Introduction: Why an Escrow Account Is Taxed Twice in Two Different Years
An escrow account on a UK company sale holds back part of your consideration, typically ten to fifteen per cent, for twelve to twenty-four months while the buyer waits to see whether any warranty claim emerges. Most sellers treat it as money they have not yet received. HMRC does not agree, and the IRS does not agree with HMRC.
Search the question in Britain and you will be told that tax falls when the funds are released. That advice is wrong for the overwhelming majority of UK share sales, and it is wrong in the most expensive direction. HMRC's published position is that this money is taxed in full at completion, years before it reaches your bank.
Meanwhile the American analysis runs the other way. Where the arrangement imposes a genuine restriction on your right to the money, the IRS accepts that you have not constructively received it, and the gain is deferred until release. Consequently an American selling a UK company faces the UK charge in year one and the US charge in year three.
That is a foreign tax credit problem, not a rate problem. Furthermore, the credit system was never built to bridge tax years, so the UK tax paid in year one has nothing to relieve in year three, and the US tax in year three has no UK tax left to credit. At TaxYork we see this stranded credit destroy six-figure sums on otherwise well-advised transactions. The fix exists, it is straightforward, and it must be elected on the return for the year of sale.
What an Escrow Account Actually Holds on a UK Share Sale
An escrow account is a separate bank account held by a neutral third party, controlled jointly or by a third-party agent, into which the buyer pays a slice of the purchase price at completion. The share purchase agreement then sets out the circumstances in which the money is released to the seller or paid back to the buyer.
Retentions work similarly but the buyer simply keeps the money rather than depositing it. The distinction matters commercially, because escrow protects you against the buyer's insolvency, and it matters for tax, because only an escrow arrangement creates a foreign financial account in your name.
Typical triggers include warranty claims, tax indemnity claims, completion accounts adjustments and specific identified risks such as pending litigation. Notably, the money is yours unless something goes wrong, which is precisely why both revenue authorities take an interest in it.
Why the Generic Advice You Have Read Is Wrong
The consumer-facing legal explainers state that an escrow account defers income recognition until release. That statement describes some US commercial arrangements reasonably well. It does not describe a UK capital gains disposal at all.
UK capital gains tax attaches to the disposal, not to the receipt. Therefore the question is never when the money arrives but whether the amount was capable of being calculated at completion. In a standard escrow the amount is perfectly calculable, because the sum deposited is written into the agreement.
How HMRC Taxes an Escrow Account at Completion
The UK analysis turns on a single distinction that HMRC sets out across its deferred consideration guidance. Deferred consideration is either ascertainable or unascertainable, and almost everything follows from which side of that line your escrow account falls.
Ascertainable But Contingent Means Taxed in Full Now
HMRC defines ascertainable consideration as consideration where all of the events which affect the amount occur before the date of disposal. A fixed sum sitting in an escrow account plainly meets that test, because the deed specifies the figure.
The fact that you might not receive it changes nothing. HMRC states the rule directly at CG14883: payments which are ascertainable but contingent are treated in the same way as all other ascertainable amounts. Accordingly the whole escrow sum enters your disposal proceeds for the tax year of completion.
The practical consequence is a dry charge. Specifically, you report the full consideration, you pay capital gains tax on 31 January following the tax year of sale, and a substantial part of the money is still locked in an account you cannot touch.
An Earn-Out Is Different, and the Difference Is Expensive
Where the sum genuinely cannot be calculated at completion, the Marren v Ingles analysis applies instead, producing two separate disposals and a very different profile. We set that out in full in our guide to earn-out tax on a UK company sale.
Sellers frequently assume an escrow account works the same way. It does not, because the escrow figure is fixed and the earn-out figure is not. Confusing the two produces either an underpayment with interest or an unnecessary acceleration of tax.
The Section 48 Claim If the Money Never Arrives
Where the buyer draws on the escrow account under a warranty claim, you have paid tax on consideration you never received. Relief comes from section 48 of the Taxation of Chargeable Gains Act 1992, and HMRC explains the mechanism at CG14930.
The test is strict. You must show that the consideration has become permanently irrecoverable, as a demonstrated fact rather than a possibility, and CG14933 sets out what a claim must identify. A claim in progress is not enough, and a negotiated settlement should be documented carefully to evidence the final position.
Importantly, relief adjusts the original year rather than the year of the claim. Therefore the interaction with your US return is not automatic, and an amended US filing is usually required to keep the two systems aligned.
How the IRS Treats the Same Escrow Account
The American analysis begins from an entirely different premise. The IRS asks whether you have actually or constructively received the money, and a well-drafted escrow arrangement answers no.
Rev. Rul. 79-91 and the Substantial Restriction Test
Constructive receipt applies where funds are credited to you or made available so that you can draw on them without substantial limitation. Revenue Ruling 79-91 supplies the escrow gloss: the arrangement must impose a substantial restriction serving a bona fide purpose of the buyer, meaning a real and definite restriction on the seller or a specific economic benefit conferred on the buyer.
A genuine warranty escrow clears that bar comfortably, because the buyer has a real claim on the fund. However, a restriction based solely on the passage of time does not. Consequently an escrow account that simply pays out after eighteen months with no substantive conditions risks immediate taxation in the United States as well.
That distinction is worth engineering deliberately into the share purchase agreement. Additionally, it should be documented at the time, because reconstructing the commercial purpose years later rarely persuades an examiner.
The Installment Method Under Section 453
Where the restriction holds, your escrow account becomes a contingent payment eligible for the instalment method under section 453. The gain is then reported as and when payments are received, using Form 6252, and the IRS sets out the mechanics in Publication 537.
Crucially, the instalment method is the default. You do not elect into it; you must elect out of it. That default is what creates the mismatch with Britain, because HMRC has already taxed the whole amount in the year of completion.
The Section 453A Interest Charge on Larger Deals
High-value sellers face an additional cost that smaller ones never meet. Under section 453A, where the sale price exceeds $150,000 and your outstanding instalment obligations at year end exceed $5 million, the IRS imposes an interest charge on the deferred tax.
The charge is calculated annually and reported with your return. Therefore deferral is not free, and on a substantial escrow account the interest can materially exceed the cash-flow benefit of waiting.
Imputed Interest Turns Capital Gain Into Ordinary Income
A further trap catches almost every seller. Where the agreement does not provide adequate stated interest on the deferred amount, the Code imputes it, converting part of your eventual escrow release from capital gain into ordinary interest income.
Section 483 governs contracts of $250,000 or less and section 1274 governs most business sales above that figure. The rate is drawn from the applicable federal rates the IRS publishes monthly. Since ordinary rates reach 37% against 20% for long-term gain, the recharacterisation is expensive, and it is entirely predictable at the drafting stage.
The Timing Mismatch and How to Fix It
Put the two systems side by side and the problem is obvious. Britain taxes the full escrow account in the year of completion. America taxes it in the year of release. The foreign tax credit relieves double taxation within a year, never across years.
Why the Credit Cannot Bridge the Gap
In the year of completion you report a UK gain that America has not yet recognised, so there is US tax of nil against which to claim the UK tax. In the year of release you report a US gain on which Britain charges nothing, so there is no foreign tax to credit.
Carryover offers only partial rescue. Excess credit in the passive category carries back one year and forward ten under section 904(c), and a later escrow release can in principle absorb it. Nevertheless the categories must match, the limitation must exist, and many sellers have no other passive income to make the arithmetic work. Our analysis of foreign tax credit basket errors explains how easily the relief is lost.
The Section 453(d) Election Out
The clean solution is to elect out of the instalment method under section 453(d). That election accelerates the entire US gain into the year of completion, aligning it precisely with the UK charge, so the UK tax and the US tax land in the same year and the credit works as intended.
The election is made on a timely filed return, including extensions, for the year of the sale. Furthermore it is generally irrevocable without IRS consent, so the decision must be taken deliberately rather than discovered by default. In our experience it is the single most valuable line in the return for an American selling a UK company with an escrow account.
When Electing Out Is the Wrong Answer
The election is not automatic good practice. Where the escrow is genuinely at risk, electing out means paying US tax on money you may never see, and the correction later is an amended return rather than an adjustment.
Additionally, a seller whose UK effective rate is low, or who has ample carryforward capacity, may prefer the deferral and the section 453A interest charge to the acceleration. Accordingly the analysis should be run with real numbers before the return is filed, not assumed either way.
Is Your Escrow Account an FBAR Account?
This is the question clients ask last and should ask first, because the reporting penalties dwarf the tax at stake. It is also the question on which no direct published guidance exists.
The Financial Interest Test
FBAR reporting under 31 CFR 1010.350 applies to a United States person with a financial interest in, or signature or other authority over, a foreign financial account where aggregate balances exceed $10,000 at any point in the year. A UK escrow account is unquestionably a foreign financial account, and FinCEN's FBAR guidance contains no escrow carve-out.
Whether the seller holds a financial interest depends on the drafting. Where the account is in the seller's name, or the seller is the beneficial owner subject only to the buyer's contingent claim, the conservative and in our view correct answer is that it is reportable.
Why Conservatism Costs Nothing Here
Filing an FBAR that was not strictly required carries no penalty and no tax. Omitting one that was required exposes you to penalties that begin in the thousands and, for wilful failures, reach the greater of $100,000 as adjusted or half the account balance.
Given that asymmetry, we report the escrow account. Moreover, sellers routinely cross the $10,000 threshold for the first time in their lives through a completion escrow, having never filed an FBAR before, and our FBAR and FATCA service exists precisely for that moment.
Form 8938 and the Sale Proceeds
Separately, the escrow balance and the underlying right to deferred consideration are specified foreign financial assets for Form 8938 purposes, where the thresholds for taxpayers living abroad are met. The two regimes overlap but are not identical, and filing one does not satisfy the other.
If you have missed earlier years, address it before the escrow releases rather than afterwards. The IRS Streamlined Filing Compliance Procedures remain available to non-wilful taxpayers, and we handle those through our IRS streamlined filing service.
The Currency Problem Nobody Models
Your escrow account is denominated in sterling. Your US return is denominated in dollars. Between completion and release the rate moves, and that movement has tax consequences on both sides.
Two Different Rates on Two Different Dates
For US purposes the gain is translated at the rate on the date of the relevant transaction, so an escrow released two years after completion converts at a different rate from the cash paid at closing. Consequently your dollar gain can exceed your sterling gain, or fall short of it, purely on exchange movement.
Sterling weakness between completion and release increases the dollar cost of the UK tax already paid while reducing the dollar proceeds. Therefore the stranded credit problem and the currency problem compound each other rather than offsetting.
Interest Earned Inside the Account
Interest credited to the escrow account during the holding period is income, and the agreement decides whose income it is. Where it accrues to the seller, it is UK savings income taxed at up to 45% and US interest income in the same year, which at least keeps the two systems in the same tax year.
Importantly, that interest is separate from any imputed interest under sections 483 or 1274. Sellers and their advisers regularly count one and miss the other, and both belong on the return. Our tax treaty optimisation service addresses how the resulting credits are allocated.
A Worked Case Study: A $9m Escrow on a London Software Sale
Consider David, a US citizen and UK resident who sells his UK software company in October 2026 for £12,000,000. The buyer retains £1,800,000 in an escrow account for eighteen months against warranty claims, releasing in April 2028.
The UK Position at Completion
The escrow sum is written into the agreement, so it is ascertainable but contingent, and HMRC taxes it in full for 2026/27. David's base cost is £200,000, giving a chargeable gain of £11,800,000. Business Asset Disposal Relief covers the first £1,000,000 at 18%, and the balance falls at the main 24% rate set out in gov.uk's capital gains tax rates guidance.
His UK capital gains tax is therefore £180,000 plus £2,592,000, a total of £2,772,000, payable on 31 January 2028. At that point £1,800,000 of his consideration remains locked in the escrow account, so he funds part of the tax from the cash element of the deal.
What Happens Without the Election
Under the instalment method default, the IRS recognises only the £10,200,000 actually received in 2026. The escrow account is deferred to 2028, and because David's outstanding instalment obligation exceeds $5 million, the section 453A interest charge applies for 2027 as well.
The damage is in the credit. In 2026 David has UK tax of £2,772,000 against a US gain that excludes the escrow, so roughly £423,000 of UK tax attributable to the escrow has nothing to relieve. In 2028 he reports a US gain of about $2,430,000 on the release, with no UK tax that year to credit, producing US tax of roughly $486,000 plus net investment income tax of $92,340.
What the Election Delivers
Electing out under section 453(d) on the 2026 return pulls the entire US gain into 2026. Both systems then tax the same £11,800,000 in the same year, the UK tax of £2,772,000 becomes creditable against the whole US liability, and the excess simply absorbs into the ordinary carryforward rather than stranding against a year with no matching income.
The election also removes the section 453A interest charge entirely, because no instalment obligation remains outstanding at year end. Additionally it eliminates the imputed interest recharacterisation, since there is no deferred payment to impute interest on. Across the three effects, the election is worth approximately $486,000 of otherwise unrelieved US tax plus two years of interest charge.
The residual cost is the 3.8% net investment income tax, which no credit ever relieves. David also files an FBAR reporting the escrow account for 2026 and 2027, and a Form 8938 alongside each return.
How TaxYork Can Help With Your Escrow Account
We advise American and dual-national sellers of UK companies from heads of terms through to the final escrow release, and the value of our involvement falls heavily at the front of that process.
Before Completion
We review the draft share purchase agreement for the substantial restriction language that protects your US position, check whether the escrow sum is ascertainable, and model the cash requirement for a UK tax bill that will fall due while part of your money is still locked away. Furthermore we identify where imputed interest will bite and flag the drafting that prevents it.
We also confirm your reporting position, because a completion escrow is the most common reason a long-compliant seller suddenly acquires a first FBAR obligation.
At Filing and Release
We run the section 453(d) analysis with your actual figures and file the election where it wins, coordinate the UK and US returns so the credit lands in the right year and the right basket, and handle the section 48 claim if the buyer draws on the escrow account. Additionally we track the position through to release so that no year is filed in isolation.
Professional Standards
Our team works to the technical standards of the Institute of Chartered Accountants in England and Wales and the Chartered Institute of Taxation, and holds the US credentials required to represent clients before the IRS. Consequently one firm carries both sides of the transaction.
Conclusion
An escrow account is the most commonly misunderstood line in a UK company sale, and the misunderstanding runs in a predictable direction. Britain taxes it at completion because the sum is ascertainable, whatever the generic guidance says, while America defers it to release under the instalment method default.
That mismatch is not a rate problem and it is not solved by better record keeping. It is solved by the section 453(d) election, made on a timely filed return for the year of sale, which pulls the American charge back into the year Britain has already taxed and makes the foreign tax credit work.
Ultimately the decisions that matter are all made before you file: the drafting of the restriction, the ascertainable analysis, the election, and the reporting. Sellers who address the escrow account at heads of terms keep the money. Those who address it when the funds are released are usually too late to do anything but pay.
Contact Us
If you are selling a UK company with an escrow account or retention and you are an American citizen, green card holder or dual national, speak to us before you sign rather than after the money is released. We handle the UK and US analysis together, file the elections, and manage the reporting through to release.
Email hello@taxyork.com or call 020 3488 8606 to speak with a specialist. Alternatively, book a consultation and we will review your draft agreement and model both tax years before your position is fixed.
Disclaimer
This article provides general information about the UK and US tax treatment of escrow and retention arrangements on a company sale and does not constitute tax advice for any person or transaction. Tax rules change, and the treatment of any escrow account depends entirely on the drafting of the agreement and the specific facts. You should obtain professional advice tailored to your circumstances before acting or refraining from acting on anything set out here. TaxYork accepts no liability for any loss arising from reliance on this article. Further general guidance is available from HM Revenue and Customs and from the AICPA tax resources.