Contingent payment sales

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In business dealings, transactions often occur that include variables based on future events that can be difficult to ascertain (for example, a company may sell in an amount stock along with a percentage of that company's net profits.) As these transactions are contingent on payments that occur in the future, and the total selling price cannot be determined as of the end of the taxable year of the sale, they are known as Contingent Payment Sales. [1] Because of the uncertainty surrounding the final amounts of these transactions, they are difficult to evaluate for the purpose of tax liability. Section 483 of the Internal Revenue Code provides descriptions for the handling of contingent payments and interest on contingent payments. [2]

Contents

Methods of computing tax liability for contingent sales

Maximum Selling Price

If the maximum amount of sales can be determined in the year in which they occur by assuming that all contingencies are met, the price can be calculated in a manner similar to the installment sales method. If the amount is reduced in subsequent years, than the formula is recomputed accordingly. [3] [4]

Fixed Period

If the maximum selling price cannot be determined, but the period over which payments may be received is fixed, then the seller's basis is recovered ratably over the period during which payment may be received under the contract. [5]

Example in Finance

General Mills Acquisition Case

Seeking to build growth momentum, General Mills studied areas of potential growth and value creation in the spring of 1998. This had generated some smaller acquisitions and a general receptivity to acquisition proposals by the firm. In early 2000, the firm's financial advisers suggested that Diageo might be interested in selling Pillsbury, in an effort to focus Diageo on its beverage business, and that Pillsbury would complement General Mills’ existing businesses.

In March 2000, Diageo's chief operating officer contacted General Mills’ chairman and CEO to explore a possible sale of Pillsbury. General Mills submitted its proposed deal terms to Diageo in June 2000—the total proposed payment was $10.0 billion. Diageo submitted an asking price of $10.5 billion. The two sides would budge no further, and it looked as if the negotiations would founder. General Mills did not want to issue more than one-third of its post-transaction shares to Diageo, and believed that its shares were undervalued in the stock market. Diageo believed it was necessary to value General Mills’ shares at the current trading prices. In an effort to bridge the difference in positions, the two firms agreed upon including in the terms of the deal a contingent payment on the first anniversary of the transaction that would depend on General Mills’ share price. James Lawrence, chief financial officer of General Mills, said, “We genuinely believe this is a way in which they could have their cake and we could eat it, too. There’s no question in my mind that, absent this instrument, we wouldn’t have been able to reach this deal.”

David Van Benschoten, General Mills’ treasurer, added that the contingent payment was another example of the “development of the use of [options] in the past 20 years as finance has come to first understand, and work with, the constructs of optionality.”

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Short (finance) Practice of selling securities or other financial instruments that are not currently owned

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Sales Activities related to the exchange of goods in a given time period

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Receipt Written acknowledgment that a person has received money or property in payment

A receipt is a document acknowledging that a person has received money or property in payment following a sale or other transfer of goods or provision of a service. All receipts must have the date of purchase on them. If the recipient of the payment is legally required to collect sales tax or VAT from the customer, the amount would be added to the receipt and the collection would be deemed to have been on behalf of the relevant tax authority. In many countries, a retailer is required to include the sales tax or VAT in the displayed price of goods sold, from which the tax amount would be calculated at point of sale and remitted to the tax authorities in due course. Similarly, amounts may be deducted from amounts payable, as in the case of taxes withheld from wages. On the other hand, tips or other gratuities given by a customer, for example in a restaurant, would not form part of the payment amount or appear on the receipt.

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In United States income tax law, an installment sale is generally a "disposition of property where at least 1 loan payment is to be received after the close of the taxable year in which the disposition occurs." The term "installment sale" does not include, however, a "dealer disposition" or, generally, a sale of inventory. The installment method of accounting provides an exception to the general principles of income recognition by allowing a taxpayer to defer the inclusion of income of amounts that are to be received from the disposition of certain types of property until payment in cash or cash equivalents is received. The installment method defers the recognition of income when compared with both the cash and accrual methods of accounting. Under the cash method, the taxpayer would recognize the income when it is received, including the entire sum paid in the form of a negotiable note. The deferral advantages of the installment method are the most pronounced when comparing to the accrual method, under which a taxpayer must recognize income as soon as he or she has a right to the income.

Basis of accounting

A basis of accounting is the time various financial transactions are recorded. The cash basis and the accrual basis are the two primary methods of tracking income and expenses in accounting.

Tag-along right

Tag along rights comprise a group of clauses in a contract which together have the effect of allowing the minority shareholder(s) in a corporation to also take part in a sale of shares by the majority shareholder to a third party under the same terms and conditions. Consider an example: A and B are both shareholders in a company, with A being the majority shareholder and B the minority shareholder. C, a third party, offers to buy A's shares at an attractive price, and A accepts. In this situation, tag-along rights would allow B to also participate in the sale under the same terms and conditions as A.

Special journals Specialized lists of financial transaction records

Special journals are specialized lists of financial transaction records which accountants call journal entries. In contrast to a general journal, each special journal records transactions of a specific type, such as sales or purchases. For example, when a company purchases merchandise from a vendor, and then in turn sells the merchandise to a customer, the purchase is recorded in one journal and the sale is recorded in another.

Paul S. Walsh British businessman (born 1955)

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A monetized installment sale is a special type of installment sale whereby a seller of appreciated assets attempts to defer U.S. Federal income tax liability over a period of years while currently receiving cash or other liquid assets via a monetization transaction, such as a loan.

References

  1. ↑ See Donaldson, Samuel A., Federal Income Taxation of Individuals: Cases, Problems and Materials, 734 (2nd. Ed. 2007)
  2. ↑ "Number: 201451003" (PDF). www.irs.gov. IRS. December 19, 2014.
  3. ↑ Treas. Reg §15.A453-1(c)(2)(i)
  4. ↑ Viahos, Lou (January 12, 2015). "Deal Economics: Contingent Purchase Price & Imputed Interest". www.taxlawforchb.com.
  5. ↑ Treas. Reg. §15.A453-1(c)(3)(i)
  6. ↑ Treas. Reg. §15.A453-1(c)(4)(i)
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