EMI, VCT And Related Reliefs - IP-Based Activities And Investments

There have been two Budget-related changes in this area affecting companies which take advantage of the EMI, VCT, EIS and CVS legislation.

• A welcome change is that corporate groups can now transfer IP to newly-established subsidiary companies so that options over and investments in shares in the parent company still qualify for the reliefs.

• However, an unpublicised and adverse change is that the receipt of IP royalties and licence fees by an acquired company can no longer form the basis of these reliefs being available. VCTs which have set up acquisition vehicles to acquire such companies in the past will no longer be able to receive tax relief when they buy companies in the future.

Those companies will also not be able to grant further EMI options.

This change affects EMI option grants and other investments made on or after 6 April 2007.

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There have been two Budget-related changes in this area affecting companies which take advantage of the EMI, VCT, EIS and CVS legislation.

• A welcome change is that corporate groups can now transfer IP to newly-established subsidiary companies so that options over and investments in shares in the parent company still qualify for the reliefs.

• However, an unpublicised and adverse change is that the receipt of IP royalties and licence fees by an acquired company can no longer form the basis of these reliefs being available. VCTs which have set up acquisition vehicles to acquire such companies in the past will no longer be able to receive tax relief when they buy companies in the future. Those companies will also not be able to grant further EMI options.

This change affects EMI option grants and other investments made on or after 6 April 2007.

The Enterprise Management Incentive (EMI) option, Venture Capital Trust (VCT), Enterprise Investment Scheme (EIS) and Corporate Venturing Scheme (CVS) arrangements share much common legislation. A common feature of these schemes is that they are not available if there is involvement in any of a long list of activities.

Exploiting intellectual property (IP) through receiving royalties or licence fees is not an eligible activity unless the IP has been internally generated. As a general rule, this is understandable because these schemes are intended to promote the development of IP rather than encourage the purchase of IP developed by others. However, there are many companies who have acquired a company which has developed the IP (e.g. a software or biotech company) rather than just the IP itself and then take it into commercial development under their new ownership. To date, this has been treated as internally generated IP.

Until 6 April 2007 the definition of internally generated IP required the company or companies which had substantially contributed to the IP to be

• either the company currently carrying on a trade and using it and/or

• a company which has been connected to that trading company at all times when the connected company was developing the IP.

The current legislation has allowed a company to acquire a company which had developed IP, and for shares and options in that acquiring company then to benefit from the various reliefs described above as if it were internally generated IP - indeed much VCT and other investment activity in this area has taken advantage of this. One disadvantage, however, has been that the IP may not be transferred to a newly-formed group subsidiary, which has been a drawback in some circumstances.

Assuming the Finance Bill is passed in its current form, the relevant rule will have been changed from 6 April 2007. In order to be "internally generated", the IP must either have been developed by

• either the company in which the relevant investment is made and/or

• a company or companies which was or were a subsidiary of that company at all times when that subsidiary was contributing to the IP.

This is a welcome change in one respect, in that it now enables IP to be transferred to newly formed companies in a group without causing the loss of reliefs which would previously have occurred (and is the reason given for the change). However, it has a distinctly unwelcome side effect. The revised legislation no longer allows companies to acquire a company with IP and use that company as the basis of trading activity and grant EMI options and use the other various tax reliefs. Even inserting a new company on top of an existing company (whether for the purpose of an acquisition or otherwise) could cause reliefs to be lost.

EMI options granted and investments made before 6 April 2007 are not affected by this change – but later options and investments will be, if this change goes through. For example, if your company has been set up as a holding company for a company developing IP, you may not be able to grant EMI options going forward.

This is a serious limitation on future buy-out or spin-out activity in the sector, which could also prevent VCT investment. We are making representations on this through appropriate bodies to HMRC and the Treasury.

While it may be possible to restructure arrangements so they are not affected by the changes, this would need to be looked at on an individual basis. For example, it would appear that the legislation would be satisfied if investment were made direct in the company which has developed the IP, rather than in a new company set up for the purposes of raising the investment, so long as a controlling investment was not taken. However, this may not be possible in many cases.

A further point to note is that although the other VCT changes in the Budget (i.e. the new limits on the numbers of employees allowed and the amount of capital a company can raise in any 12 month period) do not affect existing VCTs, there is no grandfathering of existing funds for this IP-related change.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

The original publication date for this article was 09/05/2007.