Originally published October 2004

The saga relating to the application of the employment related securities legislation to university spin-out activities rambles on without satisfactory conclusion.

The Inland Revenue together with UNICO published a Memorandum of Understanding in April 2004 setting out a ‘safe harbour’ for particular spin-out structures using convertible preference shares. For our Bulletin on this MOU, please see Inland Revenue's Views on Tax Treatment of Spinout Transactions.

In addition to the MOU mentioned above, we have now seen further draft guidance from the Inland Revenue describing the manner in which tax charges may arise in a number of different spin out structures. It should be stressed that this guidance is currently only a first draft and that comments have been invited from interested parties. However, as currently drafted, it seems a second ‘safe harbour’ can be drawn out of the guidance as follows:

  • Academics acquire shares in Spinout when Spinout has little or no value;
  • Spinout secures venture capital funding and uses funds to purchase IP from University for full value;
  • University passes relevant proportion of proceeds to Academics under IP sharing policy and invests remainder in Spinout;
  • Academics will be subject to income tax and NICs on the amounts received under the IP sharing policy. Net amount will be available to invest in Spinout - if at full market value, no income tax charge to arise in respect of shares;
  • Any profit made on ultimate disposal of shares will be subject to CGT.

Whilst the guidance is helpful in providing an indication of the Inland Revenue's view of the specified example structures, it does not provide a universal solution for all circumstances. Where a structure does not correspond exactly with one of the examples, further guidance may be sought from the Revenue via a formal application under the procedures set out in the Inland Revenue's Code of Practice 10.

It seems clear that the Inland Revenue wishes to find a solution to the difficulties arising from the new employment securities legislation within the context of spin-out activities, recognising that the technology transfer sector is an important area for productivity and enterprise. A ‘safe harbour’ approach has also been reached by the Inland Revenue in partnership with the BVCA in relation to private equity transactions, but it seems the considerations in the spin-out context are different and further work is required on the part of the Inland Revenue to reach a satisfactory position - legislative change has not been ruled out.

As further progress is made in this area, we will issue further bulletins to keep you informed - watch this space!

Action points

  • Consider spin-out structures at an early stage. Where possible, structure in order to ensure no tax is payable before cash proceeds are received, looking at the safe harbours currently proposed by the Revenue
  • Are systems in place to deal with any PAYE/NIC liabilities in relation to spin-out activities?
  • Where tax treatment is uncertain, do the parties involved wish to apply to the Inland Revenue for a ruling under COP 10?

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.