The UK government has been making a concerted effort in recent years to create what it hopes will be one of the most competitive corporate tax systems in the G20. It has been trying to make the UK a more attractive location for investment generally, and one specific area of focus is intellectual property. It is hoped that the new Patent Box Regime will encourage more businesses to hold their IP or research and development centres in the UK.
On 6 December 2011, the UK government published draft Patent Box legislation. The Patent Box Regime will tax a UK company on its worldwide income that arises from existing as well as new patents at a rate of 10% (with full benefits phased in over five years), rather than 23% (which will be the rate of corporation tax from 1 April 2013). Qualifying UK businesses who take advantage of the Patent Box Regime will be able to benefit irrespective of how they use their patents.
During the phasing in period, a company’s patent related income will be taxed at 40% for the 2013 financial year, 30% for the 2014 financial year and 20% for the 2015 financial year with the full 10% tax rate being available for the 2016 financial year.
Does the company want to be in the Patent Box Regime?
An IP holding company has to elect into the Patent Box Regime. It can only do so if certain conditions are satisfied as the Patent Box Regime is only open to “qualifying companies” that hold relevant patent interests.
Does the company qualify to be in the Patent Box Regime?
Briefly, a company will qualify if it holds qualifying IP rights or if it holds an exclusive licence in respect of qualifying IP rights and it receives income from those rights. For a company to be within the Regime, it must be actively involved in the exploitation of a patent or be actively managing it, and it must receive income from the IP rights. A passive IP holding company will not qualify for the Regime. UK subsidiaries of foreign owned groups may find the exclusive licence provision particularly helpful.
In a group scenario, if a company is managing the IP rights, it must undertake a significant amount of management activity. Although the company does not have to make all of the decisions relating to the IP’s management (it should form plans and make some of the decisions), it is hoped that it will be reasonably clear in practice whether the company’s management activity is “significant” or not. 24
Companies will be allowed to opt out of the Patent Box Regime if they so desire. However, if the decision is made to opt out of the Regime, companies will not be allowed to go back into the Regime for five years.
What sort of patent will qualify?
The patent must be granted by the UK Intellectual Property Office or the European Patent Office. Companies will also benefit from the Patent Box Regime if the patent is granted by specified EEA countries which have similar examination and patentability criteria as the UK.
The Patent Box Regime will not be extended to patents authorised by the US Patent and Trademark Office.
The Patent Box Regime will apply to existing as well as new IP, and also to acquired IP on the basis that the company has further developed the IP or the product which incorporates it. The company must have made a significant contribution to the creation or development of the invention claimed in the patent or a product incorporating this item; otherwise the Patent Box Regime will not apply.
How are the relevant IP profits in the Patent Box calculated?
It is important to note that the Patent Box Regime and the reduced rate of tax applies to profits rather than gross income. To qualify for the reduced rate of tax the profits have to fall within one of the following categories:
- profits from worldwide sales of the patented item or a product that derives its value (or some of it) from the patent;
- worldwide licence fees and royalties generated by third party use of the patented product;
- profits from the sale or disposal of the patent rights;
- payments generated by third-party infringement; and
- any other compensation, for use of the patent.
The Patent Box Regime taxes qualifying profits generated from the relevant IP at 10%. In calculating the profits attributable to the patent, it is possible for the company to use a formulaic approach; the company can either allocate its profits between patent income and other income together with the appropriate expenses on a just and reasonable basis or simply apportion an amount to relevant IP income (using the ratio of IP income to gross income) in order to produce 25 an approximate (albeit reasonable) figure. Alternatively, a more bespoke calculation can be prepared.
Once the relevant IP profits have been calculated, the Patent Box Regime taxes those profits at a reduced rate. In practice, the relevant IP profits are reduced by an additional deduction in the company’s corporation tax computation. The effect of this additional deduction is to reduce the rate of tax charged on the relevant IP income to 10%. If the Patent Box deduction reduces the relevant IP profits to a negative figure, then the rules specify how the losses will be used. Any losses will be ring-fenced and must be set-off against future Patent Box profits of the company or any other relevant IP profits of another group company.
What happens to income while the patent is pending?
The Patent Box Regime only applies to profits from patents that have been granted. However, income that is derived from a patent, or a product deriving its value from the patent, and that is earned in the period between application for and grant of a patent may benefit from the reduced rate of taxation under the Patent Box Regime in the year when the patent is granted. The company should calculate what the relevant IP profits would have been, for the period between application and grant. The aggregate amount for this period will be added to the relevant IP profits in the year in which the patent is actually granted. The benefit of the look-back provision will only extend to six years of relevant income. If it takes longer than six years to obtain the grant of a patent (following application) then the additional income will not be covered by the Regime.
Are there any anti-avoidance rules?
There are anti-avoidance rules to prevent unreasonable tax benefits arising from schemes that are designed to avoid certain provisions of the Patent Box legislation or to create a mismatch between the expenditure incurred in acquiring the IP rights (prior to electing into the Regime) and the income generated from the IP rights once the company has elected into the Regime (subject to the 10% rate of tax). The anti-avoidance rules are also designed to prevent the artificial inflation of the amount of relevant IP profits.
If a licence is granted and the licence is expressed to be “exclusive,” it will not qualify for the Patent Box Regime if the exclusivity is “spurious” or the rights conferred are commercially irrelevant in an attempt to shoehorn any IP profits from a licence into the Patent Box Regime and ensure that any income generated qualifies for the 10% rate of tax.
Have the UK done enough?
The UK government is certainly taking steps to ensure that the UK is a more competitive jurisdiction, especially after recent years which saw certain high-profile businesses relocating to Ireland and Zurich (amongst other destinations). Has the UK done enough to reward innovation? Other European countries already operate similar regimes. The Netherlands imposes a rate of 5% and Luxembourg imposes tax at 6% on profits arising from patents. Belgium also offers an attractive rate of tax for profits arising from patents and Ireland offers low tax rates in any event regardless of whether the income arises from the exploitation of patents. Only time will tell whether this new Regime together with other measures that have been taken by the UK government will be sufficient to promote business in the UK.