In early November, the UK and Germany released a joint statement announcing an intention to end the existing UK patent box scheme. Doug Ealey asks what might replace the scheme, what this might mean for business in the UK and what steps can still be taken to make use of the scheme while it remains available.

What is the patent box?

Intended as an incentive to protect and profit from innovation, the patent box is an opt-in scheme for reducing corporation tax payable on profits earned from patented inventions to potentially as little as 10%, though only a proportion of profits obtained from using patented rights receive the reduced rate.

For a more information on the patent box scheme itself, see our patent box guide: www.dyoung.com/patentbox 

What prompted the joint statement?

Germany has argued that the preferential tax treatment of IP in the UK creates inequality within Europe. Whilst the UK is not the only EU member to provide a patent box, it does potentially offer the largest tax relief at 10%, compared to 15% or higher from other states offering such schemes.

Germany is also concerned that the patent box does not require the R&D underpinning an eligible patent to have actually occurred in the UK, and that consequently in addition to the legitimate effect of stimulating the commercialisation of innovation in the UK, it has the potential to act as a tax haven for multinational companies whose R&D operations are based elsewhere in Europe.

How will the patent box change?

Among other things, the joint statement included a proposal to close the existing patent box scheme to new entrants as of June 2016. We understand that 'new entrants' refers to businesses that have not previously used the patent box, rather than to new patent rights being relied upon within the scheme after this date.

Those already making use of the patent box by June 2016 should therefore be able to continue benefitting from the current scheme until June 2021, at which point it will be abolished.

It had been hoped that the Chancellor's Autumn Statement on 03 December 2014 would provide additional details about how the scheme will evolve. However, it seems likely that further clarity on the patent box will be deferred until the 2015 budget, leaving some uncertainty in the meantime as to its fate and what replacement scheme might follow it.

We expect that the most likely outcome will be a new scheme enabling a reduced base rate of tax closer to 15% than the 10% of the current scheme, to harmonise with IP tax breaks elsewhere in Europe. It is also likely that such a scheme will additionally require that in order to participate, the R&D that gives rise to a qualifying patent must also be conducted in the UK. This follows from the 'modified Nexus' approach, proposed by the Organisation for Economic Co-operation and Development (OECD) forum on harmful tax practices, to provide IP tax relief in the same location as the R&D expenditure.

What does this mean for businesses in the UK?

Clearly the R&D provision is likely to affect multinational companies, and a key point will be how R&D is interpreted as satisfying any national provenance requirements given the reality of collaborative research across states. It may be, for example, that where research has been conducted within the UK only, there is no further nationality requirement, whereas where research has been conducted collaboratively across several countries, a UK national may need to be identifiable as an inventor. For now however this is speculation and we will have to wait for details.

Meanwhile, this new provision is unlikely to affect most UK SMEs. In fact, the Chancellor's Autumn Statement appeared to directly target SMEs for further assistance, making changes to the existing R&D tax credit scheme to increase 'above the line' credit from 10% to 11% and increase the rate for the SME scheme from 225% to 230% as of 01 April 2015. The Chancellor also announced plans to streamline the application process for SMEs, with detail to be announced soon. This can only be good news.

Clearly however, it seems likely that any new patent box scheme will be less generous than the existing one.

The loss of the existing patent box could reduce the incentive for SMEs in particular to take the extra step of protecting their IP, particularly as interest in the patent box has only just started to take root; tax returns for periods covered by the scheme are only now enabling a direct illustration of its benefits. We therefore believe that it is important for the UK Government to announce a replacement scheme as soon as possible to provide continuity.

What can businesses do now to make use of the patent box while it is still available?

Businesses who already have a patent or patent application, whose subject matter covers at least some aspect of one of their products, should already be investigating whether to make use of the patent box; but now they have a further incentive to do so before the gates are shut on the current scheme.

Those businesses that do not currently have a patent or patent application should consider building an IP review into their product development cycle now. This should look for problems solved, efficiencies found or new features that could be the subject of a patent. Factors to consider in identifying valuable IP include how relevant it is to your unique selling point(s), how difficult it is to work around to achieve similar effects, and how easy it is to detect in competitor products; although it's worth remembering that innovation can be highly specific to your own product rather than being generalised or ground-breaking to target your competitors.

Consequently a patent application can be narrowly tailored to unique aspects of your own product, with a view to simplifying and expediting the patent grant procedure. This in turn will allow you to benefit from the patent box scheme more quickly.

This approach may be all the more relevant now that the clock is ticking.

Useful links

Germany-UK joint statement in full, online at the UK government website (PDF): http://dycip.com/UKGermanyIPstatement

The Chancellor's Autumn Statement: http://dycip.com/ukautumnstatement.