The UK government recently announced reforms to the taxation of patent profits. The intention is to make the UK a more attractive location for businesses seeking to enhance their patent portfolios.
The “Patent Box”
The reforms will result in a preferential regime for the taxation of patent profits, known as the “Patent Box.” The headline rate of corporation tax for patent profits will be reduced from the main rate (currently 28 percent) to 10 percent, effective April 1, 2013. The Patent Box regime will be optional and the profits to which it will apply include net royalty income and ”embedded income” included in the price of patented products. All patents first commercialized after November 29, 2010 will qualify for inclusion in the Patent Box.
The government’s intention is to enhance UK tax competitiveness; in fact, it aims to create the most competitive corporation tax regime amongst the G20 nations. In 1997 the UK had the 10th lowest corporation tax rate amongst the 27 EU member states. By 2010 it had slipped into 20th position. One of the consequences was that businesses were given little, if any, incentive to headquarter themselves in the UK. From a patent perspective, this meant that technology companies with a focus on R&D chose to base themselves in other jurisdictions which provided specific fiscal incentives to innovate. In 1970 the then Patent Office received 62,101 patent applications, a number that has declined steadily each year. The number of applications filed in 2009 was 22,465, a reduction of almost two thirds over a 30-year period.
The government believes that reducing the rate of corporation tax for patent profits will result in technology companies remaining in or returning to the UK. This will bring a number of benefits to the UK including more jobs and a higher overall tax yield, both of which will contribute to sustained economic recovery. The government’s focus is on patents, rather than intellectual property generally, because of the link between high-tech R&D and manufacturing activity which, in the current economic climate, the government is particularly keen to foster in the UK.
Other Supporting Reforms
The reduction in the headline rate of corporation tax for patent profits will be supported by other reforms to benefit companies for which intellectual property is the most significant asset. For example, the government intends to introduce a more territorial approach to the taxation of intellectual property with changes to the Controlled Foreign Companies regime. This means that the monies generated from the exploitation of intellectual property that has little connection with the UK will be beyond the reach of the UK tax system, although steps will also be taken to ensure that companies do not artificially divert such profits to low tax jurisdictions. The government also intends to review how well the existing R&D tax credits support innovation.
The government’s announcement is just the first stage in a phased introduction of the reforms. The announcement merely outlines the government’s plans; more detail will be given when a formal consultation on the proposals is launched in spring 2011. Draft legislation is to be published this autumn and a Finance Bill passed into law in 2012, coming into force on April 1 of that year.
The reforms have been criticized by some including the Institute for Fiscal Studies. The criticisms center on the fact that the reforms focus too much on the commercialization of patents once obtained, rather than providing additional tax breaks at the earlier R&D stage. In addition, it is generally recognized that the new Patent Box regime still does not match the patent profit tax rates of some other countries although the government’s view is that the new 10 percent rate strikes a balance between affordability and competitiveness.
Despite these criticisms, the reforms will be welcome to companies engaged in research and innovation. To take maximum advantage of the reforms, companies will need to base themselves in the UK and ensure that their patent portfolios are adequately exploited. The new regime rewards commercialization rather than the passive holding of patent rights. Companies may want to review their existing patent portfolios. Should patents be obtained for technology currently protected by other intellectual property rights, such as confidentiality? Also, companies should ensure that they retain comprehensive records of which patents were first commercialized after November 29, 2010.