An earnout arrangement ties part of your sale price to how the business performs after you sell it. Look-through treatment applies to qualifying earnout rights created on or after 24 April 2015, and it treats every earnout payment as extra capital proceeds from the original sale rather than as a gain on a separate asset. Nothing is assessed on the earnout right upfront, so the tax falls due as each payment arrives and the sale year assessment is amended.
Look-through treatment carries eight conditions, and all eight must be satisfied. A non-qualifying earnout right is taxed as a separate CGT asset, which means an assessment in the sale year on money you have not yet received.
Blackwattle Tax advises middle market sellers on the capital gains tax position when selling a business, including how earnout terms are drafted.
What an Earnout Is and Which Treatment Applies
An earnout ties part of your sale price to how the business performs after settlement. This is the merger and acquisition sense of the term, not an employment earn-out or a commission arrangement.
A standard earnout gives the seller a right to additional payments when the business meets agreed performance thresholds. A reverse earnout gives the buyer a right to repayment when those thresholds are missed.
An earnout is not a deferred settlement. An earnout payment has an amount that is not reasonably ascertainable when the right is created. A deferred settlement has a known amount and a later payment date. The two attract different treatment.
Two tax treatments exist for earnout rights. Look-through treatment applies to qualifying rights created on or after 24 April 2015. Any arrangement that fails the conditions falls back to separate-asset treatment. Both outcomes are settled by how the contract is drafted.
What You Are Taxed On Under Look-Through Treatment
Under look-through treatment, every earnout payment you receive increases the capital proceeds from the original sale.
A look-through earnout right is not a separate CGT asset. Capital gains and losses on the right itself are disregarded. The right carries no reporting obligation and requires no valuation.
Each financial benefit received is added to the capital proceeds from the disposal of the business or asset sold. Each benefit paid back reduces them. The buyer receives the mirror outcome, with payments adjusting the cost base and reduced cost base of the asset acquired.
A worked example
A business sells for $1,200,000 upfront against a cost base of $900,000. The contract adds 30% of annual revenue above $2,000,000 for the following three income years. Figures are illustrative.
Income year | Earnout payment | Amended capital proceeds | Amended capital gain |
Year 0 (sale) | none | $1,200,000 | $300,000 |
Year 1 | $120,000 | $1,320,000 | $420,000 |
Year 2 | $180,000 | $1,500,000 | $600,000 |
Year 3 | $90,000 | $1,590,000 | $690,000 |
The gain grows as payments arrive, and every adjustment attaches to the Year 0 sale. No new CGT event happens in Years 1, 2 or 3.
When the Tax Falls Due
An earnout right carries no assessment at the time of sale, so the tax falls due as each payment arrives.
The amendment cycle
- The sale year is lodged on the upfront amount alone.
- An earnout payment arrives in a later income year.
- An amendment is requested to the sale year assessment, using labels 7F and 7G of the CGT schedule.
- The amended assessment issues, with tax owed on a gain belonging to an earlier income year.
- The cycle repeats for every payment.
Plan cash for this sequence. The payment lands in one income year and the liability attaches to another, so the two never appear in the same assessment.
The period of review is extended to match. It runs for the later of the normal period and four years after the end of the income year in which the last possible payment could be made under the right. That extended period is set by the drafting of the earnout, not by the date payments arrive.
Interest you are not charged, and the exception
Shortfall interest charge does not apply to the additional tax, provided the amendment is requested by the lodgment due date for the income year the payment arrived.
That relief has a limit. It falls away to the extent a concession was claimed that you turn out not to be eligible for once the payments are counted. The relief also runs one way. The Commissioner pays no interest on an overpayment created by an earnout payment.
The Eight Conditions Your Earnout Must Meet
Look-through treatment is conditional, and an earnout right qualifies only when all eight conditions are satisfied.
- The right is a right to future financial benefits that are not reasonably ascertainable when the right is created.
- The right was created under an arrangement involving the disposal of a CGT asset.
- The disposal caused CGT event A1 to happen.
- Just before the CGT event, the asset was an active asset of the entity disposing of it.
- All financial benefits under the right are to be paid within five years after the end of the income year in which the CGT event happened.
- The benefits are contingent on the economic performance of the asset, or of a business in which it is expected to be an active asset over the relevant period.
- The value of the benefits reasonably relates to that economic performance.
- The parties deal with each other at arm’s length in making the arrangement.
Conditions 6 and 7 fail most often, usually because the payment trigger is tied to something other than what the business earns.
Where the five-year clock starts
The five-year limit runs from the end of the income year in which the CGT event happened, not from the contract date.
A sale settling in May 2027 falls in the 2026-27 income year, giving an outer date of 30 June 2032. A sale settling in August 2027 falls in the next income year, giving an outer date of 30 June 2033. Two deals three months apart receive outer dates almost eleven months apart.
An earnout with a final payment date past that outer limit fails condition 5, and the entire arrangement loses look-through treatment.
What Happens If Your Earnout Does Not Qualify
A non-qualifying earnout right is treated as a separate CGT asset and is assessed at the time of sale.
The market value of the right forms part of the capital proceeds in the sale year. Later payments end the right and trigger separate CGT events, each producing its own gain or loss.
Cash flow is the practical difference. The assessment lands in the sale year on the market value of money not yet received, and possibly never received.
The same deal, treated as a separate asset
The same sale, with the earnout rights valued at $360,000 at the date of contract.
Income year | Look-through | Separate asset |
Year 0 | $300,000 gain | $660,000 gain |
Year 1 | $120,000 added to Year 0 | nil |
Year 2 | $180,000 added to Year 0 | $60,000 gain |
Year 3 | $90,000 added to Year 0 | $30,000 capital loss |
Both routes report $690,000 in total. One of them requires tax funded on $660,000 in the year of sale, before a single earnout dollar has arrived.
Where qualification is uncertain, a private ruling from the ATO settles the position before lodgment rather than after.
Small Business CGT Concessions Across an Earnout Period
Concessions claimed on the original sale carry through to earnout payments, because those payments form part of the same capital proceeds.
The reverse also holds. Later payments can change the answer. They can affect whether you still satisfy small business CGT concession eligibility, and they can affect the time available to take the steps a concession requires.
Remaking your choices, and the deadline
A choice affected by earnout payments can be remade. The remaking deadline is the lodgment time for the income year the payment arrived. Past that point the original choice stands.
Deferral is the alternative. Where eligibility is likely to move, holding a choice until the position is clear produces a better outcome than committing early.
The superannuation contribution trap
A superannuation contribution made to access a concession cannot be withdrawn if that concession later becomes unavailable.
The sequence runs like this. Earnout payments arrive, they push the seller past a threshold, the concession falls away, and the contribution made to claim it stays locked in the fund. Model eligibility across the full earnout range before contributing, not against the upfront figure alone.
Capital Losses Under an Earnout Arrangement
A capital loss on a sale with an earnout attached is temporarily disregarded until the amount becomes certain.
The loss cannot be final while future payments could still reduce it. Once no further payment can change the figure, the loss becomes available from the income year it was originally incurred, not the year certainty arrived.
Sellers carrying losses forward are affected by that timing. The loss lands in an earlier year against gains already reported there, which changes the carry-forward position for every year in between.
When an Earnout Is Taxed as Income Instead of Capital
An earnout payment tied to the seller staying on, rather than to what the business earns, puts capital treatment at risk.
Conditions 6 and 7 require the payment to be contingent on economic performance and to reasonably relate to it. A retention payment, a service-linked bonus, or a milestone controlled by the seller personally meets neither test cleanly.
Two outcomes follow. The right may fail look-through treatment. Separately, an amount paid for continued service can take the character of income rather than capital proceeds, which removes any CGT discount and taxes the amount at full marginal rates.
Draft the payment trigger against business performance, not against the seller’s presence.
Reverse Earnouts and Clawback Payments
A reverse earnout gives the buyer the right, and the seller repays amounts when the business misses its thresholds.
Look-through treatment operates the same way in reverse. Each amount repaid reduces the capital proceeds from the original disposal, and the sale year is amended downward rather than upward.
Some contracts run in both directions at once, with either party able to owe the other depending on performance. The same logic applies to each leg.
When the Earnout Pays Nothing
A qualifying earnout that pays nothing requires no amendment at all.
The assessment stands on the upfront amount alone, because look-through treatment adjusts only for benefits actually received or paid.
A non-qualifying earnout produces the opposite result. The assessment already included the market value of the right in the sale year, so a nil outcome leaves tax paid on money that never arrived. A capital loss arises when the right ends, several years later, with nothing to offset.
Earnout Terms Worth Fixing Before Contracts Are Signed
The drafting decisions that determine look-through qualification are made before contracts are signed, not after settlement. Four terms carry the most tax weight.
- Final payment date: Confirm it falls within five years after the end of the income year of the CGT event, not five years from the contract date.
- Payment trigger: Tie it to revenue, profit or another measure of business performance rather than to continued involvement.
- Concession modelling: Test eligibility across the full earnout range before making any superannuation contribution.
- Amendment planning: Record the lodgment due date for every income year a payment could arrive.
Our Chartered Accountants advise on capital gains tax, small business concessions and private rulings for sellers across the middle market. Book a free 30-minute strategy session with one of our directors while the earnout terms can still be changed.
Earnout Tax Questions Sellers Ask
How are earnouts treated for tax purposes in Australia?
Qualifying earnout rights created on or after 24 April 2015 receive look-through treatment. Payments are treated as adjustments to the capital proceeds of the original sale rather than as gains on a separate asset. Non-qualifying rights are taxed as separate CGT assets.
Are earnout payments taxed as capital gains?
Under look-through treatment, yes. Each payment increases the capital gain on the original disposal. A payment tied to continued service rather than business performance can take the character of income instead, which removes the CGT discount.
Do I have to amend my tax return when I receive an earnout payment?
Yes. Each payment requires an amendment to the assessment for the year of the original sale, made through labels 7F and 7G of the CGT schedule. Request it by that income year’s lodgment due date to avoid shortfall interest.
Are earnout payments expensed by the buyer?
No. For CGT purposes, the buyer adds payments to the cost base and reduced cost base of the asset acquired rather than claiming them as an expense.
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Disclaimer: We endeavour to make sure the information provided in this guidance is up to date and accurate. Please note, that the information is only intended to be a guide, with a general overview of information. This guidance is not a comprehensive document and should not be interpreted as legal advice or tax advice. The information is general in nature. You should seek the assistance of a professional opinion for any legal and tax issues related to your personal circumstances.