The issue raised
In July 2019 during a visit to the UK, Australia’s Treasurer Josh Frydenberg was asked at a business event whether he would consider introducing a patent box into Australia. In response, the Treasurer said: “We need to have a tax regime around intellectual property to attract companies and maintain their investments in Australia”. The Treasurer also indicated that he was happy to have a close look at the British system with the aim of both protecting IP and accelerating it.
The question for Australian companies is: is this a politician’s thought bubble or is the Australian government genuinely interested in fostering innovation by providing an incentive for businesses to obtain Australian patents for products that are generating a commercial return?
What is a patent box?
A patent box is a tax incentive scheme which reduces the tax payable on income derived from intellectual property, particularly patents. The aim of the scheme is to provide an incentive for companies to retain and commercialize patented inventions and to pursue patent protection for new inventions in their home country. The idea of a patent box is not new, with Belgium, China, Ireland, the Netherlands, Spain, Switzerland, Turkey and the United Kingdom adopting patent box schemes in the last two decades.
The UK patent box
A patent box was introduced into the UK in 2013. This scheme reduced the tax rate to 10% (down from the company tax rate of 20%) for profits arising from IP. In order to qualify for the reduced tax rate a company was required to have qualifying IP, be the owner or the exclusive licensee of the IP and earn an income from the IP.
In response to a 2015 OECD report classifying the UK patent box as a “harmful tax practice”, the scheme was updated in 2016 to require that majority of the R&D be carried out in the UK.
The most recent data available indicates that in 2016-2017 large companies were the biggest beneficiaries of the UK patent box with 95.5% (£720.2miliion) of the total tax relief provided being claimed by companies having greater than 250 employees and either £50million turnover or greater than £43million total assets.
Australia’s R&D tax incentive
The R&D tax incentive is Australia’s flagship program for supporting R&D in Australia, providing up to 43.5% tax offset for companies undertaking R&D, which is refundable for companies in losses. Larger companies with a turnover of greater than $20M can access a 38.5% non-refundable offset for their R&D. This program has been in existence in various forms since the mid-1980s.
Innovation in Australia
According to “[a]n innovation-ready nation” published by the Federal Government on 18 March 2016, “[c]ompanies that embrace innovation, that are agile and approach change confidently are more competitive, more able to grow market share and more likely to increase their employment…we [the government] want to help innovators contribute to defining Australia’s competitiveness and agility in our fast-growing Asia Pacific region.”
The R&D tax regime already contributes to the start-up phase and incentivises businesses to improve its offerings. What should result out of at a proportion of R&D are new products, services and processes which are patented. It is this product-directed patented output that could be the subject of patent box regime in Australia. The introduction of a patent box scheme would complement the R&D tax regime by providing an incentive for companies to retain commercialization and exploitation of IP (including manufacturing, export and sales) in Australia instead of transferring these activities to more tax friendly jurisdictions.
A patent box for Australia is not new
This is not the first time a patent box scheme has been considered in Australia. In 2015, the Office of the Chief Economist published a report into the implementation of a patent box in Australia. The conclusion of the report was that while the scheme would “certainly increase the number of patent applications filed at IP Australia” most of these filings would likely be opportunistic and not tied to real economic activity. The report concluded that the loss in tax would not be compensated by the increase in revenue by IP Australia and the overall return of the scheme would be negative.
More often than not, governments face problems that require resolution. The present Federal Government is very much focussed on fiscal responsibility and bringing the budget back into surplus. In this context, we have witnessed a government that has reduced personal income tax as well as corporate tax rates. Both of these measures reduced the accrual of tax revenue. However, the government believes that these measures will increase personal disposable income, encourage corporate investment, raise productivity, increase GDP and raise real wages and living standards. Seen in this context, it is apparent that the above report failed to take account of the likely positive impact on these important economic factors.
An Australian patent box is not a problem, it’s an opportunity
We assume that the Treasurer’s comments were serious. With all political parties supporting innovation, with the R&D tax regime intact, the time is right for an Australian patent box system.
The only question should be the framework to be adopted and timing. In the South East Asian region, Australia needs to be mindful of the innovative Singaporean economy with a significantly lower corporate tax rate (17%) and rapid movement to improve its patent system. Will Singapore introduce a patent box? Moreover, Australia’s largest trading partner, China, already provides significant financial incentives to businesses that file patent applications.
Based on the UK experience, there must be a fundamental requirement that eligible R&D leading to a patent is conducted in Australia. This requirement could mirror the current R&D Tax requirement. Another requirement should be that the only eligible patent is an Australian standard patent. Acquired IP should also be included within the scheme provided it fulfilled the R&D requirement and is further developed or actively managed by the Australian company.
It is apparent from the UK data that the 50% reduction in tax rate incentivises business. Relief claimed under the UK patent box has increased from £365.4 million in 2013-14 to £942.5million in 2016-17 (preliminary data).
In view of the UK data which indicates that the biggest beneficiaries are large companies, it would be open to the government to provide a cap on the size of an eligible business if it considered that better value accrued to supporting, for example, SME’s. Alternatively, the government could put a cap on the amount of tax relief a company could claim. Similarly, the government could specify that only patents granted after a particular date would qualify rather than being locked in to already granted patents.
One of the issues identified in the UK is the apparent complexity in supporting a patent box tax claim. We think that given the likely similarity with the R&D Tax regime, this should not prejudice Australian tax claimants.
Meeting an objective
How should the success or otherwise of a patent box regime be assessed? It is obvious that there will be a reduction in tax revenue from an innovative business using the patent box in a steady state situation. But what if some of the additional revenue is invested in the business such its overall economic activity is increased? Such an increase in economic activity, whilst difficult to measure, aligns with the current governments thinking on reduction in personal and corporate tax rates. On this basis, a patent box regime is entirely consistent with the existing government tax policy.