Intellectual Property and Spin Outs

28 February 2024      Julia Ascott, Employment Taxes Specialist

On Wednesday, 28 February, we were joined by Paul Moreels (Employment Tax Director and HE lead) and Lydia Ward (Reward Senior Manager) from KPMG for a Time to Talk session discussing the employment tax implications of Intellectual Property (IP) and spin-out companies within Higher Education.

It was an excellent session and members really engaged with the subject matter, asking lots of questions with a BUFDG/KPMG action point on guidance for the valuation of IP. You can watch the recording and access the slides here, but for a summary of the session, please continue reading.

Intellectual Property

As many people who work in employment taxes at HEPs will tell you, we share a common barrier of language. What we might call IP, isn’t actually IP for tax purposes, it’s really a revenue sharing agreement (think of it like a bonus).

What we therefore need to think about when we look into payments relating to IP, is who owns the IP. You can find this out by checking employment contracts, patent and licence agreements, PHD and fellowship agreements. In 95% of cases, universities own all IP created by employees or PHD students, however, fellowship and PHD arrangements may be more bespoke. Any changes in relationships post IP creation (e.g. student becomes employee or vice versa) won’t change the tax point because the tax point arises when the IP is created/generated.

If the university owns the IP which becomes monetised, the university will receive a payment of royalties. Any subsequent payments to individuals are usually part of a revenue sharing agreement and will be taxable income:

  • if they are employees, the share of revenue is employment income which should be reported through the payroll for PAYE/NIC
  • if they are not employees (that means did not perform any employment duties during the creation of the IP – so check employment status), then payment can be made in full and the individual will need to account for taxes via their self-assessment tax return

If the individual owns the IP (or shares ownership with the university, other employees or third parties), they should be receiving a payment of royalties directly, with 20% withholding tax deducted by the payer. There are occasions where, for ease, the university might be asked to pay royalties to a number of IP owners (who are likely to be university employees), withholding 20% and included on the CT61 submission.

Common issues with revenue sharing arrangements

  1. Leavers – an employee with a revenue sharing agreement is taxed through the payroll, however, on leaving, the payment is reclassified as a royalty (with 20% deduction and CT61) which is incorrect. It should still be treated as employment income
  2. Death – a payment to the beneficiary of the individual will still be taxable as employment income but strictly, reported via a separately payroll as an Employer Financed Retirement Benefits Scheme (EFRBS) but might be able to include in existing payroll returns with HMRC agreement
  3. Location at the time of invention/creation is key to where tax is payable, not the time payment is made. If employees leave and go overseas, there is still a UK tax obligation on the employment income which becomes even more complicated for tax purposes if the individual believes they are in receipt of a royalty, rather than the employment income they have actually received.

Spin out companies

Where shares are created in the spin-out and given (at little or, more often, zero cost) to former, current or prospective employees, this will be an Employment Related Security (ERS). The tax position at the time the shares are acquired by those employees will depend on whether the shares are seen as a Readily Convertible Asset (RCA). Where a university or third party has a controlling stake in the spin-out (i.e. more than 50% ownership), the ERS are likely to be an RCA.

Tax is due on RCAs on their market value, less (if any) the price paid by the employee on acquisition (i.e. when they are given to the employees).

However, the researchers tax exemption may apply where the following four conditions are met:

  1. There is an agreement to the transfer of IP from a research institute to the spin out
  2. The individual must acquire shares prior to the transfer of the IP to the spin out, or within 6 months of the transfer
  3. The shares must be given by reason of employment
  4. The individual must be involved in research related to the transferred IP (no definition of ‘involved’ but university/individual must be able to demonstrate a link with the individual’s research and the IP created)

Common issues that makes exemption ineligible

  • Employees who were not involved in the research acquire shares, e.g. individuals made directors of the spin-out for management responsibilities given shares
  • Employees given options over shares/share options but not actual shares – different tax treatment involved and no exemption
  • Valuation of the shares are not accurate – need to look at all the sources of income, investment and value [NB BUFDG/KPMG will look into further to see whether general guidance can be drafted for HEPs]

Common issues more generally

  • Complexities arise where there are two or more collaborating research institutions (and/or private business) and who has what reporting responsibilities, however, there is HMRC guidance on these types of scenarios
  • Annual reporting requirements – if a PAYE scheme hasn’t been set up for the spin-out, the university/research institute will be responsible for reporting the ERS activities – whether that is the initial provision of shares, changes to valuations, share option awards and exercises, etc. Where universities are carrying out reporting requirements and subsequently relinquishes/sells its share holding, KPMG recommended a formal communication with the spin-out to confirm that the university will no longer perform any reporting requirements on its behalf

Triage the common issues

KPMG left attendees with four action points which they would focus on if they were working at a university:

  1. Identify who owns the IP (checking contracts, etc)
  2. Create a tax treatment matrix based on ownership, employment/student/fellowship arrangement, etc
  3. Ensure all relevant policies, procedures and future contractual terms (employment, student, fellowship, etc) are up to date, fit for purpose and manage expectations for all parties on responsibilities
  4. Implement policies and procedures, identify the payments and confirm/action tax treatment in advance

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