A 10% corporation tax rate will apply to qualifying profits from companies' worldwide trading activities providing they hold a patent granted by the UK's Intellectual Property Office (IPO) or the European Patent Office (EPO), the Treasury said in a consultation document seeking views on what it is calling the 'Patent Box'.
The main rate of corporation tax is currently 26% of profits, following a reduction in April from the previous rate of 28%.
"The aim is to provide an additional incentive for companies in the UK to retain and commercialise existing patents and to develop new innovative patented products," the Treasury's Patent Box consultation paper (52-page / 587KB PDF) said.
"This will encourage companies to locate the high-value jobs associated with the development, manufacture and exploitation of patents in the UK and maintain the UK’s position as a world leader in patented technologies," the consultation paper said.
The 10% corporation tax rate will apply to profits that stem directly from what businesses earn from holding a patented invention, the Treasury said. The Treasury proposes a three-stage calculation to establish the profits that will be eligible for the lower tax rate.
To determine the eligible profits businesses should first establish the part of their corporation tax profit that applies to income generated from patent activities, such as licensing, selling royalties or trading patented goods, the Treasury said.
"To do this the company’s total taxable trading profit and expenses will be apportioned pro-rata, based on the proportion of the company’s total trading income which is qualifying income for the Patent Box," the Treasury said.
"Where a simple pro-rata allocation is inappropriate a more accurate allocation can be achieved by use of 'divisionalisation' rules," the Treasury said. Divisionalisation rules will allow companies to break down profit and expenses separately within different divisions of their firm, the consultation paper said.
Businesses then have to establish what extra profits it has generated from holding intellectual property (IP), the Treasury said.
"Step two requires companies to calculate this residual profit by deducting a simple fixed percentage return on routine activities from the corporation tax profit attributed to qualifying income," the Treasury said.
The final stage of calculations requires firms to break down the value of patents specifically to their extra profit, the Treasury said. There are no plans to include profits generated from copyright or trademark trading, the Treasury said.
"The Government does not propose to include other forms of IP such as trademarks or copyright, as these have a weaker or more variable link to high-tech activity and have no parallel process of independent examination which would allow the Government to be confident that the resulting product is technologically innovative," the Treasury consultation paper said.
All royalties or licence fees a company receives for use of its invention counts towards a company's qualifying income, the Treasury said.
Income from the sale of product that incorporates at least one invention will count towards qualifying income for the tax deductions, the Treasury said.
"The incorporation of the invention or inventions into the product must be genuinely commercial and the patent must not have been added just with the intention of making the product qualify for the Patent Box," it said.
Income received from licensing intangible assets could also be included in a company's qualifying income, the Treasury's proposals said.
Businesses that sell parts of a patented product can claim tax relief on that income, the Treasury said.
"Where extraneous items are included, or non-patented products are simply sold together with a patented product, then the income related to them will not become qualifying income," the Treasury said.
All businesses that pay UK corporation tax and either own patent rights or licence them will be able to claim the tax break, the Treasury said in its consultation.
"The benefits of the Patent Box will be accessible both through legal ownership and through holding an exclusive licence to exploit a patent commercially," the Treasury's consultation paper said. "The licence can be limited by field or territory, provided that it still results in effective market exclusivity," it said.
Patents developed under partnership, joint venture and cost-sharing arrangements should also be eligible for the tax benefits, the Treasury said.
Only businesses that have an active say in the decision-making process for exploiting patents should be eligible for the deduction, the Treasury said.
"The Government wants to ensure that companies benefiting from the Patent Box are actively involved in the patent development cycle and are not merely passive recipients of income from holding patents," the Treasury said.
Companies that have collaborated to develop a patent will be eligible for the tax benefit if it can prove its development contribution or application of the patent has been "significant", the Treasury said.
Expenses associated with the development or application can prove a company's eligibility if they "exceed a pre-defined proportion" of the patent's value when it was acquired or of the total costs of the project, the Treasury said.
The Treasury consultation paper is asking businesses to respond to its proposals by 2 September 2011. It first announced businesses would benefit from a reduction in the tax rate on patents late last year.
The Treasury proposes to draft new tax laws relating to the Patent Box scheme in the autumn and proposes that the scheme will come into affect from 1 April 2013, the consultation paper said.
