The patent box regime enables UK companies to elect for a lower tax rate for profits earned from patented inventions and certain other intellectual property rights. The tax rate was phased in but is 10% from 1 April 2017.
The regime changed for new entrants to the patent box on or after 1 July 2016. Under the new rules, the profits qualifying for the reduced rate of corporation tax will depend upon how much of the development expenditure was incurred by the company claiming the relief.
The new regime may be less favourable than the old regime for companies that have bought IP rights or have subcontracted R&D to related parties.
This guide covers only the post-July 2016 rules. IP which was within the old patent box by 30 June 2016 will continue to benefit from the old regime until 30 June 2021. See our separate guide to the patent box regime for entrants before July 2016.
Why has the regime been modified?
The patent box regime has been modified for new entrants from 1 July 2016. This is in order to comply with the recommendations of the Organisation for Economic Cooperation and Development (OECD) as part of its base erosion and profit shifting (BEPS) project to reduce international tax avoidance by multinationals. The OECD was concerned that preferential tax regimes, such as the patent box, could be used for profit shifting, unless the availability of the regime was linked to economic substance in the country concerned.
The key difference between the regimes is that under the new regime the company claiming the relief will have to have incurred expenditure in developing the IP, simply managing the rights will no longer be sufficient. Additional calculations and detailed record keeping will be required as 'streaming' of income and expenditure for each individual patent will be compulsory.
Who will be affected?
A company which owns 'qualifying IP rights' or has exclusively licensed in such rights, can potentially elect to benefit from the regime.
The new regime applies to pre-July 2016 IP which has not been elected into the patent box for a period before 1 July 2016 and to IP rights applied for after 30 June 2016. Companies already within the old regime will continue to benefit from that regime, although there will be increased administrative requirements if they have old and new IP.
Qualifying IP rights
The new regime applies to the same types of IP as the old. In addition to patents granted by the UK Intellectual Patent Office and the European Patent Office, the regime includes patents from certain EEA states being; Austria, Bulgaria, Czech Republic, Denmark, Estonia, Finland, Germany, Hungary, Poland, Romania, Slovakia and Sweden.
Certain supplementary protection certificates, certain plant breeders or plant variety rights and certain EU marketing authorisation rights of medicinal or plant protection products will also be within the regime.
Which profits qualify?
The patent box rate applies broadly to a proportion of the company's profits derived from licensing or selling qualifying IP rights, selling products incorporating a patented invention or using a patented invention elsewhere in the course of the company's trade. Profits derived from a company's routine manufacturing or development functions, or marketing activities are excluded.
The old rules provided two possible methods for calculating the profits benefiting from the patent box rate; the standard method and streaming. The standard method required the identification of the proportion of relevant IP income derived from the trade of the company and used it to make a pro-rata allocation of total company profits.
Streaming required income and expenditure to be allocated to two streams, one for all IP income and the other for all non-IP income. Only streaming will now be permitted. However, under the new regime there has to be a separate sub-stream for every individual IP right or, where this is not reasonably practicable, for each patented product or product family. This individual streaming requirement will mean that companies will need to have comprehensive systems in place to track and allocate expenditure and income to the relevant stream.
Even companies which are within the old regime will need to begin to carry out more detailed allocation of expenditure as they will need streaming information from July 2016, once the old regime comes to an end in July 2021.
The nexus fraction
The OECD recommended that favourable IP regimes like the patent box should only be available to companies engaged in 'substantial activities' in relation to the IP.
The 'nexus fraction' is designed to achieve this. It will be applied once the profits from the IP have been calculated. Its broad effect is that patent box relief will only be available to the extent that the company holding the IP has incurred expenditure itself on relevant R&D or has subcontracted the expenditure to an unconnected third party.
The fraction includes a maximum 30% uplift, which allows IP acquisition costs and R&D sub-contracted to connected companies to qualify if they do not amount to more than 30% of the aggregate of the R&D spend by the company itself and the R&D subcontracted to unconnected parties.
R&D subcontracted to a connected company – even another UK company - or costs incurred in acquiring the IP, may (subject to the 30% uplift) result in a restriction in the relief. Groups may need to restructure to ensure that the IP is held by the company incurring the expenditure.
The rebuttable presumption
In exceptional circumstances, companies which have had their patent box relief unfairly restricted by the nexus fraction may be able to get relief.
What businesses need to do
- Consider whether electing any existing IP into the old regime would be more favourable (the time limit is two years from the end of an accounting period that ended before 1 July 2016)
- Ensure systems can deal with streaming of income and expenditure for each individual patent
- Review group structure to ensure that R&D activities are taking place in the company holding the IP and consider restructuring where necessary.