On 10 June 2011, the UK Government launched a Consultation on the “Patent Box”, a preferential corporation tax regime of 10 per cent on profits arising from patents. According to HM Treasury, the consultation forms part of the Government’s plans to make the United Kingdom’s tax system the most competitive in the G20.

BACKGROUND

In November 2010, the UK Government published a Corporate Tax reform consultation that included a wide-ranging review of taxation of intellectual property (IP). The Patent Box consultation builds on that initial review and provides a detailed explanation of how the Government proposes to implement the Patent Box.

The idea is that from April 2013, the Patent Box will apply a 10 per cent corporation tax rate to profits attributed to patents. The Government is focusing on patents because they have a particularly strong link to high-tech research and development and manufacturing activity.

Special regimes for patent income are available in some other countries and there have been concerns that the UK system has become less competitive, leading to pressure to locate elsewhere.

THE CONSULTATION

The proposals reflect the Government’s dual aims for the Patent Box: to cover a wide range of patent income and to minimise where possible uncertainty and risk of dispute.

All businesses within the scope of UK corporation tax will potentially be eligible to elect for the Patent Box regime to apply to their trading profits. In order to claim the Patent Box tax deduction, the business must actively hold a qualifying patent or other qualifying IP and must receive income related to that patent or IP.

The proposed model for calculating patent profits is based on the fact that valuable patents and other forms of IP will produce additional returns over companies without valuable IP. The amount of this extra profit, known as the “residual profit”, is a measure of the profit created by the IP rather than though routine business activities.

The consultation questions cover five main areas:

  1. The patents and associated IP types that will be eligible for the Patent Box. For example, should the Patent Box cover patents granted by any other EU national patent office, and do the current ownership laws adequately permit exclusive licensees of patents to qualify for the Patent Box?
  2. The types of income that will be eligible. For example, the Government is seeking views on how the arm’s-length profit attributable to patents used in processes or to provide services should be calculated.
  3. How the profit attributable to patents will be calculated. For example, should there be special rules for any one-off items of income or expenditure? Further, the Government is asking for businesses’ views as to how to separate effectively patent profits from those arising from other forms of IP and on how Patent Box losses should be dealt with.
  4. The computational methodology and interaction with group loss relief, chargeable gains, double tax relief and transfer pricing regimes, and potential anti-avoidance rules. For example, is using a computational tax deduction method the right approach and what are businesses’ views on the interaction with double tax relief rules?
  5. The commencement date of the regime. The Government is asking for views on its proposal for a phase-in approach rather than a cut-off date approach as initially proposed in the November 2010 consultation.

COMMENT

The November 2010 document outlined a number of high level principles to guide the design process, such as: the box should have a broad scope, it should take a formulaic approach, it should apply to profits not receipts, and it should benefit active ownership and innovation. The proposals in this second stage consultation incorporate all of those principles. In addition, the consultation includes a flexible, formulaic approach for calculating patent profits in order to balance the desire for certainty and simplicity with the need for the Patent Box to be flexible enough to take into account different business models and group structures.

The consultation closes on 2 September 2011.