Lifesciences companies have until 22 February 2011 to respond to a Government consultation on a number of important reforms to UK corporation tax which could have a significant impact on the sector. As part of its “Corporate Tax Road Map”, the Government seeks industry views on introducing a “patent box” regime, reforming the controlled foreign company (CFC) rules in relation to IP companies, and changing tax credits available for research and development (R&D).

The Government’s stated aim is to provide a more competitive tax system, with a particular emphasis on activities related to scientific and high-tech IP.

The patent box

A patent box regime allows profits arising from patents to be subject to tax at a lower rate than general corporate profits. This is a new concept in UK corporation tax, and is intended to apply from 1 April 2013. The suggested rate of tax for patent income is 10% – much lower than the current 28% rate of corporation tax.

The idea of a UK patent box was first announced in the Pre-Budget Report 2009. The Government recognises that IP is mobile and that multinational groups have a choice as to where to locate their IP ownership. The aim of the patent box regime is to try to encourage companies to locate their IP in the UK.

The key beneficiaries of the patent box regime will be the UK's pharmaceutical and biotech sectors. Government is keen to engage with businesses that may be affected to try to understand what the behavioural impact of this reform might be. In addition, we would encourage companies in the lifesciences sector to have their say while this consultation is open, as a number of important issues have yet to be resolved.

One key area of uncertainty is how profits from a patent income stream will be calculated where the value of a patented innovation is captured in a product sale price rather than through a discrete royalty. Other points on which lifesciences companies may wish to have their say include whether income from foreign patents, acquired patents and patent pending innovations should qualify for the lower rate of tax.

Controlled Foreign Companies (CFCs)

The UK’s CFC rules seek to prevent international groups from reducing UK corporation tax by diverting profits into subsidiaries in a low tax jurisdiction. Many multinationals feel that these rules go much further than is necessary to tackle this type of avoidance, and that “innocent” overseas activity can be caught, unfairly increasing the tax bill for groups based in the UK. For example, lifesciences companies can face a CFC charge on profits that arise from IP that was developed entirely outside the UK – a huge disincentive to locating the top company in the UK. It is proposed that the existing CFC regime will be replaced in the Finance Bill 2012. The Government has specifically been looking at how this can be applied fairly in relation to IP.

As an interim measure – to be introduced in the Finance Bill 2011 – there will be an exemption for CFCs whose main business is to exploit IP where both the IP and the CFC itself have a minimal UK connection.

The suggested approach for the fuller reform in 2012 is that the focus will be on “high risk” IP-holding CFCs which have excessive profits in relation to the activities they have undertaken. In particular, where IP is developed in the UK, effectively managed in the UK, or funded from the UK, but in either case held offshore, a UK CFC charge may be imposed in relation to profits that are seen as artificially diverted from the UK.

R&D tax credits

R&D tax credits provide an incentive to companies to invest in research and development by allowing a generous tax deduction for R&D expenditure. Under the current rules, small and medium size enterprises (SMEs) are entitled to tax relief at 175%, and larger companies at 130%, on qualifying expenditure. In other words, for every £100 spent by an SME, taxable profits are reduced by £175. A cash payment from HMRC of up to 24.5% of qualifying expenditure can be claimed by SMEs that are in a loss making position.

Since their introduction in 2000, R&D tax credits are said to have supported nearly £52bn of R&D activity by UK companies. While it recognises that the regime is popular and widely used, the Government is considering whether the R&D credit system could be improved, and says it welcomes views on any suggested changes that could affect the impact or delivery of the schemes. Possible areas for reform include the types of costs that are eligible for relief, the definition of R&D, the claims process and a greater focus on start-ups and the smallest companies.

One feature of the current rules that can produce anomalies is the cap on R&D cash payments at the total amount of payroll taxes (i.e. PAYE and NICs) paid by the company. This can put companies which subcontract a significant amount of the R&D work at a disadvantage. If businesses want to raise this or any other issues in relation to R&D tax credits, responses to the consultation can be made up until 22 February 2011.

Further information

Details of the Corporate Tax Road Map and the consultations described above can be found by clicking here.