What Is a Contingent Payment Sale?

A contingent payment sale is a type of sale where the specifics of the sale—such as the full sales price or the number of fixed payments to complete the sale—depends upon future events. Because these transactions are contingent on payments that occur in the future, the total selling price may not be able to be determined at the end of the taxable year of the sale.

Key Takeaways

  • A contingent payment sale is a type of sale where the specifics of the sale—such as the full sales price or the number of fixed payments to complete the sale—depends upon future events.
  • Because these transactions are contingent on payments that occur in the future, the total selling price may not be able to be determined at the end of the taxable year of the sale.
  • An example of a contingent payment sale may occur when a company is under contract to purchase another company, but the sale will be completed several months out.

Understanding a Contingent Payment Sale

An example of a contingent payment sale may occur when a company is under contract to purchase another company, but the sale will be completed several months out. The final sale price of the target company will be determined by the target company's sales for the remainder of the year. Another example is a company that may sell an amount of its stock along with a percentage of that company's net profits.

Contingent payment sales can occur over a period of time longer than a tax year so they entail a special set of rules that vary according to whether the price or the schedule is the fixed amount. There are two methods for computing taxes due during the tax year for a contingent payment sale: maximum selling price or fixed period.

With the maximum selling price method, the assumption is made that all contingencies will be met. So, the price is calculated in a similar manner to the installment sales method. The formula is recalculated if the amount is reduced in subsequent years.

The fixed period method is used if the maximum selling price cannot be determined. With the fixed period method, the period over which payments may be received is fixed. So, the seller's basis is recovered ratably over the period during which payment may be received under the contract.

In some cases, the agreement may not specify either a stated maximum price or limit payments to a fixed period. In this situation, it is fair to question whether or not a sale has realistically occurred. Section 483 of the Internal Revenue Code provides descriptions for the handling of contingent payments and interest on contingent payments.

Example of a Contingent Payment Sale

In the spring of 1998, General Mills began exploring possible business acquisitions. After learning that Diageo might be interested in selling Pillsbury, it was generally agreed that Pillsbury would complement General Mills’ existing businesses.

General Mills submitted the terms for its proposed deal to Diageo in June 2000 with a total payment of $10 billion. Diageo's asking price was $10.5 billion. After both sides refused to negotiate their terms, it seemed like the deal would not go through. However, in an effort to resolve the difference between the two 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.

General Mills didn't want to issue more than one-third of its post-transaction shares to Diageo, and Diageo believed it was necessary to value General Mills’ shares at the current trading prices.