During M&A negotiations, it is highly improbable that the seller and the buyer immediately agree on the same price for the company in question. It is understandably foreseeable that the seller has a much higher valuation of his company than the buyer of the company that they are trying to acquire. In such situations, adding an earn-out clause to the contract being negotiated helps scale that gap between valuations of the company by both parties. An Earn Out clause, more formally known as a deferred consideration clause, is a clause that declares both parties’ intentions to delay a part of the contractual payment to a later date. This later payment is dependent on some aspect of the performance of the company being sold.[1] In simple terms, a part of the payment will be made to the seller after a fixed period after the finalisation of the deal based on whether the company performed as well as the seller had predicted or the parties had decided.

The company’s performance in that period could be measured on any factor as decided by the parties; common markers used to check this are turnover, profits, earnings before tax etc. The parties could also use other markers, such as how much intellectual property has been developed, or whichever other aspect suits the parties’ needs to measure the growth of the company.[2]

This mechanism can be beneficial for both parties in more ways than just helping them reach a consensus on the price of the company. Among others, from the buyer’s perspective, including an Earn out also ensures that the seller of the company still has some stake in the company’s functions even post the sale. This way the seller still has an incentive to ensure that the company undergoes a smooth transition and assists the buyer with any issue they may face.


Indian law is quite ambiguous regarding the existence and definition of deferred consideration itself, let alone its taxation. The RBI sent a notification in 2016 allowing the deferrals to be only until a maximum of 18 months after the date of the contract formation, and this deferred part of the consideration can be a maximum of 25 percent of the total consideration in the deal.[3] Beyond these guidelines, all aspects have been left to the imagination and interpretation of the courts and other authorities.[4]

In such a situation, especially from a tax point of view, it becomes imperative for at least the money earned from an earn-out clause to be better defined and classified which the law has failed to do.

Section 45 of the Income Tax Act describes Capital Gains[5] and does not explicitly include or exclude deferred consideration earnings. This same issue arises with Section 17 of the act which describes the salary earned from the employer.[6] In some cases of mergers and acquisitions, the onus of the company shifts completely to the buyer, while in others, the seller continues to be an employee or holds a managerial position in the company being sold. In the latter, the deferred consideration could be viewed as a part of their income due to their contribution to a company that is no longer owned by them, i.e. salaried income. Neither definition clarifies the position of income earned through deferred consideration in either situation; determining which head this group would fall under is important to decide on which year the taxes should be paid and what percentage of tax should apply.


Ideally, tax should apply only to real income, i.e. money that has reached the hands of the taxpayer. Many judgements support this view, the latest notable one being that of Dinesh Vazirani v PCIT.[7] 

In this case, the taxpayer had filed an Income Tax return based on a total amount, including the deferred consideration which was kept in an escrow account. However, payments were later made from that escrow account due to which the entire deferred consideration that had already been taxed was not given to the taxpayer. The Bombay High Court held that since the money had not been received by the taxpayer, he should be taxed only on the real income earned from those capital gains, and hence he would be eligible for a refund of the extra taxes he had paid over and above the taxes the consideration he received.[8]

On a similar line, in Hemal Shete v CIT, the Bombay High Court held that the potential amount that the taxpayer was to receive as deferred consideration was not assured, but only a maximum possibility. This amount was a contingency, and could not be said to be accrued by the taxpayer until he had the right to claim it, which he did not yet have. Hence, since the taxpayer did not have a right to claim the amount in the year of the transfer of the company, he cannot be taxed in the year of the transfer of the shares.[9]

The opposing view has been elucidated in cases like Ajay Guliya v ACIT, where the Delhi High Court held that according to Section 45(1) of the Income Tax Act, the entire consideration should be taxed in the year of the transfer of share without taking into account the year of the transfer of the consideration. Furthermore, since the ownership and title of the shares are not dependent on the transfer of the deferred consideration being accrued to the seller, the consideration is said to have accrued to the seller irrespective.[10]


It is clear from the above-provided examples that there is no unanimous opinion on which head the income from deferred consideration should be taxed under, nor which year it should be taxed in.[11] It is important to pay properly calculated taxes to be on the right side of the law and not cause yourself any inconvenience. But in such circumstances, deciding which precedent to follow while filing taxes would be a daunting task for even taxation experts, let alone laymen. The RBI must take cognizance of this gap in the law, and set up a framework for defining and categorising each case of deferred consideration if not club all such income under a separate category altogether.

Author(s) Name: Aadithri Shetty (OP Jindal Global University, Sonepat)


[1] Christian Tallau, ‘The Value of Earn-out Clauses: An Option-Based Approach’ (2009) 28(4) Business Valuation Review <http://dx.doi.org/10.5791/0882-2875-28.4.174> accessed 15 July 2023

[2] Ibid

[3] Notification No.FEMA.368/2016-RB

[4] Palash Taing and Aishwarya, ‘Tax Implication of Earn-out Transactions – Tax Authorities – India’ (Mondaq, 15 January 2019) <https://www.mondaq.com/india/tax-authorities/771952/tax-implication-of-earn-out-transactions> accessed 15 July 2023

[5] Income Tax Act 1961, s 45

[6] Income Tax Act 1961, s 17

[7] Dinesh Vazirani v Principal Commissioner of Income Tax and Others (2022) 445 ITR 110

[8] Ibid

[9] The Commissioner of Income Tax v Respondent: Hemal Raju Shete (2016) MANU/MH/0754/2016

[10] Ajay Guliya v Assistant Commissioner of Income Tax, New Delhi (2012) MANU/DE/3348/2012

[11] Shruti KP et al., ‘The Elusive Clarity on Taxation of Deferred Consideration under the Indian Income Tax Act’ (The Legal 500, 30 January 2023) <https://www.legal500.com/developments/thought-leadership/the-elusive-clarity-on-taxation-of-deferred-consideration-under-the-indian-income-tax-act/> accessed 15 July 2023

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