The UK Patent Box was introduced in April 2013 to allow companies that derived profits from patented technologies to benefit from a low (10%) rate of corporation tax on those profits.
In 2013, the European Commission ruled that the UK Patent Box regime constituted harmful tax competition. At about the same time, as part of the Base Erosion and Profit Shifting (BEPS) project set up by the Organisation for Economic Co-operation and Development (OECD), the OECD’s Forum on Harmful Tax Practices also indentified the UK Patent Box as an area which needed reform.
The main objection to the original Patent Box rules was that they allowed companies the tax advantages without requiring any real economic activity in the UK. This could arise if, for example, a company owned IP in the UK but conducted most (or all) of its research and commercialisation outside the UK.
In December 2015, the Government published draft legislation to be included in the Finance Act 2016 to introduce changes to the Patent Box in order to make the regime “BEPS compliant”.
Effect of changes
The rules will be amended to include a so-called ‘modified nexus approach’. This is designed to ensure that the benefits that can be obtained from the Patent Box are only available where substantial research and development activities are undertaken in the UK and where there is a clear link between that research and development and a patent, product or product family owned by the company seeking to claim the tax benefits.
To reflect this new approach the way relevant IP profits are calculated will be amended in order to require that profits are ‘streamed’ which means that profits that are attributable to a particular patent (or if there are multi-patent items, to a particular product line) are considered together.
Once profits have been streamed according to patents/products, the profits eligible for relief will be calculated (and possibly reduced) by applying the “R&D Fraction”. This is designed to reflect the proportion of development activity a company carries on itself (or sub-contracts to an unconnected third party) versus the amount of development activity that is sub-contracted to connected parties. The aim here is to remove the benefit of the Patent Box from profits that are attributable to development activities undertaken by connected parties in other jurisdictions.
Commencement and transitional rules
The new rules will apply to any company electing into the Patent Box regime after July 2016. There will be a period where the old rules will continue to apply to companies that elected into the Patent Box regime prior to July 2016. However, this transitional period will come to an end in June 2021 and all companies will be required to use the new rules from that point.
The way ahead
There has been broad international agreement on applying the ‘modified nexus approach’ to preferential tax regimes for intellectual property and so we should all be hopeful that these are the last changes to be made to the, still relatively new, UK Patent Box for the foreseeable future.
What seems likely is that companies will be doing all they can now to elect into the old regime before July so that the maximum benefits possible under the old regime continue for as long as possible. Against that, they will, of course, need to have in place structures that will work under the new rules for any new IP or once 2021 arrives in relation to existing IP.