Taxing Escrows and Earn-Outs In Share Purchase Agreement

In M&A transactions, buyers frequently deposit a portion of the sale consideration into escrow accounts to mitigate future risks or indemnify against potential liabilities. Because the seller lacks an unconditional right to these funds until specific conditions are met, the income does not legally "accrue" and is not taxable in the year of transfer. However, the Income-tax Act, 2025 contains a statutory lacuna: it lacks a specific deeming fiction to tax these escrow releases in the subsequent year they accrue. Strictly interpreted, subsequent escrow realisations constitute non-taxable capital receipts, although prevailing market practice pragmatically taxes them as capital gains in the year of release.

INTRODUCTION

It is increasingly common in contemporary acquisitions of shares or businesses for the consideration to include an element that is either deferred or contingent. Deferred consideration refers to consideration that is fixed as of the date of transfer but payable after a specified period. Contingent consideration, conversely, comprises additional consideration that becomes payable only upon the satisfaction of specified future conditions, such as the achievement of stipulated profit levels or EBITDA. Such arrangements are often structured as “earn-outs”, whereby the acquirer undertakes to transfer additio