You spend five, maybe ten years building a company from a laptop in your bedroom to a multi-million pound exit. The deal is signed. You celebrate. But months later, a letter from HM Revenue and Customs arrives. They want to reclassify your hard-earned sale proceeds as a monthly salary.
This isn't a hypothetical scare tactic. It is happening across the UK tech and business ecosystem right now.
HMRC has heavily intensified its focus on how founders are compensated during a corporate acquisition. The tax authority is looking closely at earn-out structures. These are the common contract clauses where a portion of your sale price is held back and paid later based on the business hitting future targets.
If you get the structuring wrong, you don't pay the lower Capital Gains Tax rate. Instead, you face the standard income tax rates of up to 45% plus National Insurance contributions. For a founder expecting a life-changing payout, this mistake can easily wipe out a massive chunk of your net proceeds.
The Reclassification Trap
The tension sits entirely between two different types of money: capital and income. When you sell shares, the profit is a capital gain. If you qualify for Business Asset Disposal Relief, you might pay a reduced rate on your first slice of profit, or the standard capital gains rate on the rest. Either way, it's significantly cheaper than income tax.
HMRC sees things differently when a founder stays on at the company post-sale. Buyers almost always want the original team to stick around to ensure a smooth transition. This is where the risk climbs.
If your legal paperwork links your future earn-out payments directly to your ongoing employment, HMRC will argue that the cash isn't actually part of the purchase price for your shares. They will argue it's just a bonus disguised as a capital gain to dodge taxes.
What Triggers an Investigation
Tax inspectors look at the internal mechanics of your Share Purchase Agreement. They don't care about what you call the payment. They look at the actual reality of the conditions.
Several factors will immediately cause an inspector to challenge a deal.
- The Employment Link: If the contract says you lose your earn-out money the moment you quit or get fired, you have a problem. True share consideration belongs to you because you owned the asset. If receiving the money requires you to stay in your office chair, HMRC views it as salary.
- Unrealistic Salaries: Founders often agree to take a tiny salary post-sale because they expect millions from the earn-out. This looks highly suspicious. If your post-sale salary is far below the market rate for a chief executive or top engineer, the tax office will assume the earn-out is making up the difference.
- Symmetrical Payouts: If three founders sell a business but have different shareholdings, their earn-out payments should reflect their original ownership percentages. If the earn-out distributes cash equally among them despite unequal shareholdings, it looks like a performance bonus for work, not a payment for equity.
HMRC uses its advanced internal data systems to cross-reference corporate filings with individual tax returns. A sudden, massive drop in regular salary combined with a huge capital gains claim after a company sale stands out clearly on their dashboard.
Setting Up a Defensible Structure
You can still use earn-outs to bridge valuation gaps with a buyer. You just have to build them with commercial drivers rather than personal ones.
The targets inside the purchase contract must belong to the business, not to you as an individual. Base the milestones on objective corporate metrics like overall revenue growth, EBITDA thresholds, or specific product delivery timelines. Avoid linking the targets to your personal performance reviews or individual key performance indicators.
The contract drafting needs to decouple the money from your employment status wherever possible. Good leaver and bad leaver provisions must be handled delicately. If you have to exit the business due to illness, the capital value of your shares shouldn't magically vanish. If it does, you're essentially telling the tax authority that the cash was tied to your personal labor all along.
Immediate Steps Before the Deal Closes
Do not wait until the deal is drafted to think about the tax profile. Once the legal structure is locked in, reversing it is incredibly difficult.
First, benchmark your post-acquisition salary. Ensure the buyer pays you a realistic, defensible market wage for the role you will perform during the transition period. This removes the argument that you are intentionally underpaying yourself to convert salary into capital.
Second, consider applying for a formal statutory clearance from HMRC before completion. This process involves laying out the commercial realities of the deal structure to the tax authority ahead of time. Getting a green light provides a substantial shield against future retrospective challenges, provided you disclosed all material facts honestly.
Keep meticulous records of the entire negotiation. Save the emails, pitch decks, and valuation models that prove the earn-out structure was created because of genuine disagreement over the company's future value, not as a creative payroll mechanism.
