Sale of shares is one of the most common types of reorganization transactions. It can be used for many purposes, including selling part or all of a business, as well as for internal reorganizations.

From an income tax perspective, the sale of shares appears to be one of the simpler transactions to account for. On the one hand, you need to estimate the market value of the shares being sold, which will constitute taxable income. On the other hand, you need to estimate the expenses incurred in acquiring the shares to determine the deductible cost. The profit calculated this way is taxable at a rate of 19%. At the same time, profit from the sale of shares is added to the taxpayer’s other sources of income, with exceptions specified in the law, to calculate the solidarity tax, once the sum of income exceeds the threshold of PLN 1 million per year.

However, the widespread use of share sale transactions also means that the specific terms can vary widely. One of the common detailed provisions used in business practice is the payment of the price in tranches. In this context, payment can both be spread into installments or separate tranches, as well as be subject to certain conditions.

The inclusion of additional provisions in the contract as to how the price is to be paid can have a significant impact on the manner of taxation, including, in particular, the moment when tax liability arises. In this context, the question may arise in what value to recognize profit from the sale of shares if the payment of the price is subject to additional conditions. In other words, often the payment of the price is not only divided into parts, but also the payment of each of these parts may be made dependent on future uncertain events. For example, the company whose shares are the subject of the transaction as of the date of the sale has not yet developed the final product and has not begun sales. Nevertheless, given the value of the idea for the product itself and the conceptual and design work done, the buyer is interested in acquiring shares in the company. The existing shareholders of the company calculate its value based on the planned sales of the developed products in the future and want the buyer to include this value in the price. However, for the buyer, the achievement of the planned sales, or even the full development of the product as of the date of the transaction, is uncertain. Therefore, the parties can negotiate a solution whereby the buyer will pay a certain value as of the transaction date, but in the event that the company develops the product and achieves the corresponding sales thresholds, it will pay the amounts specified by the parties to the sellers of the shares in the future. The parties may even stipulate in the share sale agreement the total sale value, but at the time of the transaction the buyer may pay only a portion of this value, and make the payment of further portions contingent on the fulfillment of certain conditions, such as the company’s development of a product and the achievement of adequate sales performance.

This type of solution is often used for transactions involving start-ups, especially in the IT market. In the case of such entities, the main value is the innovation of the product under development, while its manufacture is most often capital- and time-intensive. From an economic perspective, making the payment of a portion of the price stipulated in the contract contingent on additional conditions regarding such issues as the company’s production of the product and the company’s achievement of appropriate sales ceilings may result in the fact that the entire price stipulated in the share sale agreement may never be due to the seller. If the company fails to produce the product after the sale of the shares, or fails to obtain an adequate number of customers for the product for market reasons, the seller would not be entitled to claim payment of the portions of the price contingent on these conditions.

This type of solution is often used in deals involving start-ups, especially in the IT market. In the case of such entities, the main value is the innovation of the product under development, while its manufacturing is most often capital and time intensive. From an economic perspective, making the payment of a portion of the price stipulated in the contract, under additional conditions regarding such issues as the company’s production of the product and the company’s achievement of appropriate sales thresholds may result in the fact that the entire price stipulated in the share sale agreement may never be due to the seller. If the company fails to produce the product after the sale of the shares, or fails to obtain an adequate number of customers for the product for market reasons, the seller will not be entitled to claim payment of the portions of the price contingent on these conditions.

This type of case was the subject of a recent individual interpretation issued by the National Tax Information Service (interpretation dated June 27, 2023, ref. no. : 0114-KDIP3-1.4011.36.2023.4.MG) The interpretation concerned the situation of a co-founder of a start-up, who, together with other partners, sold shares in a German company in 2023. The buyer of the shares was a US investor. The amount of remuneration was divided into four equal parts (i.e., 25% each). With the provision that the first part (i.e., the first 25% of the price) was paid upon the transfer of ownership of the shares, while the payment of subsequent parts was contingent on the company achieving specific goals and milestones. If these targets are not met, each of the three subsequent parts of the sale price (i.e., the second, third and fourth) will not be due and will not be paid by the buyer. At the same time, each of the subsequent disbursements will not occur earlier than one year, two years and three years, respectively, as of the date of transfer of ownership of the shares.

Consequently, the sale price of the shares, in the case of transfer of ownership of all shares in the company, was certain and due only to the extent of 25% of the price specified in the contract. Payment of the remaining 75% of the price was contingent on the company’s fulfillment of certain conditions, which, as of the date of the request for interpretation, had not been met and their fulfillment was not certain, nor was the date of their fulfillment known. There was even a possibility that none of the conditions would be fulfilled by the company, with the result that 75% of the price specified in the Agreement would never be due to the applicant. In addition, the application indicated that the consideration for the shares sold was set at the market value of the company’s shares, as of the date of their sale. The transaction was made between entities that were not related. The value of the sale price set in the share sale agreement represented the market value of the company, accepted by the buyer of the company, but only if the company, after the share sale transaction, achieves the goals set forth in the agreement. Only if the company achieves the three objectives set forth in the contract will the buyer of the shares pay the entire price set forth in the contract. 25% of the price set in the contract was assigned to each of these targets. In contrast, the first 25% of the price was paid at the conclusion of the share purchase agreement. In other words, in economic terms, according to the applicant, at the time of the conclusion of the share sale agreement, only 25% of the price set in the agreement represented the market value of the shares to be purchased. This value will increase by further portions as the company fulfills the objectives specified above. At the same time, if none of the stated objectives is achieved by the company, 25% of the price specified in the agreement will be the total market value of the shares sold. Accordingly, when one of the targets is met, it will be 50%, two targets: 75% and all three targets: 100%.

The applicant asked whether he should consider only 25% of the price it has already received as taxable income for 2023. The tax authority issued a negative interpretation, indicating that the entire price stipulated in the contract should be recognized as taxable income for 2023, despite the fact that no conditions stipulated in the contract have been met. The authority’s position was justified by the fact that the entire price for the sale of the shares was stipulated in the agreement, while according to Article 17 Section 1ab of the PIT Law, income from the sale of the shares should arise at the time the ownership of the shares is transferred to the buyer. It should be noted that the case presented may cause difficulties in interpreting the regulations due to the fact that the provision clearly indicates the date on which income arises when the ownership of the shares is transferred. Instead, the value of the income should be determined in the amount of the sale price of the shares. In the case at hand, the price was specified in the contract, but was not and may never have been due to the seller. Therefore, the question arises as to whether the authority correctly assumed that the market value of the shares sold was equal to the price specified in the contract. It is also worth pointing out that the applicant, in response to the authority’s question, indicated that at the time of the sale only 25% of the value specified in the contract constituted the market value of the company. This is because if the conditions set forth in the agreement are not met, the company will not be worth any more. Thus, one may wonder whether the value specified in the contract, despite calling it the sale price, in economic terms should only be a value to which the value of the company was to be referenced to, depending on the fulfillment of the conditions specified in the contract. This is because the revenue should not deviate from the market value of the subject of the sale, which the tax authority itself seemed to emphasize in the justification for the issued interpretation. At the same time, however, the authority decided that the market value is the entire sale price, despite the explicit denial by the applicant.

The interpretation in question shows that tax authorities may apply a simplified interpretation of the regulations, which does not necessarily lead to conclusions that are justified from an economic point of view. As a result of the ruling issued, the applicant may be obliged to pay tax in an amount that will be almost equal in value to the payment received for the shares, since he will pay 19% tax (plus 4% above PLN 1 million) on 100% of the contract price, while he will receive only 25% of that price. This seems likely to defeat the purpose of income tax, which is to actually tax the income earned, rather than hypothetical values that may never be due. It would be appropriate to point out that in order to avoid such situations, tax authorities should take into account the actual market value determined by the parties, and not just the value established in the contract.

The solution taken in the interpretation under discussion may prove to be particularly relevant in the context of potential transactions involving start-ups. As indicated at the outset, in business practice it is very common for an investor to join a company or acquire a start-up while it is still in the conceptual stage. In such a case, the payment of the price is divided into parts and depends on future conditions related to the start-up’s performance. It should therefore be remembered that already at the stage of construction and negotiation of the agreement to take into account the potential tax consequences of specific arrangements.