An earn-out is a promise of future money. That raises an obvious tax question: when does the seller pay tax on it? If the answer is “now”, the seller may face a capital gains tax bill on money it may never receive. If the earn-out is linked to the seller’s continued employment, there is a further risk that SARS treats it as salary rather than sale proceeds.
This article explains the main tax rules for earn-outs in South Africa, for both sellers and buyers. It is a guide to the issues, not a substitute for tax advice on a specific transaction.
The starting point: accrual
South African income tax and capital gains tax (CGT) generally apply when an amount is received by or accrues to the taxpayer, whichever happens first.
An amount accrues when the taxpayer becomes unconditionally entitled to it, even if it is payable in the future (CIR v People’s Stores (Walvis Bay) (Pty) Ltd 1990 (2) SA 353 (A)). This has two important consequences for deferred consideration:
- a fixed deferred amount that is payable unconditionally on a future date generally accrues on the date of sale; and
- an amount payable only if an uncertain future event happens is subject to a suspensive condition. It does not accrue until the condition is fulfilled.
Most earn-outs depend on the business meeting performance targets. That is uncertain, so the earn-out is conditional and should not accrue on the date of sale.
Capital gains tax for the seller
Where the seller holds the shares or business as a capital asset, the sale gives rise to a capital gain or loss under the Eighth Schedule to the Income Tax Act 58 of 1962.
In the year of sale, the seller calculates its gain using the proceeds that have accrued, which are usually the fixed portion of the price. The conditional earn-out is not included at that stage.
Section 24M: unquantified amounts
Section 24M of the Income Tax Act deals specifically with assets disposed of or acquired for an amount that cannot be quantified at the end of the year of assessment. In broad terms, the unquantified portion is deemed not to accrue to the seller (or to be incurred by the buyer) until the year in which it can be quantified. Earn-outs calculated by reference to future profits usually fall within this rule.
When the earn-out is later determined and accrues, the seller includes it as a further capital gain in that later year. If the seller had already included an amount that is later reduced or not paid, the Eighth Schedule allows an adjustment (a capital loss) in the later year.
Section 24N: deferred payments for shares
Section 24N can defer the accrual of quantified or quantifiable amounts payable for equity shares until they become due and payable. It applies only if strict requirements are met, including that:
- more than 25% of the price is payable after the end of the seller’s year of assessment in which the sale took place, and is based on the future profits of the company;
- the shares sold represent more than 25% of the total value of the equity shares in the company;
- the buyer and seller are not connected persons after the sale;
- the buyer must return the shares if it fails to pay any amount when due; and
- the amount is not payable in terms of a readily tradeable financial instrument.
Section 24N is most useful where the deferred price is linked to profits but can still be quantified in principle. Where its requirements are not met, the common law principles and section 24M may still defer accrual of a genuinely conditional earn-out.
Timing mismatches
A seller should model when tax will be payable against when cash will be received. A common mistake is to treat a deferred amount as an “earn-out” when it is actually payable unconditionally. If so, the full amount accrues on the date of sale and the seller pays CGT before receiving the cash. Drafting matters: whether a payment is conditional depends on what the agreement actually says.
Capital or revenue?
Most business sales are capital in nature. But if the seller is in the business of buying and selling companies, or acquired the shares with the intention of selling them at a profit, the proceeds may be revenue and fully taxable as income. Section 9C of the Income Tax Act deems the proceeds on the sale of equity shares held for at least three years to be capital, which gives certainty to long-term holders.
The employment income risk
Where the seller stays on as an employee or consultant after the sale, earn-outs are often linked to their continued service. For example, the earn-out may be forfeited if the seller resigns or is dismissed for cause (“bad leaver”).
This creates a real risk. The definition of gross income in the Income Tax Act includes amounts received in respect of services rendered. If an earn-out is, in substance, a reward for the seller’s future work rather than part of the price for the business, SARS may treat it as employment income. That means:
- it is taxed at the seller’s marginal income tax rate, which is much higher than the effective CGT rate;
- the buyer (or the company) may have to withhold employees’ tax (PAYE); and
- the buyer may be liable for penalties if it fails to withhold.
To reduce this risk:
- link the earn-out to business performance, not to the seller’s continued employment;
- pay the seller a market-related salary for their services, separate from the earn-out;
- where retention incentives are needed, set them up as a separate, clearly identified bonus or incentive scheme; and
- document the commercial rationale for the earn-out as part of the purchase price.
Where the buyer pays the earn-out in its own shares, and the seller is an employee, the rules in section 8C on equity instruments acquired by employees may also need to be considered.
The buyer’s position
Base cost
For the buyer, the price paid for shares or capital assets forms part of its base cost, which reduces the gain on a future sale. Under section 24M, an earn-out that cannot be quantified is only added to the buyer’s base cost when it is quantified and incurred. Section 24N similarly matches the buyer’s cost to the seller’s accrual where it applies.
Business assets and allowances
In an asset sale, the buyer may claim capital allowances on qualifying assets based on their cost. Where the earn-out increases the price of the business, the parties should agree how the earn-out is allocated between assets (for example, goodwill, intellectual property and equipment). Goodwill generally does not qualify for an allowance. Intellectual property may qualify under section 11(gA), subject to conditions.
Interest
Interest on debt used to fund the earn-out may be deductible if the requirements of the Income Tax Act are met, for example under section 24O where the buyer acquires an operating company, and subject to the interest limitation rules in section 23N.
VAT and securities transfer tax
- Share sales: The sale of shares is an exempt financial service for VAT. Securities transfer tax at 0.25% applies to the consideration for the shares. Where the consideration increases due to an earn-out, the parties should consider whether further securities transfer tax is payable.
- Asset sales: If the business is sold as a going concern between VAT vendors and the requirements of section 11(1)(e) of the VAT Act are met, the supply is zero-rated, including the earn-out component. If not, VAT at the standard rate is payable on the earn-out when the time of supply occurs for that payment, and the agreement should state whether the price is inclusive or exclusive of VAT.
Practical checklist
- Check whether each deferred payment is truly conditional. If it is not, it probably accrues on the date of sale.
- Consider sections 24M and 24N at the drafting stage, not after signing.
- Keep the earn-out separate from employment. Pay salary separately and avoid making the earn-out depend on the seller staying.
- Agree the price allocation in an asset sale, including the earn-out.
- Model the cash flow and tax timing for both parties.
- Consider an advance tax ruling for large or complex transactions.
How O’Reilly Law can help
We structure earn-out arrangements with sellers and buyers, and work with tax advisers to make sure the legal drafting supports the intended tax outcome. Speak to our business structuring team.
Contact us to discuss your transaction in confidence.
This article is general information and not legal or tax advice. Tax outcomes depend on the specific facts and wording of the agreement, and specialist tax advice should be obtained. Correct as at October 2026.