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The Patent Box is a special corporate tax regime in which the patent revenues are taxed differently from other commercial revenues. This was first introduced in Ireland in the early 1970s wherein there was an absolute relief of tax from licenses that were patented in Ireland.
The United Kingdom introduced a Patent Box scheme in April, 2013 taxing qualifying Intellectual Property at a reduced rate of 10% rather than the normal corporate tax rate of 20%. The Patent Box in the UK is a tax incentive regime designed to encourage companies to keep and commercialize their patents and innovations by reducing the UK tax paid on those profits. The United Kingdom Government wished to support the high-value growth in UK public limited company through a competitive tax regime that supports UK R&D from conception to commercialization. The Patent Box forms a key part of this strategy by encouraging companies to retain and commercialize their patents and R&D in the UK. The companies willing to do so must elect into the Patent Box to apply the lower rate of corporation tax i.e. 10 percent. The regime is largely applied to patents but other medicinal and botanical innovations can also take advantage of this regime.
Who can benefit from this regime?
A company can use the Patent Box regime if:
- It is liable to pay the corporation tax.
- It makes a profit from exploiting patented inventions and innovations that qualify under this regime.
- It either owns or has exclusive license in the patents.
- It has taken qualifying development of the patents.
- The Patent is granted by the UK Intellectual Property Office or the European Patent Office.
- The Company is a member of the group of companies that worked in a particular invention, and has active ownership of the invention and take a significant role in managing its whole portfolio of patented inventions.
It is mandatory for the companies to elect into the Patent Box for acquiring benefits of the reduced rate of corporation tax. It shall be done within 2 years after the end of the accounting period in which the relevant profits and income arose. An election to the patent box can be made either in computations that should accompany the company’s Tax return or separately in writing, there is no special form of words for election in the patent box.
Income/Profit covered under this regime?
In order to qualify for the patent box regime, the company should be liable to UK corporation tax and should make profit by exploiting the qualifying patented inventions. The main income category is the sales income from the patented inventions. A product can have only one patented component to qualify within this regime. Apart from direct sales, the profits from patent licensing and royalties received, patents used in processes or services, invention rights sold, income from damages and infringements of the invention can also qualify within this regime. The concept of notional royalty (which is the appropriate percentage of the IP derived income) shall be taken into consideration while determining the sale of processes and services of the patented invention since this cannot be easily determined like the direct sales income. After the identification of the IP income in the patented inventions, relevant expenses are allocated appropriately. A series of calculations is then carried out to strip out profits from routine or marketing activities of the patented products to leave only residual profits that are derived from the underlying patented invention. All sales procured from a patented invention of a company which owns a UK or European patent (or exclusive rights to that patent) are basically included in the three fold patent box calculation steps:
- Allocation of taxable profits to either a patent box stream or a non-patent box stream,
- Routine Return deduction-deduct this by an element of normal profit
- Reduce this for an element of profits relating to brand marketing asset return.
This results in Relevant Intellectual Property (IP) Profits on which the reduced patent box tax rate (10%) applies after a company-wide election has been made. This reduced tax profit incentivize business-houses to commercialize their patent rights and promote Research and Development (R&D).
Changes to the Patent Box regime in 2016
The Organization for Economic Cooperation and Development (OECD) identified this Patent Box system as a harmful tax practice. In December 2015, in response to the harmful tax practice claim, the HMRC (Her Majesty’s Revenue and Customs) published drafted legislation to change the design of the patent box under the Finance Act to make it parallel with recommendations from the OECD. This reform was more prohibitive which made the companies review their plans to avail the benefits under the Patent Box regime. The reason for bringing the amended draft legislation was that the original legislation did not require a claimant for tax relief to carry out any R&D in the United Kingdom. The previous system was abused by a number of multinational companies who sought to take benefit of the system by relocating their tax domicile to the United Kingdom, prompting some EU states, to claim that the UK Patent Box scheme could provide scope for abusive tax avoidance practices.
The new updated regime that came into force in July 2016 introduces a ‘modified nexus approach’ by which the amount of tax relief available will depend on the extent to which the R&D leading to the patented invention was carried out in the United Kingdom. This modified system helps create necessary impediments for companies who outsource their R&D to other group of companies and avail benefit thereof. However, there is still scope of some of the R&D that may be outsourced or acquired, but the same has been capped at 30% of the qualifying expenditure only. The objective of this amended system is clear i.e. allowing the Patent Box to fulfill its intended purpose, incentivize innovative companies to develop new patented products in the United Kingdom more successfully, while also minimizing the opportunity for harmful tax avoidance.
The Patent Box tax relief calculations have always been complex, and even more so in the changes introduced in 2016. There has been an added complexity of the calculations, by introducing an obligation for every individual IP right (assets, patented products or product families) to be separately streamed, which means that a company with four patented products shall carry out four separate calculations, allocating income and expenses to each and also adding a new ‘Nexus Fraction’ to the calculations. This change has been made in order to link to Patent Box benefit more closely to a company’s R&D activities. The calculation is based on cumulative R&D expenditure made by the company. The resultant is then multiplied by the Relevant IP Profits as calculated under the existing rules for each type of IP. Additionally, in calculations in the new regime, companies will also need to ‘track and trace’ their R&D spent and map the data to their IP.
Since the new rules came into force in June, 2016, there are several companies that have already been elected into the old patent box regime and such companies who have entered into the old regime before 30 June 2016, can continue to be the subject of the benefits from the previous original regime and the old calculation methods for obtaining the 10% tax rate on Patent Box profits, until 30 June 2021. However, they are not spared from tracking and tracing their current R&D to their IP in light of the new rules. All the new IPs created after 30 June 2016 will be made subjected to the new rules, even if the company is already elected into the patent box under the previous rules. There is a potential scope of complexity because some companies may be making calculations under both the old and new rules. Starting from 2021, all companies will have to mandatory follow the new calculations regardless of the time they opted for election in the patent box regime.