAS 37 defines a contingent asset as one that arises from past events but whose existence will only be confirmed by the occurrence or non-occurrence of one or more uncertain future events outside the entity’s control. It also introduces an important threshold: an event is considered “probable” when it is more likely than not to occur, i.e. a probability greater than 50%.
Applied to earn-outs, two scenarios arise at completion:
Where the contingent consideration can be measured reliably
In this case, the seller must recognise a contingent asset at fair value, and any difference compared with the carrying amount of the disposed investment is recognised in profit or loss in the year of sale.Where it cannot be measured reliably at completion
This is more common where long-term, highly volatile variables are involved. In such cases, no income is recognised at the time of sale. Recognition (and therefore taxation) is deferred until uncertainty is resolved, typically when the agreed milestone is achieved and the amount becomes certain
Why does this matter from a tax perspective?
The practical consequence is that the timing of taxation of the earn-out depends on a case-by-case assessment of the level of uncertainty in each transaction.
This has significant implications for tax planning, as the seller (a legal entity) should assess during the negotiation phase how the contingent payment will be treated for accounting purposes. This will determine whether the entire gain is taxed in the year of disposal or whether part of it is deferred to future tax periods.
Deferred earn-out and the exemption under Article 21 LIS
Article 21 of the LIS provides for a 95% exemption on capital gains arising from the transfer of shares or equity interests, provided certain conditions are met.
A key question arises: where the contingent payment cannot be reliably valued at the time of sale and taxation is therefore deferred, must the conditions for the exemption be assessed in the year of transfer or in the year in which the earn-out is ultimately received and quantified?
Binding Tax Ruling V0062-26 addresses this issue and concludes that the exemption may also apply to the contingent portion of the consideration, even if it accrues in a later financial year, provided that: the requirements under Article 21 were met at the time of the share transfer; the income derives from the same underlying transaction already carried out; and the nature of the future events determining the payment is properly evidenced.
The DGT further confirms that this approach is consistent with its earlier ruling V3370-16.
FAQ on earn-outs and double taxation relief in Corporate Income Tax
What is an earn-out in an M&A transaction?
An earn-out is a variable or contingent portion of the purchase price in an acquisition. Its payment depends on the achievement of future performance targets.
Why are earn-outs used in M&A?
They bridge valuation gaps between buyer and seller by linking part of the price to future business performance.
How is an earn-out taxed under Corporate Income Tax?
Taxation depends primarily on its accounting treatment, since the taxable base is based on accounting profit unless otherwise provided by the LIS.
When should earn-out income be recognised for accounting purposes?
Earn-out income must be recognised when its amount can be determined with reasonable reliability. If the contingent consideration can be reliably measured at the time of the sale, it is recognised in that financial year. If it cannot be reliably determined, its accounting and tax recognition is deferred until the uncertainty is removed and the amount is quantified.
What happens if the earn-out cannot be reliably measured at completion?
If the earn-out cannot be reliably valued at the time of the transfer, no income is recognised in that financial year in respect of it. Recognition is deferred until the contractual condition is met and the amount becomes certain.
Can the Article 21 LIS exemption apply to an earn-out?
Yes. Binding Tax Ruling V0062-26 issued by the Spanish Directorate-General for Taxes (DGT) clarifies that the Article 21 LIS exemption may also apply to the contingent portion of the price, even if it accrues in a later financial year, provided that the legal requirements are met.
When must the requirements under Article 21 LIS be satisfied?
According to the DGT’s interpretation, the requirements under Article 21 LIS must be met at the date of the share or equity transfer, even if the earn-out is received in a later financial year.
What conditions must be met to apply the exemption to a deferred earn-out?
In order for a deferred earn-out to benefit from the exemption, it is necessary that: the Article 21 LIS requirements were satisfied at the time of the transfer; the income derives from the same completed disposal transaction; and the nature of the future events determining payment is properly evidenced.
What exemption percentage is provided under Article 21 LIS?
Article 21 LIS provides for a 95% exemption on capital gains arising from the transfer of shares or equity interests, provided that the statutory requirements are met.
Why is it important to analyse the earn-out before signing the SPA?
It is important because the accounting treatment of the earn-out determines the timing of taxation under Corporate Income Tax. In M&A transactions, it is therefore advisable to assess during negotiations how the contingent consideration will be classified and whether it may benefit from the Article 21 LIS exemption.
Need advice? Access the related area on earn-outs and double taxation relief under Spanish Corporate Income Tax:
