Further to its initial announcement last November, on 10 June the Coalition Government published a consultation paper on its proposal to charge corporation tax at a reduced rate of only 10% on company profits derived from qualifying patents and analogous intellectual property (the Patent Box).
This client advisory is the second in a series of four articles summarising aspects of the proposed Patent Box regime, and describes the intellectual property rights that will qualify for favourable tax treatment.
To read the first advisory in this series, which provides an overview of the key features of the regime, please click here.
QUALIFYING PATENTS AND IP
In determining the nature of IP that would be permitted to benefit from the Patent Box, the UK Government had to take a number of factors into account:
- should all patents, wherever granted, qualify for the Patent Box?
- to what extent - if any - should non-patentable IP be included?
- what sort of ownership interests should qualify: for example, should licensed, acquired or jointly developed patents be permitted within the Patent Box?
- finally, to what extent should the company itself have been responsible for developing the IP and how should this be determined?
Qualifying patents and income
The Government has proposed that only patents granted by the UK Intellectual Property Office (IPO) and the European Patent Office (EPO) will qualify. There are two reasons for this:
many foreign patent registries do not undertake a full examination process before granting patents. Consequently, there is a greater risk that their patents will not demonstrate novelty or innovation. This raises two issues:
- the Government is not satisfied that in all cases such patents will have demonstrated sufficient innovation or usefulness to justify benefiting from the lower tax rate; and
- the lack of due investigation may lead to a greater risk of those patents being overturned.
- Other jurisdictions permit the patenting of inventions and processes that would not be patentable in the UK. It would be inconsistent to allow such patents to qualify when equivalent inventions in the UK would not. Furthermore, even if patents from other jurisdictions were patentable in the UK, to permit their inclusion would require the UK tax authorities to have to assess this on a case by case basis, which would be both bureaucratic and (for a tax authority) inappropriate.
The consultation paper does offer an olive branch, however. It asks whether other EU Member States have sufficiently similar patent regimes to allow the Patent Box to be extended to cover them too.
Whilst the geographic/jurisdictional scope of the patents is narrow, there is no restriction on the source of income derived from them (or from other qualifying IP). Accordingly, a company's global revenues from qualifying patents/IP will be eligible for the Patent Box.
Other qualifying IP
The Government has no plans to extend the Patent Box to cover trademarks or copyright, as they are not subjected to the same degree of independent investigation and need not demonstrate innovation. However, the following rights will fall within the regime:
- supplementary protection certificates in respect of patents originally granted by the IPO or the EPO; and
- other analogous rights that cover innovations that can't be patented, such as regulatory data protection and plant variety rights.
Qualifying ownership interests
The consultation paper proposes that the range of interests in patents falling within the regime will be wide and driven by commercial considerations. Accordingly, as long as there is evidence of active involvement in the patent development cycle, the following interests will benefit from the Patent Box:
- formal legal ownership;
- an exclusive license to exploit a patent commercially (even if limited by field or territory);
- jointly developed patents e.g. via partnerships, joint ventures or cost sharing arrangements, as long as the parties to the arrangement own or hold an exclusive license to the patent;
- acquired patents.
The "development" criteria
If a company is to benefit from the Patent Box, it will have to show that it has been actively involved in developing the patented invention. The consultation paper makes clear that merely holding patents for financial reward will not be sufficient. Companies will be judged by two criteria:
- first, they must remain actively involved in ongoing decision-making connected with the exploitation of the patent; and
- secondly, either the company or another company in its group must have performed significant activity to develop the invention or its application. This can include project risk management, as well as R&D activity, so it will be possible to sub-contract R&D and remain eligible for the regime.
The paper does not provide any guidance on what a company needs to do to satisfy these tests, except to say that the activities need not necessarily occur prior to the patent being granted, or lead to further patents being granted. They must, however, be more than the activities associated with management of a financial investment or mere legal protection of the patent.
Where patents have been acquired or developed jointly with unrelated companies, it may be difficult to determine whether the applicant has undertaken "significant development activity". The consultation paper therefore proposes two options to address this and invites views on which would work better for companies. The options are:
- that the patent will only qualify if the applicant's development expenses in relation to the patent are greater than a pre-defined proportion of the acquisition value or the total costs of the joint project; or
- that the assessment is made on a case by case basis, taking all relevant factors into account.
The first option offers greater certainty, ease of administration and therefore, probably, lower cost, but the arbitrary "all or nothing" cliff will give rise to winners and losers. The second option should lead to fairer results, but with greater uncertainty and cost, and possibly greater scope for the tax authorities to vary their interpretation of "relevant factors" over time.
Where a qualifying patent has benefited from the Patent Box regime, but is subsequently overturned, it will cease to be eligible for the Patent Box, but there will be no claw-back of prior benefits.