Taxation of intellectual property (IP) is back in the spotlight this week with the publication of the Government's latest proposals which detail how the 10% tax rate, or 'patent box', will work. Overall there is good news for innovative businesses subject to UK corporation tax.

Under its "Plan for Growth" the Government committed itself to creating the most competitive tax system in the G20. Across a range of policy areas, it is giving high priority to encouraging innovation which it sees as a key generator of growth in the UK economy. This includes a programme of corporate tax reforms specifically relevant to intellectual property:

  • The Patent Box
  • The R&D tax regime
  • The controlled foreign company regime.

All companies will also benefit from the series of reductions in the main rate of corporation tax which will bring it down to 23% by 2015.

Patent Box - background

The objective of the patent box is to establish a regime that encourages business across a wide range of sectors to invest in the UK, generating growth and creating jobs. Companies will pay a 10% corporation tax rate on profits generated from exploiting "qualifying patents". It is an optional regime.

In the original consultation the Treasury set out a number of high level principles, namely:

  • To make the patent box regime competitive for the widest range of businesses it should include both patent licence income and patent income embedded in the proceeds of selling patented products.
  • To minimise the administrative burden, HMRC's approach to identifying income embedded in products will be based on a formula, rather than by requiring businesses to make an arm's length valuation of their individual patent profits.
  • That it should apply to net profit after associated expenses including pre-commercialisation expenses, rather than to gross income.
  • That its aim is to encourage businesses to engage actively in developing patents and exploiting them rather than to reward the acquisition and passive holding of patents.

The new consultation document provides more detail of how this will work in a number of important areas.

The main issues are:

  • Which patents qualify?
  • What income qualifies?
  • How will the amount to which the 10% rate is to be applied be calculated?

Qualifying patents


Patents granted by the UK's Intellectual Property Office (IPO) or the European Patent Office (EPO) will qualify. The rationale given for this is that they are properly examined and so more likely to indicate real inventions than patents granted by IP offices with less rigorous examination procedures. One point on which feedback is requested is whether there are other EU countries with effective patent examination processes that should be included. This seems likely to result in the addition of at least German patents to the list.

It looks as though the argument for the inclusion of Japanese and US patents has been definitively ruled out because their inclusion would undermine the UK policy of not granting patents for some inventions such as business methods.

Businesses that intend to take advantage of the regime will want to consider whether they should apply under the national UK regime as well as under the EPO regime. This would increase the likelihood of obtaining at least one qualifying patent.

Scope of qualifying IP

In addition to patents, Supplementary Protection Certificates (SPCs), regulatory data for new pharmaceutical and agrochemical products, and plant variety rights will also qualify.

While the consultation document makes it clear that the Government does not intend to include other forms of IP such as trade marks or copyright, there are some provisions which will cover know-how if it is licensed as part of a package with a qualifying patent.

Mention of registered design right is noticeably absent from the document. This right is often used to protect innovation that is embodied in the internal or external appearance of a product, whether or not the feature is patented. Where there is a patent covering the product, profit generated from the design right will fall into the patent box. However, where there is no patent, it will not. Wragge & Co has asked for clarification of the Government's position in relation to design right.


In order to qualify for the patent box regime, a business must be subject to corporation tax in the UK. It will then be entitled to benefit from the patent box for all worldwide income from inventions covered by a qualifying patent. This will apply regardless of whether that invention has patent protection in other countries. It will not matter whether the business owns the patent outright or has an exclusive licence either for a particular field or any particular territory. Income from jointly-owned and from acquired patents will also be eligible provided that in each case the business claiming the tax relief meets two tests:

  1. It must "remain actively involved in the ongoing decision-making connected with the exploitation of the patent"; and
  2. Either it or another group company must have "performed significant activity to develop the patented invention or its application".

The document specifically says that sub-contracting of research and development work will not necessarily prevent the group from meeting this requirement. However, there are other areas of concern. For example, what will be the position where a business participates in a research and development consortium by providing funding for the project and expects to share and exploit ownership in any resulting patented invention? Will the provision of funding amount to "performing significant activity"?

The meanings of "remaining actively involved" in decision-making and "performing significant activity" in the development of the patented invention will doubtless provide plenty of scope for debate. A pragmatic approach and some guidance notes from HMRC will be needed if this is to be workable.

The policy objective behind these provisions seems to be aimed at excluding two kinds of business activity from the patent box: firstly, those whose business model is to acquire patents for licensing, rather than developing them ("non-practising entities"); and secondly, the financing of innovation. The reasoning for this is less than clear and it seems likely to be an area of significant debate in the course of the current consultation.

Qualifying Income

Territorial scope

It is proposed that worldwide income earned by UK businesses from inventions covered by a qualifying patent falls into the patent box. While this is a generous approach to the issue, it does potentially raise problems in deciding whether or not a particular product is "an innovation covered by a currently valid qualifying patent". Again there is likely to be some pressure in the consultation for clarification of how this will be assessed in practice.

Types of income

Qualifying income will include the following:

  • Royalties and licensing fees generated by an invention which is covered by a qualifying patent.
  • Income from licensing a bundle of intangible assets as a single product – this seems to cover licensing the invention covered by the qualifying patent together with related know-how, as well as possibly designs and copyright etc.
  • Income from the sale of products incorporating at least one invention covered by a qualifying patent ("embedded income").
  • Income from the sale of spare parts for a product covered by a qualifying patent, whether or not the spare parts are covered by a qualifying patent themselves e.g. printer cartridges (this is also embedded income).
  • Damages or compensation paid by third party infringers (presumably this will be embedded income in some cases and not in others).
  • Proceeds of the sale of patents.
  • Notional arm's length royalties for the use by a company of its own patents in industrial processes. To claim this, the business will have to use special rules known as "divisionalisation" to allocate the ownership and use of those patents to different parts of the business.

The following will not be included:

  • Income from products made by a patented process (unless it also falls within one of the categories above).
  • Service income relating to patented products.
  • Income arising from financial arrangements, such as interest.
  • Income or profits which fall within the North Sea ring fence regime applying to the extractive industries.

Timing of income

The current proposal is that up to four years' income arising between the date of application for the patent and its grant will be eligible for inclusion once the patent is granted. All that income will be treated as arising in the accounting period of the date of grant.

The Government is expressly requesting input on whether this proposal is fair and workable. Businesses will need to look at their pattern of prosecution and licensing histories to establish whether the four-year rule routinely excludes early licensing income.

Start date for patent box regime

The original proposal was that the patent box would apply to all patents first commercialised after 29 November 2010. In the previous consultation a number of companies indicated that the date of initial commercialisation may be very hard to identify or define.

The Government is therefore offering an alternative method. All qualifying patents in existence at 1 April 2013 would be eligible for the patent box. Clearly, this would be a far greater number than the original proposal, so to keep the cost of the regime within budget the 10% rate would be phased in over five years.

The chosen model will be mandatory for those opting in to the patent box and businesses will not be able to opt for their own preferred model.

How much?

The patent box will apply to the net profit attributed to qualifying patents and not their gross income. This means that associated expenses will be deducted in full.

A further refinement is that in order to reward the contribution made by the patent itself there will be a flat-rate deduction of 15% from the profit attributed to its exploitation. This is intended to reflect the profit that the business could be expected to make anyway. For example, if a company were to sell two types of widgets, one patented and the other not, the patent box would apply to the premium price it charged for its patented widgets over the price charged for non-patented ones.

In order to try and minimise the burden of calculating the amount that is eligible for the patent box, HMRC will apply what it calls a "formulaic approach". This will avoid the need to make specific calculations of actual profit attributable to qualifying patents. In essence, the company's taxable profits will be apportioned pro rata to the share of its gross income attributable to exploitation of qualifying patents. A fixed proportion of 15% will then be deducted to represent the routine profit. The balance apportioned between profit attributed to qualifying patents and that attributed to non-qualifying IP such as a brand.

There will also be a requirement to apportion the profit between that earned by the patent and that earned from the use of other IP, usually a brand. To reduce the burden on small companies of making the calculation, they will be allowed to apply a standard 50% apportionment. Larger companies will have to calculate the actual contribution of the brand to the profit.

It is not clear from the document whether this approach is to be used for licensing income and proceeds of the sale of patents as well as to embedded income. Wragge & Co has asked the Treasury team for clarification and will update this briefing when a response is received.

While there is some merit in the proposed approach which will inevitably involve some rough justice, it is questionable whether applying a 15% notional "routine profit", regardless of industry sector and company size, is appropriate.

The Government recognises that this is unavoidably quite a complex regime and that it will impose an additional administrative burden on those companies which choose to use it. However, it has indicated it is open to comments and suggestions about how the administrative burden could be further reduced. The apportionment between profit attributed to qualifying patents and that attributed to a brand is an obvious candidate for an alternative approach. For example, this could benefit from an agreed methodology that utilises information already captured by most companies.

R&D tax schemes

There is a consultation on taxation of research and development (R&D) running to the same timetable.

The main contentious issue is the possibility of replacing the current "super deduction" scheme with an "above-the-line" tax credit. There are also several proposals relating to subcontractors and to the use of agency or other external workers. A pilot scheme to assist start-ups and small companies that have not yet claimed R&D tax relief is also announced.

More information on the scheme can be obtained by contacting Wragge & Co's IP team.

Controlled Foreign Companies (CFCs)

We are still waiting for the Government to publish its next consultation document on CFCs.

Implementation timetable

This consultation is the final stage of the Government's policy-making. Responses are required by 2 September 2011 and will be followed by draft legislation in the autumn. The patent box regime is due to come into effect on 1 April 2013.


It is likely that the patent box regime will be of particular benefit and attraction to sectors including pharmaceuticals, life sciences, electronics, communications and defence.

The Government's objective is to encourage investment in development of new patents and to prevent the movement of IP offshore by innovative businesses who might otherwise invest elsewhere. This will support the creation of high value jobs in the UK and help boost domestic economic activity. Although some economists have questioned whether the measures will achieve that objective, the proposals have been generally welcomed by IP-rich businesses. It will be important to establish clear, workable guidance so that in practice, businesses do find it worthwhile to take advantage of the scheme.