UK Patent Box allows 10% corporation tax for sales of patented products and patent royalties; existing regime to be closed for new companies in June 2016 but available for five more years to those who have opted in.
Companies that own or have an exclusive licence over patents granted by the UK Intellectual Property Office or the European Patent Office can elect into a scheme known as the Patent Box regime. This regime allows companies to apply a rate of corporation tax of 10%, instead of the normal rate, 20% from April 2015, on profits attributable to patents. The income received from the patents to be taxed at the lower rate can be derived from sales of products which incorporate at least one patented component or from royalties from patents. Income from products which only have copyright protection are excluded.
The patent box regime was introduced from 1 April 2013 to provide an incentive to companies to maintain, develop and manufacture their patents in the UK. In common with many territories, the UK Government is keen to encourage the development and exploitation of original ideas and to promote the UK as being an excellent location for technology based businesses. It was part of a range of measures introduced at the time to increase the UK’s competitiveness from a corporation tax point of view, including a relaxation of the CFC rules and a dividend exemption system.
To qualify for eligibility into the regime, various criteria must be met. These are:
- A company must own qualifying intellectual property rights to the patent and must have performed qualifying development expenditure in relation to it.
- If a company owns the patent but licenses it to another company for development purposes, it can still qualify for the scheme provided it plays an active role in managing the intellectual property rights.
- If the company is a member of a group, it can enter the scheme provided that it has either developed its own intellectual property rights or undertakes a significant active role in managing the rights.
The above criteria prevent groups from transferring their intellectual property rights to ‘passive’ companies and thus benefiting from the lowered and advantageous corporation tax rate. However, they do allow for a range of possible ownership and exploitation arrangements within a group that is worthy of careful consideration for groups of companies with appropriate registered patents.
It is necessary to elect into the regime within two years of the end of the accounting period to which the regime is to apply. There are a series of calculations to be performed in order to ascertain exactly how much of a company’s total profits in the period will be subject to the lower rate of taxation. These involve removing some element of profits that are deemed to be associated with a ‘normal rate of return’ on overhead expenditure and also a ‘normal’ marketing return. The regime is intended to benefit the super-profits that derive to an organisation as a result of its innovation.
The reduced rate of taxation is being phased in over four years, with the full reduction to 10% only becoming available in the year commencing April 2017.
The original proposal for the UK patent box regime came under fire from Germany and a number of other EU member states. It was argued that the regime was too generous and was encouraging companies to artificially shift their profits to the UK thereby resulting in a negative impact on the tax positions and collections of these states. As a result, the UK has agreed to a compromise agreement with regard to its new regime.
The UK regime will close to new entrants by 30 June 2016, and the existing arrangements will be phased out completely by 30 June 2021. Companies who have elected into the regime by June 2016 will therefore be able to continue to benefit from the existing arrangements for five years. After this time, it seems likely that all countries will be required to operate regimes based on the modified nexus approach as part of the work being done by the OECD. This approach considers where the research and development expenditure is incurred in developing the patent and is unlikely to be as beneficial as the existing UK scheme.
Work by the OECD on the modified nexus approach to Intellectual Property tax reliefs is progressing and will be included in the 2015 progress report from the Forum on Harmful Tax Practices.
Advice for companies
The existing UK Patent Box regime now carries a time limit. A number of groups have not yet fully explored the possibilities of the regime, partly because it is not yet available at the best rate of relief. The take up from SME companies in particular has been low.
For standalone UK companies and for parent companies with subsidiaries in the UK who sell patented products, now is the time to review whether they can and should elect their business into the regime. The answer is not always clear cut and the best approach is to conduct a feasibility analysis to determnone to what extent the regime will be beneficial. Doing nothing however, risks missing the opportunity. However, the revised regime ends up being legislated it will almost certainly be less beneficial that that which currently exists.