Patent box tax break for innovation "does not facilitate profit shifting", says UK Treasury

In a recent speech the commercial secretary to the Treasury, David Gauke, said that the policy "categorically … does not create an opportunity for businesses to reduce their taxes without increasing their value to the UK economy". He said that the UK had "raised a number of issues that we feel require further attention" with the Paris-based Organisation for Economic Cooperation and Development (OECD), as its recently-published work on 'harmful tax practices' as drafted could prohibit the arrangement.

In his speech, Gauke highlighted the impact that the policy was already beginning to have on life science and pharmaceutical companies in particular, as well as those in the engineering and technology sectors.

"The patent box was introduced to encourage innovation and to bring high value science and technology jobs and investments to the UK," he said. "It also ensures that the jobs that are already here will stay here."

"GlaxoSmithKline has attributed to the patent box its additional investment of £500 million in manufacturing in the UK, along with the creation of 1,000 new jobs and the construction of a new factory ... The UK economy will see a positive effect as a result of that," he said.

The patent box regime came into force on 1 April 2013 and allows companies to elect to apply a 10% rate of corporation tax to all profits earned from patented innovations and certain other IP rights. The discounted rate can be applied to profits paid separately as royalties or embedded in the price of products. Qualifying patents are those granted by the UK's Intellectual Property Office or the European Patent Office.

The European Commission is currently looking into the patent box as part of a wider assessment of whether various tax regimes applicable to IP in the EU comply with EU rules on state aid. The state aid regime is intended to prevent the distortion of competition that could occur if national companies grant advantages or incentives to particular companies. The incoming EU competition commissioner, Margrethe Vestager. has said that anti-competitive tax practices will be a "high priority" when she takes over the role next month.

"The life sciences sector is in a period of global transformation," said life sciences expert Helen Cline of Pinsent Masons, the law firm behind Out-Law.com. "The patent box along with other measures such as the research and development tax credit and the catalyst funds are important aspects of the UK’s support for the sector. The UK government is expected to publish a Science and Innovation Strategy for the chancellor's Autumn Statement on 3 December . The strategy may further articulate how the government plans to defend the patent box so that it can fulfil its potential to encourage research and development in the UK."

Tax expert Heather Self of Pinsent Masons said that pharmaceutical firms generally had "less to fear" from the EU's recent raft of state aid investigation than companies operating in other sectors.

"Many pharmaceutical companies have made significant investments and large numbers of genuine jobs have been created," she said. "But, as always, if tax arrangements agreed with national authorities are 'too good to be true', they could be vulnerable to challenge."

"Looking at the OECD's proposals to prevent abuse of transfer pricing rules and harmful tax practices, the emphasis will be on ensuring that incentives are only given for 'real' activity. The UK may come under pressure to tighten its qualifying conditions to meet this," she said.

The OECD's work on base erosion and profit shifting (BEPS) is aimed at ensuring that multinational companies are taxed in the same jurisdiction as their actual business activities take place. One area the UK Treasury has sought clarity on is when businesses can be said to be engaging in 'substantial activity' within a country in order to qualify for preferential tax treatment.

In his speech, Gauke said that the patent box was only available to companies that had either developed IP themselves or had "actively managed the commercial exploitation" of that IP. "This is a substantial amount of activity for a business to undertake," he said.

He said that although many countries had endorsed the OECD's approach, there had been "no consideration of its feasibility or proportionality" and there were areas in which it may not be compatible with EU law.

"The restrictions on eligible expenditure could influence the location of business activities within the EU and therefore infringe the freedom of establishment," he said.

"It is also inconsistent in its principles. It does not allow acquisitions from third parties, although third party outsourcing is allowed. Introducing these sort of false distinctions could distort commercial decisions ... The UK's preference is for well-understood and accepted transfer pricing principles," he said.