An Overview of the UK’s Recent Reform of Intellectual Property Taxation
“[The UK] has a remarkable record of ideas and innovation. We’ve won more Nobel Prizes than any country of our size. We need to do more to support this ingenuity and ensure this creativity is harnessed in this country. I want to encourage research and development in the pharmaceuticals and biotech industries. So, following consultation with business, I will introduce a 10 percent corporation tax rate on income which stems from patents in the UK.”
Alistair Darling, Chancellor of the Exchequer (2009)
It was not uncommon a few years ago for UK multinational companies to house their intellectual property abroad. GlaxoSmithKline, for example, moved a majority of its research activities out of the UK citing unattractive corporate taxation of intellectual property rules. GlaxoSmithKline was not the only company to make that particular complaint or to take that action.
This was no surprise as, at that time, the UK corporate tax system was widely perceived as generally being uncompetitive for corporates and particularly unsympathetic to intellectual property-focussed companies.
The UK corporation tax rate then (and until as recently as six years ago) was 30 percent, there were no specific reliefs available for intellectual property, the Controlled Foreign Company (CFC) regime was extraterritorial in scope and overseas dividends received by UK companies were prima facie subject to tax. In contrast, jurisdictions such as Luxembourg and the Netherlands provided significantly lower corporate tax rates (particularly for holding companies), a wide participation exemption for dividends and gains and a taxpayer-friendly ruling system (not to mention the absence of CFC rules in these jurisdictions).
Since then, a lot has changed in the UK corporation tax landscape.
Since the late 2000s, the UK has embarked on an ambitious set of corporate taxation reforms to make it an attractive corporate tax jurisdiction. Following implementation of these reforms, the UK corporation tax rate now stands at 23 percent (dropping to 20 percent in 2015)—historically this rate of tax was the domain of countries the UK used to consider (not positively) as “low-tax” jurisdictions, the CFC regime has been significantly recast to be more territorial in scope and application, most overseas dividends received by UK corporates are now tax-exempt in the UK (in the absence of any “tax mischief”) and the UK has recently introduced a dedicated regime that applies a reduced rate of UK corporation tax (effectively 10 percent by 2017) to “qualifying” patent income.
It was more than symbolic of the UK’s newfound attractiveness as a competitive corporate tax jurisdiction (particularly for patent-rich companies) when on 1 July 2013, GlaxoSmithKline announced that it intends to move 150 overseas research projects back to the UK. This followed another recent announcement by GlaxoSmithKline that it will set up a new factory in the UK (the first in 40 years) which forms a part of GlaxoSmithKline’s £500 million investment plans in the UK.
UK Corporation Tax Regime—the Focus on Innovation
The UK has legitimately prided itself on encouraging innovation. In fact, for the size of its population, it has won more Nobel Prizes than any other nation. It is therefore unsurprising that the UK Government has positioned its intellectual property reform (see below) as one of the essential pillars of its new corporate tax policy.
The UK’s intellectual property reform focuses (some might say too narrowly) on patents. Commonly referred to as the Patent Box regime (the “Patent Box”), the Patent Box allows companies to elect to apply an effective 10 percent rate of UK corporation tax to profits attributable to qualifying patents, whether received as a royalty or embedded in the sales price of products. This, the UK hopes, will encourage UK multinational groups to develop, retain and exploit intellectual property in the UK rather than house it overseas in jurisdictions offering preferential tax treatment to that historically available in the UK.
The Patent Box took effect from 1 April 2013 with the full benefit to be phased in over the next four financial years as follows (with the full reduced rate applying from 1 April 2017):
Click here to view table.
Broadly, in order to benefit from the Patent Box, a company must hold “qualifying IP rights” or an exclusive licence in respect of “qualifying IP rights”. “Qualifying IP rights” include patents granted by the UK Intellectual Property Office, the European Property Office or under the law of a specified list of countries in the European Economic Area (as well as other rights considered to be similar to patents). In addition, to be considered a “qualifying IP right”, the claimant company under the regime or another group company must have undertaken qualifying development for the patent by making a significant contribution to either the creation or development of the patented invention, or a product incorporating the patented invention.
The Patent Box regime contains detailed provisions for calculating the profits of a company attributable to qualifying IP rights (i.e., its “relevant IP profits” to which the reduced 10 percent rate applies). The detail of these provisions is beyond the scope of this article, but, broadly, this involves calculating the “total gross income” of the company’s trade and working out the proportion of “relevant IP income” (which includes sales income relating to, licence fees or royalties in respect of, proceeds from the sale of and damages for infringement of a qualifying IP right) to the total gross income of the trade, followed by the deduction of certain items (e.g., capital allowances, personnel costs and other routine expenditures).
It should be noted that the Patent Box is elective and applies only to patents and not generally to other forms of IP (for example, trademarks or copyrights), the income from which will continue to be taxed at the main rate of UK corporation tax (currently 23 percent reducing to 21 percent from 1 April 2014 and further reducing to 20 percent from 1 April 2015).
One of the key criticisms directed at the Patent Box is that it is limited to a narrow range of intellectual property (patents really) and therefore is likely to primarily benefit a select few patent-heavy industries such as the pharmaceutical and biotechnology industries. In fact, research shows that the distribution of patent holdings in the UK is highly skewed in that the majority of patent applications are filed by a handful of big multinational players (such as GlaxoSmithKline). The Patent Box, critics argue, will be of less assistance to the technology, media and telecommunications sector, which often generates intellectual property (for example, software) that is not patentable.
The second key criticism is that the Patent Box, although announced and marketed as a regime to promote innovation in the UK, (mis)places its emphasis on businesses generating patent income while offering little or no incentive to taxpayers to conduct research and development activities in the UK (although, see further below). This is in contrast to other similar regimes in Europe—the Dutch “innovation box” for example, not only applies to a wider range of intellectual property but also requires research and development to occur in the Netherlands.
The Patent Box does not require the company or group seeking to benefit from the reduced 10 percent rate to have conducted the actual research and/or development in relation to the patented invention or product in the UK (although the Patent Box does require that the company or group must either significantly contribute to the creation of the patented invention in question or, where the patented invention has been “bought into” the company or group, perform a significant amount of development activity in respect of the patented invention or product incorporating the patented invention). This, it could be argued, encourages companies and groups to separate patent income from research and development activities and hold patents on-shore while research and development are outsourced to other jurisdictions with the result that “real” innovation takes place outside the UK and income is then remitted to the UK.
Thirdly, the interaction between the UK CFC rules and the Patent Box is not entirely harmonious—would the UK treat patent box-type regimes outside the UK as being outside the scope of the UK CFC rules? If not, arguably as a quid pro quo, overseas jurisdictions (under their domestic CFC rules) could treat a UK subsidiary of an overseas company that benefits from the Patent Box as though such UK subsidiary were resident in a low-tax jurisdiction and thereby seek to tax profits of the UK subsidiary overseas in their own jurisdictions.
Research and Development Tax Reliefs
As mentioned above, while the Patent Box alone may not incentivise taxpayers to carry out research and development activities in the UK, the UK already has, what it considers, a generous tax relief regime for expenditures incurred on research and development activities and projects that seek to achieve an advance in science or technology.
In the UK, a large trading company (i.e., not an SME—which are entitled to an additional deduction of 125 percent) may claim tax relief in the form of an additional deduction against its taxable profits of 30 percent of its qualifying research and development expenditure (for example, employee costs, software, materials or utilities). This deduction is in addition to the 100 percent deduction available for trade expenses under general UK tax rules (i.e., giving a total deduction of 130 percent for large companies and 225 percent for SMEs).
The UK has gone a step further and introduced an “above the line” tax credit rule recently to encourage research and development in the UK. This rule will enable loss-making large companies to elect to claim a “net of tax” payment of a 10 percent credit in respect of qualifying research and development expenditures incurred on or after 1 April 2013 from HM Revenue & Customs.
While, as the return of GlaxoSmithKline’s patents to the UK demonstrates, the UK is expected to become an attractive patent-holding jurisdiction in the short term, it remains to be seen whether this becomes a sustainable model, particularly as more and more European jurisdictions are considering the introduction of similar rules (but which may extend beyond just patents).
However, given the general policy direction of the UK Government in relation to corporate taxation (particularly given the UK Government’s stated desire to be the most attractive G-20 corporate tax regime), it is possible that in a few years, the Patent Box will have “evolved” into a full-fledged intellectual property regime—whether or not that becomes a reality, the Patent Box, it must be concluded, establishes a robust framework for preferential tax treatment of intellectual property (albeit limited to patents at present).