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The Patent Box is available to reduce the corporation tax rate to a generous 10% on a company’s profits generated from qualifying patents. The regime is available for accounting periods commencing on or after 1 April 2013.
The aim of the Patent Box rules is to provide an incentive for companies to develop and retain patents and other qualifying intellectual property within the UK as part of the Government’s growth agenda.
The Patent Box is optional and companies can choose whether or not to elect into it. If a company has more than one trade, the election applies to all trades. The legislation makes provision for revoking an election, if necessary, but the company may not elect back into the regime for five years after the revocation.
A company qualifies for the Patent Box if it has made a valid election and it holds a UK or EU patent or a patent from certain other EEA countries.
A company can also qualify for the Patent Box if it has made an election and it holds an exclusive licence in respect of a UK or EU patent or a patent from specific EEA countries.
A qualifying company must also meet the development condition. The company (or group company) must either have created or significantly contributed to the creation of the patented invention, or performed significant activity to develop the invention or any item or process that incorporates it.
Whilst the development condition can also be satisfied by a group company, there are complex rules for companies joining or leaving groups; this can have an impact on whether or not the development condition continues to be satisfied. It is important that expert advice is sought in respect of these aspects.
How is the relief calculated?
The reduced rate of corporation tax is given by allowing a deduction to be made in the calculation of the company’s total taxable profits, instead of applying a reduced rate of tax to the relevant patent profits. The patent box deduction gives the effect that patent box profits are taxed at a reduced rate.
Companies that elect to be within the patent box regime can claim an additional deduction in calculating taxable profits, with the effect that the relevant profits are taxed at a reduced rate of 10%.
Qualifying intellectual property (IP)
The types of qualifying IP that the patent box applies to include patents granted by the UK Intellectual Property Office (IPO) and the European Patent Office (EPO), certain rights granted under the law of specified EEA states, UK and EU supplementary protection certificates, regulatory data protection, and certain plant variety rights.
Profits derived from the following activities will qualify for the reduced rate:
Routine manufacturing and development activities will be excluded.
Calculating the patent box profits
The reduced rate of corporation tax is applied to the ‘relevant IP profits’ generated by the company. The calculations set out in the legislation are complex, however they can be summarised into the following three key stages:
Changes to the patent box calculations
Harmonisation with OECD’s recommendations
Major changes to the patent box regime were made by Finance Act 2016 to bring the Patent Box rules in line with the outcome of the OECD’s recommendations on tackling preferential and arguably ‘abusive’ IP regimes. Revised rules for calculating the relevant IP profits broadly applied to new entrants to the patent box, or existing claimants generating income from new IP on or after 1 July 2016. These rules are now mandatory with effect from 1 July 2021.
In particular, the changes remove the proportional profit split option so that ‘streaming’ applies in all cases at the level of an asset, product or process. ‘Streaming’ allows a company to elect for the direct allocation of costs against the relevant streams of income. This is likely to give a more accurate measure of the actual profits from exploiting a patent, if the expenses of the company’s business are attributable evenly to its different streams of income.
As an additional step in the calculation, an adjustment is required to reflect the proportion of the R&D activity on the asset, product or process category undertaken by the company itself. Prior to FA 2016, there was no requirement for the company itself to have developed the patent in question although the company had to own or exclusively licence it.
As such, from 1 July 2021, all patent box claims follow the ‘modified nexus’ approach linking relevant R&D expenditure to the patent or patented item. This requires an R&D fraction to be calculated for each type of IP to which relevant income is attributable. The calculation is based on the attributable R&D expenditure by the company in the accounting period of the patent box claim.
The new calculation is given as:
the lesser of 1 and (D+S1) x 1.3
D = In-house qualifying relevant expenditure on R&D
S1 = Qualifying relevant expenditure on R&D subcontracted to third parties
S2 = Qualifying relevant expenditure on R&D subcontracted to connected persons
A = Expenditure on acquisition of qualifying IP.
The result is known as Relevant Intellectual Property (IP) Profits to which the reduced patent box tax rate (10%) applies once a company-wide election has been made.
Tracking and tracing
Businesses that make patent box claims do not necessarily have to develop sophisticated systems to identify the qualifying profit streams that flow from their IP. However, where the group and IP ownership structure is complex, more detailed analysis of how to track and trace the relevant expenditure may be required.
The patent box rules can seem complex, particularly with the introduction of mandatory streaming and the Nexus fraction. However, ETC has a team of experts to assist you throughout the process from putting together a Patent Box claim through to submission. Please do not hesitate to get in touch to discuss further.
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