Since its introduction in 2013 as part of a broad range of measures to encourage business-led innovation in the UK, Patent Box has been mired in both controversy and confusion. On the eve of a set of changes to the rules that particularly affect SMEs, we hope to demystify the new scheme and help you understand how and when it might apply.
A Bit of History
Patent Box was initially designed to help encourage companies generating patents to stay in the UK to exploit their IP assets and to make the UK an attractive location for patent holders from around the world to come to the UK commercialise and develop their IP. The scheme allowed companies to use the framework to apply a 10% tax rate to any profits earned from any products that incorporate patents, at the time a significant saving. The UK was relatively late introducing the scheme in comparison to countries such as Ireland and France whose schemes were introduced in the early 2000s.
While the OECD was investigating international base erosion and profit sharing (the BEPS project) in 2013 they took the view that Patent Box, as well as other preferential IP regimes around the world, was ‘harmful tax practice’. In short the schemes, by accident or design allowed large multinationals to move their IP, and the profits that followed around the world significantly benefiting from lower tax rates while carrying out virtually no activity in the jurisdiction.
The European Commission was concurrently investigating the same schemes in Europe prompting the UK and Germany to pre-emptively table a plan to resolve the contentious aspects of Patent Box and its equivalents. The OECD and all G20 countries have accepted the plan, with modifications, as the new global standard for IP asset tax incentive regimes.
As the basis of the new Patent Box rules, the ‘modified nexus approach’ was agreed in 2015 and has been subject to an international timetable of implementation, which sees all previous schemes close to new applicants on the 30th June 2016. The shared foundation of all new schemes only allows a company to benefit from a scheme when it can show that it itself undertook significant activity within the jurisdiction, such as R&D, which gave rise to the income the IP generates.
New or Old
The new regime is applicable to any company that elects to join the scheme after 1st July 2016 with any patent application that is filed after that date. Any companies that have existing IP assets filed prior to then generating profits or not yet generating profits and are already elected into the scheme will be able to benefit from the old regime until 2021. There is currently no guidance on how companies benefitting from ‘grandfathering’ the old regime will access the scheme post 2021, but it is relatively safe to assume that they will have to comply with the new rules.
No matter which scheme you are benefiting from, the phased introduction of the original Patent Box is still being enforced, so the full benefit will not be able to be claimed until April 2017 anyway.
How it works
A company files a number of patents after 1st July 2016 and elects to be part of the scheme.
Patent Box relief is given to the income that is generated from those IP assets. An IP profit calculation is made, in the same way as the previous rules and the rate of Corporation Tax paid on the qualifying profits is reduced to 10% as part of the company’s Corporation Tax calculations.
The new regime that the company is elected into has two main differences to the old;
All companies must now ‘stream’ their income from each qualifying exploited IP asset (each IP right or product). This requires separating the income and expenditure for each stream, identifying non-IP income and applying the calculations to each stream individually. This could become quite cumbersome for SMEs with multiple patents and limited accounting and administrative capacity.
The new scheme also requires companies to subject the IP profit calculations to an additional modifier to prove that there is a direct ‘nexus’ or connection between the income receiving benefits and the R&D expenditure that contributes to that income. The nexus calculation differentiates between expenditure on R&D in an in-house capacity, subcontracted to a 3rd party and subcontracted to related parties in the same way as the R&D Tax Credits scheme. In addition it also takes into account IP acquisition costs. Once all the expenditure is inputted to the formula, should the result be less than 1, the qualifying profit will then be reduced accordingly.
When to elect in
As is now hopefully clear, the scheme is only going to make any impact on your Corporation Tax liability if you are generating revenue for the exploitation of an IP asset, or assets. Therefore there is no need to consider Patent Box until then. In order to benefit though you must elect to be part of the scheme within 2 years of the end of the account period within which the relevant profits are made so retrospective election into the scheme is limited.
Our advice is that at the point of applying for or acquiring a patent it is prudent to begin recording the relevant R&D expenditure in advance of revenue generation to simplify the nexus calculation later on.
If you are generating profit from the exploitation of IP assets it is worth considering Patent Box under the new regime. Even with the upcoming reduction of the Corporation Tax rate to 17% in 2020 it will make a difference to your liability. The scheme is compatible with other UK measures to support R&D and innovation and implementing streamed accounting practices will negate much of the potential administrative burden of the new rules.