The Earnout CGT Trap: How Deal Terms Can Cost You Small Business Concessions

The small business CGT concessions are worth knowing about. If your business qualifies, you can reduce your capital gains tax by up to 50% through the 50% CGT discount, plus potentially another 50% reduction through the small business 50% reduction—which can push your effective tax rate on the sale down to 11.25% (compared to 22.5% for a standard capital gain).

That's a material amount of money. On a $5 million sale with a $2 million capital gain, the concessions can save you $225,000 in tax. But there's a catch. One of the core eligibility tests is the net asset value threshold: at the time of the CGT event (the sale date), the net assets of your business cannot exceed $6 million. If they do, you lose access to the concessions entirely.

Most sellers understand the asset test applies to the day of settlement. What they don't realise is that agreed-but-unpaid deferred consideration—your earnout, or any other staged payment term—counts as an asset of the business at the time of the CGT event. Not at the time you receive the cash. At the time the deal is agreed and the CGT event occurs. That means a poorly structured earnout can push your net assets past $6 million on day one of the sale, triggering the loss of the concessions, even though you haven't received the money yet.

How the $6M Test Works

The small business concessions regime in the Income Tax Assessment Act 1997 contains several tests you need to pass to qualify. One of them is the maximum net asset value test. At the time the CGT event happens (the time you agree to sell and the asset changes hands), the net assets of the company, trust, or partnership must not exceed $6 million.

Net assets are calculated as total assets minus total liabilities. For a typical business sale, this includes tangible assets (property, equipment, inventory) and intangible assets (goodwill, customer lists, intellectual property). The ATO's interpretation includes deferred consideration—amounts agreed to be paid by the buyer but not yet received—as an asset of the business at the date of the CGT event.

This is where the timing trap opens. You might think your business has $4 million in net assets: plant, property, and goodwill. But if you've agreed to an earnout of $2.5 million, your net assets at the CGT event are $6.5 million. You've crossed the threshold. You lose the concessions.

The Timing Trap in Action

Here's a concrete example. You own a distribution business with $3.8 million in net assets (property, equipment, customer goodwill). A buyer makes an offer: $6 million purchase price. But they want to structure it this way:

• $4 million upfront at settlement
• $2 million earnout over two years, contingent on customer retention

At settlement, your business technically receives $4 million in cash from the buyer (reducing your asset base as the business winds down). But the sale agreement also creates a contractual right to receive $2 million in earnout payments. That right is an asset, recognised for the purposes of the asset test. Your net assets at the CGT event are therefore $3.8M + $2M (earnout right) = $5.8M. You're still under the threshold. No problem.

But what if the structure is different:

• $3 million upfront at settlement
• $3 million earnout over three years, contingent on revenue targets

Now your net assets are $3.8M + $3M (earnout right) = $6.8M. You've crossed the $6 million threshold at the moment of the CGT event. You lose access to the small business concessions entirely, even though you haven't received the earnout payments yet and might never receive them in full. Your effective capital gains tax rate jumps from 11.25% to 22.5%. That $3 million earnout that looked valuable just became significantly more expensive, because the tax concessions have been forfeited.

The trap is that you don't see the impact until well after you've committed to the sale terms. The broker or accountant might have flagged it, but earnout structuring is often discussed at the negotiation stage when tax advice hasn't been obtained. By the time you realise the impact, you're already deep in the process.

Why This Matters More Than You Think

The arithmetic is stark. Let's say your actual capital gain (sale price minus cost base) is $2 million. With the small business concessions, your taxable gain is $500,000 (after the 50% reduction). At a 45% marginal tax rate plus Medicare levy, your tax bill is around $280,000.

Without the concessions, your taxable gain is the full $2 million. Your tax bill jumps to $920,000. That's a difference of $640,000 in tax on a single $2 million gain. On larger gains or higher marginal tax rates, the difference is even more dramatic.

Now, earnouts are often attractive precisely because they spread the deal value over time and reduce the upfront cash the buyer pays. But that same structure can cost you hundreds of thousands of dollars in tax if it pushes you over the asset threshold.

The Fix: Restructure Before You Agree to Terms

If you're planning a sale and earnout payments are part of the discussion, there are ways to keep yourself below the $6 million threshold. The critical point is that these need to be implemented before you agree to the sale terms, because the asset test applies at the CGT event.

Restructure asset ownership. If your business is a company, transfer non-essential business assets (investment property, surplus inventory, vehicle assets) into a separate entity before negotiating the sale. Only the assets of the operating business are tested against the threshold. This needs to happen before the buyer is even in the picture, ideally 12+ months before marketing the business.

Use a sale of shares rather than assets. The asset test applies to the assets of the business, not the assets of the shareholder. If you sell the entire business (via a share sale), the test is about the company's net assets, not your personal net assets. This distinction matters if the buyer is prepared to negotiate a share sale instead of an asset sale.

Cap the earnout or use performance hurdles instead of deferred cash. Negotiate with the buyer to structure the deal differently. Instead of "$2 million earnout payable based on revenue targets," try "up to $2 million earnout, paid only if revenue targets exceed $X by more than 10%." Genuine performance conditions (not just time-based deferrals) may not be treated as assets at the time of the CGT event, depending on how they're drafted. This requires specialist tax advice.

Get the value up front, then manage the earnout separately. Increase the upfront cash payment and reduce the earnout. Yes, this means the buyer pays more immediately, but you avoid the asset test trap and you get cash in hand. The buyer's reluctance to increase upfront payment is information—it signals they're not confident about hitting the earnout targets themselves, which is another reason to be cautious about accepting the deferred amount.

Why This Trap Exists

The $6 million threshold was introduced to target the concessions at genuinely small businesses. The intent was to prevent large, property-rich entities from claiming small business relief. But the inclusion of deferred consideration as an asset creates an anomaly: a business can structurally qualify for the concessions (real operating business, under the threshold in asset terms) and then accidentally disqualify itself by accepting staged payment terms that are standard market practice in M&A transactions.

The ATO's position is clear: the asset is recognised at the date of the CGT event, which is the date the sale is agreed and the asset changes hands. This interpretation has been tested in case law and holds up. But it's not intuitive, and many business owners and their advisers miss it.

The Takeaway

If you're an Australian SMB owner planning a sale, the small business CGT concessions could save you hundreds of thousands of dollars in tax. But you can lose them before you receive a single earnout payment if you're not careful about how deferred consideration is structured. The asset test is done at the time of the CGT event, not at the time you receive the cash. Earnouts and deferred payments count as assets at that moment.

The fix is simple: get specialist tax advice before you agree to any sale terms involving deferred consideration. Understand what your net asset position is at the CGT event, including the value of any earnout rights the buyer is creating. If you're going to lose the concessions, know it before you sign. You can then decide whether restructuring the deal or taking an alternative offer makes more economic sense.

This is exactly the kind of trap that separates well-advised sales from costly ones. And unlike earnout disputes, which are often unresolvable after the fact, this trap is entirely preventable if you see it coming.