Post-BEPS, the UK Government has set out its views on adapting the patent box to comply with the modified nexus approach.

Background

The patent box is a key initiative in terms of UK competitiveness on an international level in the field of innovation. In force since 2013, the regime allows companies to elect for a reduced corporation tax rate (10 per cent) on income from patents and similar IP, including royalties and profits arising from sales of goods and services and processes, as long as they comprise a component of the patent.

However, changes to the current approach for IP income are required in the light of the recommendations in the final report on BEPS Action 5 (Countering Harmful Tax Practices More Effectively), in order to comply with the modified nexus approach, that uses R&D expenditures as a proxy for a substantial activity test.

Proposed changes 

Consistent with the Action 5 recommendations, the proposed new rules require that income eligible for tax benefits must be linked to actual R&D expenditure. IP profits must be calculated on the basis of streaming (i.e., income is divided into qualifying and non-qualifying streams), and companies must track and trace expenditure corresponding to each stream.

Companies should therefore separately calculate a profit for each different parcel of IP, which can be per item of IP, product, product category or a mixture ‒ largely based on the current rules.

For each profit stream figure, the company will then apply the "nexus fraction" to determine the amount of income eligible for benefits.

Transitional period and grandfathering rules

  • Existing IP within the current regime can continue to benefit until 30 June 2021 (although a shorter period might be agreed upon).
  • IP acquired from related parties after 1 January 2016 would not be eligible for grandfathering, unless that IP already qualifies under an existing IP regime.
  • Companies that have not elected into the regime by 30 June 2016 can still elect within the normal time limits (up to two years after the end of the accounting period), in respect of pre-1 July 2016 profits, provided that they satisfy the conditions by 30 June 2016.
  • Subject to these rules, the current regime will be closed to new entrants from 1 July 2016.

What does this mean for businesses?

The proposals largely follow the BEPS recommendations. They offer a framework for a revised regime, but at this stage detail is short, resulting in a period of uncertainty for businesses.