BDO Corporate Tax News

Earn-out payments—contingent portions of a purchase price based on future performance—are a common feature in Danish M&A transactions. Their tax treatment is complex, especially following amendments introduced by Act No. 749 of 20 June 2025. This article provides a practical overview of how earn-outs are taxed under section 12 B of the Danish Tax Assessment Act, highlights the 2025 legislative changes and examines the risk of reclassification as salary under Danish administrative practice.

What Is an Earn-Out and When Does Section 12 B Apply?

An earn-out is a contractual arrangement in which part of the purchase price of a business is deferred and made contingent on future business performance or other post-sale conditions (e.g., revenue or profit targets). An earn-out is typically used where the parties to a transaction are unable to agree on valuation, the anticipated growth and performance of the business so the buyer agrees to pay the seller part of the purchase price at a later date provided the business meets predetermined business milestones. For tax purposes, an earn-out payment generally will be treated as part of the purchase price for the acquisition, but this may be affected where the seller continues to render services for the company. Danish tax law often considers such payments to be recurring payments, which are generally subject to a combination of capital gains tax and taxation as ordinary income. However, the tax authorities in certain circumstances reclassify an earn-out payment as compensation paid to the seller if the payment is conditioned on the seller’s continued employment post-transaction, which likely will have significant tax implications.

Section 12 B regulates the tax treatment of recurring payments and applies if there is uncertainty about either the duration or the amount of the payment, and if the payment extends beyond the year of the agreement. Most earn-out payments meet this definition, as their ultimate amount depends on future events and typically involves payments in years following the sale. For example, if a company is sold in 2025 with additional payments made in 2026 and 2027 based on performance each year, these are considered recurring payments under section 12 B.

Mechanics of Section 12 B: Capitalisation and Taxation

• For the Seller: At the time of sale, the parties must compute a capitalised present value of the future earn-out payments. This value is included in the seller’s proceeds in the year of sale and taxed accordingly. As actual payments are received, they are not taxed again until the total amount received exceeds the original capitalised value. The seller maintains a running balance (“saldo”) of the earn-out, starting at the capitalised amount and reduced by each payment received:
  • If total payments exceed the capitalised present value, the seller will generally be taxed on the excess as ordinary income in the year the balance turns negative.
  • If total payments are less than the estimate, the seller can deduct the unrecovered balance in the year the earn-out ends, provided the initial capitalised amount was taxable.
• For the Buyer: The buyer treats the present value as part of the acquisition cost. Earn-out payments up to the capitalised amount are not deductible at the time of payment but may be depreciated if the asset is depreciable. The buyer also keeps a balance:
  • If payments exceed the initial value, the excess is deductible as an expense.
  • If payments fall short of the initial value, the buyer must include the remaining balance as taxable income or adjust the tax basis of the acquired asset.

This “saldo system” ensures that both the seller and buyer are taxed or are entitled to deductions on the actual amounts paid, mirroring the outcome had the final earn-out amount been established at the time of sale.

Amendments in 2025

• No Capitalisation for Certain Share Sales: If the earn-out relates solely to the transfer of shares that are tax-exempt for both the seller and the buyer under the Share Gains Tax Act, upfront capitalisation is not required. This applies to shares classified as subsidiary shares, group company shares or certain portfolio shares. The amendment eliminates unnecessary calculations and reporting for tax-neutral share sales.
• Refined Symmetry for Non-taxable Assets: When the asset transferred yields no taxable gain for the seller and the buyer cannot obtain any tax basis benefit, earn-out payments are neither taxed for the seller nor deductible by the buyer. This ensures that tax neutrality is maintained in both directions. The effective dates for the rules are as follows:
  • Symmetry changes: 19 March 2025
  • Share-related rule: 22 June 2025
  • Agreements before these dates remain subject to the old rules.
• Risk of Reclassification as Salary When Tied to Employment: A major risk arises when the seller must continue working for the company to receive the earn-out. The Danish tax authorities may reclassify such payments as salary rather than capital gain, leading to very different tax consequences.

To determine whether reclassification is required, Danish tax law looks at whether the earn-out is “sufficiently tied to the person’s employment relationship or work effort.” If so, it can be considered salary, regardless of contractual labelling. Factors include whether the earn-out is conditioned on continued employment, whether a payment formula is linked to personal performance and whether there is forfeiture upon resignation or termination. For example, where shareholders had to remain employed to receive earn-out payments, the payments were reclassified as salary and the tax authorities split the earn-out: one part as genuine sales proceeds, the other salary for continued labour. If the earn-out is reclassified, the seller is taxed at personal income tax rates (often 56% or more), not capital gains rates; the paying entity may need to withhold tax and social contributions; and the buyer may treat the payment as a deductible wage expense, not an acquisition cost.

It should be noted that not every earn-out involving ongoing roles is automatically salary. If the employment condition is incidental or lacks substance, recharacterisation may not occur. However, if the condition is significant, the risk is real.

BDO Insight

Danish tax law provides a structured method to address earn-outs, ensuring fairness for typical deals but drawing a sharp line when earn-outs resemble pay for personal services. The 2025 amendments simplify compliance for tax-neutral transactions. However, the risk of reclassification as salary remains significant when earn-outs are tied to continued employment. Careful structuring and documentation are essential to avoid unwelcome tax surprises. Consider the following:

• When structuring earn-outs, ensure a sensible valuation for tax purposes.
• After the 2025 changes, determine whether your deal is exempt from capitalisation.
• If the earn-out includes a requirement for the seller to remain employed, consider obtaining tax advice on the risk of reclassification.
• Thoroughly document the rationale for the earn-out.
• Avoid explicit ties to employment if possible.
• Stay updated on new rulings or guidance.

Arne Riis
BDO in Denmark