SEIS / EIS

Rejected SEIS Advance Assurance Application - Solved

A Uni spin-out purchased software to develop it to license out to customers. It intended to raise SEIS funding but its advance assurance application was rejected by HMRC under the excluded activities test.

5 years ago   •   2 min read

By Steve Livingston

I've written previously about the problem that some startups can encounter when they purchase IP with a view to developing it to sell in the form of licence or royalty fee income (most typically, software).

I won't rehash the technical rules here (see below), suffice to say that this set-up does not always 'play nicely' with the SEIS and/or EIS tax reliefs.

I recently advised on this matter with a startup company who had suffered this exact problem and received a knock-back from HMRC on their SEIS advance assurance application.

The company was a software development University spin-out and the Founders were denied the advance assurance on the basis of the excluded activities test.

Why does this matter?

If a company's business is substantially (read: > 20%) comprising activities that are defined as 'excluded' then the company cannot qualify under SEIS / EIS.

Side-note: One way to look at the excluded activities is a list of great business ideas! After all, this is a list of businesses that HMRC deems insufficiently risky - and they have the figures! Admittedly, activities like ship-building, coal mining etc have their own State Aid reliefs but property development, market gardening, legal & accountancy etc...

Many Founders are unaware that the receipt of licence fee income is an excluded activity.

And what is 99% of software development businesses' revenue income made up of?

Yes, you guessed it, licence income.

Here's the solution

It's not all bad news. There is a solution.

Deeper within the rules we find a carve-out exemption that states:

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Where the underlying software IP that generates the licence fee income is created either from scratch by the S-EIS company OR where it creates the greater part of it in terms of value, then it is NOT treated as an excluded activity

This makes sense as this excluded activity is designed to prevent patent trolls from claiming the relief for investors and then passively collecting royalty/licence fee income. It is not meant to catch genuine trading software companies.

But there's a catch...

In the case of Uni spin-out, the software under development had  been purchased from the Uni. So it can't have created it from scratch. Now it had to rely on proving that it had created the greater part of the value in the software IP...

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...so a company can acquire an asset at an early stage of development and providing the acquiring company (or another in the same group) develops the asset to the point where it has created the greater part, by value, of it, it will subsequently be a relevant intangible asset in relation to the acquiring company (link)

Not so easy if you purchase the IP for say £100k. It'll take time and funding (chicken & egg: as you're trying to secure funding for the S-EIS) to demonstrate that you've created the greater part of the value in this case.

The founders ultimately got around this nail-biting hitch by restructuring the deal. Essentially purchasing the IP for a nominal sum in this case. The revised structure was ultimately accepted by HMRC.

This case really goes to show the value of the SEIS/EIS advance assurance process as on all (other) accounts, the founders were assured by those around them (myself excluded, as I didn't advise on the original application!) that they needn't worry as SEIS eligibility and consequent HMRC SEIS assurance would be a 'slam-dunk'.

Yikes, that could have been costly...

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