The UK Patent Box
What is the Patent Box?
The Patent Box is a new preferential tax regime that came into force on 1st April 2013. It enables companies to apply a reduced corporation tax rate to worldwide profits earned from their patents and certain other intellectual property (IP).
Why has it been introduced?
The Patent Box legislation hopes to encourage innovation by providing an attractive tax regime for companies to locate their development, manufacture and exploitation of patents in the UK and forms part of the Government’s wider aim to position the UK as a world leader in patented technologies.
How does it work?
Broadly, qualifying companies will be taxed at an effective rate of 10% on their worldwide profits arising from qualifying patents and certain other IP.
The full benefit of the regime is being phased in over four financial years and, during this period, companies will need to apply a percentage to the profits generated from their patented inventions. The percentages for each financial year are as follows:
- 1st April 2013 to 31st March 2014: 60%
- 1st April 2014 to 31st March 2015: 70%
- 1st April 2015 to 31st March 2016: 80%
- 1st April 2016 to 31st March 2017: 90%
- from 1st April 2017: 100%
The 10% rate applies instead of the standard corporation tax rate which is currently 23%. It has already been announced that the standard rate will be reduced to 21% with effect from 1st April 2014 and then further reduced to 20% with effect from 1st April 2015.
The reduced rate will only be available once a patent is granted. However, profits arising whilst a patent is pending, for a period of up to 6 years from application to grant, can also be included in the Patent Box for the accounting period in which the patent is granted.
Which companies qualify?
The Patent Box regime is available for companies that are subject to UK corporation tax and which commercialise patents or develop new innovative patented products, processes or services.
To qualify for the regime a company must:
- hold any qualifying IP rights (“hold” includes legal ownership, an exclusive licence to exploit a patent, partnerships, joint ventures and cost-sharing arrangements); and
- meet a “development condition” by creating or significantly contributing to the creation or development of the patented invention or any product incorporating the patented invention.
Companies that are passive holders of IP, such as IP holding companies, will not qualify.
What about groups?
For a company (A) that is a member of a group, it is possible for A to be eligible if the qualifying development has been undertaken by another member of the group (B), provided that A meet an additional “active management” condition in terms of undertaking a significant amount of the management in relation to the development or exploitation of the IP rights.
Which patents qualify?
The Patent Box regime applies to patents which have been granted by:
- the UK Intellectual Property Office;
- the European Patent Office; or
- equivalent IP offices in countries within the European Economic Area: Austria, Bulgaria, Czech Republic, Denmark, Estonia, Finland, Germany, Hungary, Poland, Portugal, Romania, Slovakia and Sweden.
The scope of the Patent Box extends to other IP rights which are similar to patents and relate to human and veterinary medicines, plant breeding and plant varieties.
What about patents which are licensed?
A company which holds a licence to use somebody else’s technology may still be able to benefit from the Patent Box. However, that company must meet all of the following conditions.
It must have:
- the rights to develop, exploit and defend rights in the patented invention;
- one or more rights to the exclusion of all other persons (including the licensor); and
- those rights must be exclusive throughout at least one entire national territory (rights to manufacture or sell within only part of a country would not qualify as being exclusive).
In addition, the licensee must also either be able to bring infringement proceedings to defend its rights or be entitled to most of the damages awarded in successful proceedings relating to its IP rights.
The exclusive licensing conditions are relaxed for groups of companies, because the Government recognises that one company in the group may own a portfolio of patents while another exploits them.
Tell me more about the type of income included?
Not all of a company’s profits may come from exploiting patented inventions.
In order to be considered as relevant IP income which falls within the Patent Box regime, the income must come from at least one of the following:
- selling patented products – that is sales of the patented product or products incorporating the patented invention or bespoke spare parts;
- licensing out patent rights (i.e. licence fees and royalty income);
- selling patented rights;
- infringement income; or
- damages, insurance or other compensation related to patent rights.
A company can also benefit from the Patent Box if it uses a manufacturing process that is patented or provides a service using a patented tool. In these circumstances, it is necessary to calculate a notional marketing royalty. A notional marketing royalty is calculated as a percentage of relevant IP income which the company would pay a third party for the exclusive right to exploit the relevant marketing assets if the company were not otherwise able to exploit them.
How is the Patent Box relief calculated?
Broadly, the reduced 10% rate is applied by taking an additional trading deduction from a company’s corporation tax profits (after certain adjustments have been made).
This is calculated using the following formula:
RP × FY% × ((MR – IPR) ÷ MR)
In the formula:
- RP is the profits of a company’s trade relevant to the Patent Box.
- FY% is the appropriate percentage for each financial year.
- MR is the main rate of corporation tax.
- IPR is the reduced rate of 10%.
This approach is used to avoid complications where a company may wish to claim losses or other reliefs for the relevant accounting period. Accordingly, before taking the deduction, it is necessary to calculate the amount of profits that qualify for the Patent Box regime.
By way of example:
If a company has taxable profits of £1,000 for the financial year from 1st April 2015 (so the 80% percentage referred to above would apply) which qualify in full for the Patent Box, and the main rate of corporation tax is 20%, then instead of arriving at a tax charge of £100 (by multiplying £1000 by 10%), the calculation is performed as follows:
| Calculation |
Amount £ |
| Profits chargeable to corporation tax |
1,000 |
| Patent Box deduction = £1,000 × 80% ((20 – 10) ÷ 20) |
400 |
| Profits chargeable to corporation tax |
600 |
| Corporation tax payable = £600 × 20% |
120 |
Where a company’s accounting period straddles two financial years, then it will be necessary to apportion the profits generated from a company’s patented inventions and other IP for that accounting period to each financial year.
How and when does a company claim the relief?
A company needs to claim the relief by way of an election and this must be made within two years after the end of the accounting period in which the relevant profits and income arose.
There is no special form of words that need to be used and the election can be made in the company’s corporation tax computations accompanying the tax return or separately in writing.
How does this work with Research & Development tax relief?
Companies which qualify for the Patent Box are also likely to be undertaking significant research and development (R&D) and, therefore, may also qualify for R&D tax credits. The Patent Box regime complements this relief and, as a result, companies will be able to benefit under both regimes if the necessary requirements are met.
What action should companies be taking?
Now that the Patent Box has come into force, companies wanting to access its benefits should consider the following (non-exhaustive list):
- Reviewing existing patent portfolio management policies – companies should consider whether to increase the number of products for which they seek patents.
- Reviewing existing systems – companies should ensure that they have adequate systems to track patents into products or services and to adequately track the attributable income and costs.
- Reviewing existing licensing arrangements – companies should ensure that the exclusivity requirement is met and, if not, whether such licensing arrangements can be re-negotiated to provide exclusivity.
- Reviewing existing IP holding company structures – the Patent Box requires a company to be carrying on a trade and, since traditional IP holding companies do not carry on any trade and would, therefore, be outside of this regime, companies should consider whether using an alternative UK IP trading structure would be more tax advantageous.
- Reviewing group ownership of patents – groups that currently hold their patents outside the UK may wish to consider owning patents in the UK in order to benefit from the regime. Whilst a UK company needs to be involved in the active management of those patents (to satisfy the active ownership condition) and carrying on a trade, the development of the patents may continue to be undertaken by a non-UK group company.
- Analysing whether expenditure incurred on creating and developing a company’s IP will qualify for the enhanced tax relief or tax credits under the R&D tax regime.
How do I find out more?
The UK Patent Box provides a tremendous opportunity for companies to access a highly generous tax regime and can, therefore, (with the Government’s backing) make a huge difference to a company’s (or group’s) overall tax charge.
We have the necessary expertise to help you take maximum advantage of this new tax regime.
If you would like to find out more and discuss how your company or group can benefit, please contact one of our Patent Box advisers on 020 7470 8820, email us at enquiries@newshams.com or visit our website http://www.newshams.com.
