The new tax rules for university spin-outs: An answer to all the problems?
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The new tax rules for university spin-outs: An answer to all the problems? Alison Hughes and Joanne Brien Date received: 8th August, 2005
Abstract This paper gives an overview of the potential tax position for an academic participating in a university spin-out following the new legislation in the UK Finance Act 2005. The paper outlines a university spin-out transaction and explains the possible tax problems in this area since 2003. It then discusses the conditions that need to be met for an academic to potentially benefit from the new tax relief and some of the remaining issues. It concludes with some practical advice for structuring transactions.
BACKGROUND
Keywords: university spinout, tax, intellectual property
Alison Hughes Senior Consultant, KPMG LLP, 1 Puddle Dock, London EC4V 3PD, UK Tel: +44 (0)20 7311 2626 Fax: +44 (0)20 7311 3224 Email: [email protected]
University spin-outs are a popular way of exploiting intellectual property (IP) developed by an academic working for a university or other research institution. The structure can vary but, at its simplest, a new company is set up and the university licenses or assigns IP with a potential commercial application to that spin-out company. The academics subscribe for shares in the spin-out at nominal value and some shares are issued to the university in return for the IP. A venture capitalist provides additional funding by way of a subscription for shares and/or loans. If the IP does prove to have a commercial application and it is successfully developed, an exit can be achieved by the shareholders selling their spin-out shares at a gain. The university spin-out industry suffered a blow in July 2003 as a result of the adverse income tax charges experienced by academics following the ‘Schedule 22 legislation’ (as contained in Part 7 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA)). The Schedule 22 legislation overhauled the law in relation to shares issued or transferred by reason of employment. It was intended to counteract perceived tax abuse arising from the payment of salary and bonuses in a non-cash form. It may be inevitable that academics will be
treated as acquiring their shares in a spinout company by reason of employment and therefore such shares fall within the Schedule 22 income tax net. Prior to Schedule 22, the authors considered that there was no tax charge when academics acquired shares in a spinout. If the shares in a successful spin-out were sold, the academics paid capital gains tax and could potentially benefit from taper relief so as to reduce their effective tax rate to as little as 10 per cent. Following Schedule 22, however, the Inland Revenue’s (now HM Revenue & Customs) position was that, when the university transferred the IP to the spinout company, income tax (and possibly national insurance) arose for the academic (and a corresponding employer’s national insurance charge potentially arose for the employing institution). The tax and national insurance charge arose under the ‘undervalue’ legislation if the IP
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