Taxation of an Earn-Out: How an Earn-Out Agreement Is Taxed

Note: This article describes Danish tax rules specifically.

If you've agreed on an earn-out as part of the price when selling a business, it's not enough to know how the earn-out structure works from a business perspective — the tax treatment differs from an ordinary, cash purchase price, and you should know this before signing.

An earn-out is classified as a "recurring payment"

For tax purposes, earn-out payments are generally classified as a recurring payment. This means a capital value of the future, conditional payments needs to be determined already at the time of sale — that is, an estimate of what the expected earn-out payments are actually worth today. This capital value is included as part of the total transfer sum and taxed under the ordinary rules for the sale itself.

What happens with payments beyond the capital value?

If the earn-out turns out to yield a higher actual return than the originally determined capital value suggested, the excess portion is taxed separately for you as the seller, as the payments are actually received. In return, this portion is tax-deductible for the buyer. Conversely, if the actual payments end up lower than the original capital value, a loss can arise that needs to be handled for tax purposes.

When is the sale itself taxed?

Taxation of the entire transfer — including the capitalized value of the earn-out — generally happens in the income year a binding agreement is entered into between the parties, regardless of whether it's an asset or share sale, and regardless of the actual earn-out payments only falling due later.

Why is the capital value so important to you as a seller?

Because any payment beyond the determined capital value is taxed separately, you as seller have a direct financial interest in how the capital value is set when the agreement is entered into. A capital value set too low can mean a larger share of the later earn-out payments is taxed as recurring income instead of being covered by the original, often more favorable, taxation of the sale itself.

Does the same apply to the sale of subsidiary shares?

If it's a sale of shares already exempt from tax — for example certain subsidiary shares owned through a holding company — the portion of the earn-out payments corresponding to the capital value will generally be covered by the same tax exemption. Payments beyond the capital value are, however, taxed separately, regardless of this exemption. See the full picture in our overview of tax and VAT when selling a business.

Why should you always have this calculated by an accountant?

Determining the capital value is an estimate, not a fixed formula, and it directly affects both your and the buyer's tax in the years after the takeover. Always have an accountant work through the consequences before you agree on the final earn-out structure — an incorrectly determined capital value can prove costly, long after the deal is closed.

Frequently asked questions

Is an earn-out taxed the same way as an ordinary purchase price?

No. Earn-out payments are generally classified as a recurring payment, where a capital value is determined at the time of sale — payments beyond this value are taxed separately, as they're received.

When do I pay tax on an earn-out agreement?

The capitalized value is taxed in the income year the binding agreement is entered into. Any payments beyond the capital value are taxed on an ongoing basis, as they're actually received.

Can I choose how the capital value is determined myself?

It needs to be set based on a realistic estimate, not freely as desired — but since it's an estimate, it's worth negotiating and having an accountant quality-check, as it directly affects your subsequent taxation.

Considering an earn-out as part of your sale? Read the full walkthrough of earn-outs when selling a business, or book a no-obligation call if you'd like help getting the structure and taxation correctly worked through.