HM Revenue & Customs publishes new guidance for university spinouts

On 29 April 2005, HM Revenue & Customs published new guidance for academics acquiring shares in university spinout companies. The guidance explains the new legislation enacted in the recent Finance Act 2005. As explained in previous Law-Nows, the university spinout industry virtually ground to a halt as a result of the draconian income tax charges experienced by academics following the "schedule 22 legislation" introduced in July 2003. Finance Act 2005 introduces a new tax relief for academics to alleviate some of the problems.

University spinouts can take many forms but, typically, an academic works for a university and is involved in research that has a potential commercial application. A spinout company is therefore set up to develop the intellectual property (IP), the academic subscribes for shares in the spinout and the university licenses or assigns the IP to it. Venture capital investors often buy shares in the spinout as well. It is almost inevitable that the academic will be treated as acquiring his or hers shares in the spinout company by reason of employment and it is therefore important to consider whether the new legislation will prevent potentially significant income tax and national insurance charges arising.

Broadly, to benefit from the new university spinout tax relief:

• there must be an agreement to transfer IP from one or more research institutions to a spinout company;
• the academic must acquire shares in the spinout company either before the IP transfer agreement is made or within 183 days thereafter;
• the right or opportunity to acquire the spinout shares must be available by reason of the academic's employment with either the research institution or the spinout company; and
• the academic must be involved in research in relation to the IP that is the subject of the IP transfer agreement.

It is important to review, in particular, the definitions of "research institution", "IP", "transfer" of IP and "involved in research" in the context of the transaction in question and to take account of any other features of the deal. The new guidance notes help to interpret the meaning of some of the definitions and contain some useful guidance on the effect of a third party injecting funding into the spinout company.

Even if the new legislation applies, income tax and national insurance charges can still arise for academics (and employer's national insurance can arise for a research institution or the spinout) depending on the detail of a transaction. Careful timing of the different steps in a spinout transaction can minimise tax charges, especially where investors are involved.

The new spinout relief took effect from 2 December 2004. However, academics who acquired shares in a spinout company set up prior to that date can, in some circumstances, make a joint election with the employing spinout company to defer a charge to income tax and national insurance contributions arising from an acquisition of shares in a spinout. Any such election must be made prior to 15 October 2005.