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Replies to Queries - 1 - The price of success

23 January 2002
Issue: 3841 / Categories:

X Ltd has recently granted key employees options to acquire shares under an enterprise management initiative. The company's main trading activity is subcontracted work from an associated company, Y Ltd, which develops computer software and other high-tech products for a multi-national.

In just over a year, it is intended that Y Ltd will cease trading, with X Ltd purchasing the intellectual property rights of Y Ltd at market value.

X Ltd has recently granted key employees options to acquire shares under an enterprise management initiative. The company's main trading activity is subcontracted work from an associated company, Y Ltd, which develops computer software and other high-tech products for a multi-national.

In just over a year, it is intended that Y Ltd will cease trading, with X Ltd purchasing the intellectual property rights of Y Ltd at market value.

The problem with the purchase of the intellectual property rights, is the subsequent receipt of royalties by X Ltd. It would appear that for the purposes of enterprise management initiative relief, X Ltd will then be carrying on a non-qualifying activity under paragraph 17(2)(a) of Schedule 14 to the Finance Act 2000.

The royalties will not be derived from a relevant intangible asset created by X Ltd and will, given the amount, undoubtedly mean that a substantial part of the company's income will be derived from a non-qualifying activity. When this happens, it would seem that the employees will have to exercise their options within forty days of the intellectual property rights being acquired, as the acquisition will be regarded as a disqualifying event.

Readers' thoughts would be welcomed on how the transaction could be restructured without the employees having to exercise their share options, but for Y Ltd still to receive payment for the intellectual property rights.

(Query T15,940) - blEMIshed.

 

According to the tenor of the query, the companies are associates, rather than members of a group, so subparagraph (1), rather than (2), of paragraph 17 to the Finance Act 2000 applies. As Y Ltd, the owner of the intellectual property, wishes to sell out, and X Ltd, although willing to buy the assets, cannot hold them without injuring its status, it is suggested that the answer may be to bring into existence a new person, legally separate from X Ltd but controlled and owned by its members.

In other words, the members of X Ltd should form (or buy off the shelf) a company (Z Ltd?), which they will own in proportion to their shareholdings in X Ltd. It need only be lightly capitalised, being merely the custodian of the intellectual property. Having deducted its (minor) running expenses from royalties received, it will distribute the profit by dividend. Thus:

* Y Ltd can receive payments for the intellectual property;

* X Ltd has no royalty income from property it did not actually create, so satisfying paragraph 17(1) above;

* the owners of X Ltd own the intellectual property, and enjoy its income via a separate custodian. - Man of Kent.

 

The desired outcome of company Y receiving payment for the intangible asset from company X is incompatible with continuing the current EMI scheme.

Paragraph 17(1)(a) of Schedule 14 to the Finance Act 2000 states that the trading requirement for a single individual company is that the company 'disregarding any incidental purposes, exists wholly for the purpose of carrying on one or more qualifying trades'. Paragraph 18(1)(c) defines a qualifying trade and says that a trade will be qualifying if 'it does not consist wholly or as to a substantial part in the carrying on of excluded activities'. Paragraph 19(1)(d) specifies excluded activities to include the receiving of 'royalties or licence fees'. Paragraph 22(2) expands on this by indicating that the receipt of royalties or licence fees 'attributable to the exploitation of relevant intangible assets' does not fall within this exclusion. A relevant intangible asset is one that has been created either by the company carrying on a trade or by another company grouped with the EMI company and, in the latter case, the group relationship must have existed throughout the period in which the intangible asset was being created.

In this scenario, company X will be receiving royalties from an intangible asset that it has not created. Thus transferring the intangible asset to company X at any time will mean that the receipt of royalties and licence fees can never fall within the relaxation provided by paragraph 22. A disqualifying event will occur as envisaged by the querist.

The only possibility for continuing relief would be to take advantage of the company reorganisation provisions in paragraphs 59 to 63. This may of course not be acceptable to the shareholders of the companies concerned and means entirely changing the transaction! In such a scenario, company Y would have to take over company X in the manner prescribed by paragraph 60 and replacement options granted in accordance with paragraphs 61 to 63 to the current option holders in company X. Alternatively company X could take over company Y. Paragraphs 59 to 63 would not be relevant.

In either case the question arises whether the relevant company (company Y or X; whichever is the parent) would cease to meet the trading activities requirement as mentioned in paragraph 47(1)(b). It seems that it would not cease to meet that requirement. Paragraphs 17(2) and 22(3) taken together have the effect of keeping the receipt of royalties by company Y as non-excluded activities so long as company Y continues as a trading company and owns the intangible asset. A disqualifying event would not take place.

The other requirements of EMI would need to be met and the querist is advised to take detailed advice before proceeding further. - Professional Training Partnership.

Issue: 3841 / Categories:
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