tax breaks in the life cycle of a spin-out: post Budget
This article considers tax reliefs that may be available to
academics and external investors receiving shares in a spin-out,
together with a tax break that may be available to spin-outs. The
article also provides Budget updates.
tax relief - academics
The tax position on the grant of shares in a spin-out to
academics who have been involved with the research to be used by
the spin-out is subject to favourable treatment, provided that
certain conditions are met.
Without this relief, those receiving shares in a spin-out would
be subject to an income tax charge based on the difference between
the amount paid for the shares and the market value of those
shares. The tax charge would arise on a 'chargeable event',
typically when the shares are sold, although it is possible to
bring forward the tax charge to the date of issue, to ensure
capital treatment for future growth in value.
The conditions that must be met in order for the relief to apply
are:
- intellectual property (IP) is transferred by agreement from a
University to a spin-out
- the academic acquires shares in the spin-out before the IP
agreement is made (or within 183 days from that date) and is
entitled to do so because of their employment with the University
or the spin-out
- the academic is involved in the research in relation to the IP
subject to the IP agreement.
Where these conditions are met, the value of the IP transferred
into the spin-out by the University is disregarded for the purposes
of calculating any income tax arising on the issue of shares. In
practice the value of the IP may be the only value in a new
spin-out, resulting in no tax charge arising on the acquisition of
the shares. On a disposal of the shares, the academic would be
subject to capital gains tax (CGT). An increase in value due to
funding injected into the spin-out after the shares are acquired
is, in practice, ignored by HMRC.
Entrepreneur's relief may be available to reduce the rate of CGT
on a disposal to an effective 10% rate provided that:
- the individual holds at least 5% of the ordinary share capital
(of a trading company or holding company of a trading group)
entitling them to at least 5% of the voting rights
- the individual is an officer or employee of the spin-out
throughout the period of one year ending with the date of
disposal.
Entrepreneur's relief is subject to a lifetime limit of gains
for each individual, which was increased in the Budget to £10
million (from £5 million).
tax relief - investors
Investors may be able to qualify for the Enterprise Investment
Scheme (EIS) on their investment, provided that conditions relating
to the spin-out, the investor and the investment are met.
The 2011 Budget has increased the income tax relief available on
an EIS investment to 30% (previously 20%), which is available on
qualifying investments up to £500,000 per tax year. EIS is
withdrawn if the shares are sold within three years, or if the
conditions cease to be met during this time.
If the shares are disposed of at a loss, the amount of the loss
(less any income tax relief given) can be set against income in the
year that the shares are disposed of.
Where an individual has received income tax relief that has not
been withdrawn (and the shares have been held for at least three
years) any gain made on a disposal of those shares is CGT
exempt.
The payment of tax on a capital gain can be deferred where the
gain is invested in EIS qualifying shares, provided that the EIS
investment is made within the period of one year before and three
years after the gain arose. This gain will come into charge when
the shares are disposed of (or cease to qualify under EIS).
Further improvements to EIS were announced in the Budget and are
intended to take effect from 6 April 2012. They are as follows:
- companies will qualify provided that their gross assets do not
exceed £15 million before the investment (currently £7
million)
- a company will be able to employee 250 employees (previously
50) and still be a qualifying company
- the maximum amount raised by an individual company per year
will be increased to £10 million (from £3 million)
- the annual amount that an individual can invest will be
increased from £500,000 to £1 million.
tax relief for the spin-out
Research and Development (R&D) relief is a relief that
reduces the corporation tax bill of a spin-out based on qualifying
expenditure.
The basic requirement is that the R&D being undertaken must
be to "resolve scientific or technological uncertainty aimed at
achieving an advance in science or technology". Advances include
new or improved products, processes and services.
Qualifying expenditure includes revenue (but not capital)
expenditure on:
- employing staff directly (or paying a staff provider to provide
staff) who are actively engaged in carrying out R&D
- consumable or transformable materials used directly in carrying
out R&D
- power, water, fuel and computer software used directly in
carrying out R&D.
From 1 April 2011, the Budget has improved the relief for small
and medium enterprises (SMEs) (annual turnover not exceeding €100
million, balance sheet not exceeding €86 million and fewer than 500
employees). The relief is now 200% of qualifying R&D costs,
which means that for each £100 of qualifying costs, the spin-out
can reduce its income for corporation tax purposes by £200. Loss
making spin-outs may surrender losses for a cash payment under the
R&D scheme (of approximately 24% of qualifying
expenditure).
Further simplification is expected (subject to State Aid
approval) in 2012 for SMEs including:
- removal of the PAYE/NICs cap on the amount of payable credit
that can be claimed under the SME scheme
- removing the minimum expenditure rules (currently requiring a
minimum of £10,000 of qualifying R&D during the spin-out’s
accounting year)
A response from the Government on its consultation in this area
is expected in May 2011.
