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Standard Calculation for Patent Box

Author

Andy Wood

Andy is a practical, creative tax adviser who assists a variety of clients in achieving their personal and commercial objectives in the most tax efficient manner.

Standard calculation for Patent Box

Introduction

Under the Standard Calculation, we calculate the profits of the trade that are attributable to the Qualifying IP.

Essentially, we calculate the percentage of IP income as a proportion of total income.

We then take this percentage and apply it to the trading profits.

We then make further adjustments from that base to calculate the Relevant IP Profit which is used to calculate the Patent Box deduction.

At a glance

First four stages

The first four stages help us reach what is known as the Qualifying Residual Profit or QRP.

  1. Calculate gross income from the trade
  2. Calculate what % of the total income is made up of patent related income
  3. We then apply that percentage to the profits of the trade to give us the percentage of profits which are patent related.
  4. We then deduct something called the ‘routine return’

If at this stage, the result is nil or negative, then no more steps are required. If the figure is negative then we have a patent box loss.

If we end up with a positive figure, then we take some further steps.

Next three stages

We then deduct an amount that is attributable to brand type IP. So, for example, where part of the price being paid relates to, say, a trademark.

There are potentially two ways of approaching this:

  • a simple method known as the ‘small claim’; and
  • an alternative basis

Where the Company makes patent related profits before grant of the patent is received then it can elect into the regime to receive Patent Box relief on these profits as and when the patent is granted.

Standard Calculation – the steps in detail

Standard calculation – step 1

In calculating the gross income, we bring in any revenue that would be recognised under GAAP (or would be if the accounts were prepared in accordance with GAAP).

We also specifically exclude finance income including credits from loan relationships and derivative contracts.

Standard calculation – step 2

First we calculate the Relevant IP Income (RIPI). This includes the following where it is in respect of a qualifying right:

  • Income from sale of a patented product
  • Income from the sale of a product incorporating the patented product
  • Licence fees and royalties received in relation to the patent
  • Income from sale of a disposal of the qualifying right
  • Payments from the infringement a qualifying right
  • Damages or compensation payments relating to the right

The income figure may also include a notional royalty where, say, a patented machine or process is used to make a non-patented product. This notional royalty is calculated under transfer pricing principles.

Once we have the RIPI figure then we then divide it by the total income figure. This gives us the proportion of the total trade income that consists of patent income.

Standard calculation – step 3

Firstly, calculate the trading profits of the Company.

However, we also need to make certain adjustments :

Add

  • Debits in relation to loan relationships & derivatives
  • Additional deduction relating to:
    • R&D tax relief
    • Television production relief
    • Video games development relief
    • Theatrical production relief

Deduct

  • Amount of RDEC brought into account
  • Finance income profits
  • Potentially make other adjustments

Secondly, we then apply the % from Step 2 to arrive at the patent related profits.

 

Standard calculation – step 4 – Deducting the routine return

Once we have calculated the patent related profits. We then need to deduct the profits which the business would have made in the absence of the IP.

This is called the routine return.

The routine return is 10% x specific expenses

These are:

  • Capital allowances
  • Cost of premises
  • Personnel costs
  • Plant and machinery costs
  • Professional services

These should be apportioned between patent and non-patent profits.

The relevant proportion of the routine return is then deducted from the patent related profits.

 

What we are left with at the end of Stage 4 is called the Qualifying Residual Profit (“QRP”)

If we are left with nil or a negative figure, then no more steps required. If the figure is negative then we have a patent box loss.

If we are left with a positive figure, then we take some further steps.

 

Standard calculation- steps 5&6

General

These are alternative steps. One can either elect for small claim treatment (simple) under step 5 or, instead, calculate the marketing asset return under step 6.

The purpose of these steps is to prevent any return produced by marketing assets from benefiting from the 10% Patent Box rate.

 

Step 5 – small claim

Broadly applies where Relevant IP Profit for all trades of the Company do not exceed £1m.

The patent box profit amount on which relief is based on the lower of:

  • 75% of QRP; and
  • Small claims threshold (£1m) divided by number of trades of associated Companies elected in to patent box regime

Generally, this substantially reduces the amount of patent box relief potentially available. As such, a Company might prefer to use STEP 6 instead.

 

Step 6 – marketing asset return

Step 6 sets out an alternative where Step 5 is not, or cannot, be used.

Firstly, we need to calculate the excess of:

  • ‘Notional Marketing Royalty; over
  • the Actual Marketing Royalty

The Notional Marketing Royalty is calculated under transfer pricing principles using the OECD transfer pricing Guidelines.

We are talking about the royalties for the use of marking assets. Marketing assets are:

  • Those for which passing off proceedings could be brought
  • Signs / indications geographical origin; and
  • Client databases for marketing purposes
  • Examples would include trademarks, design rights

If the excess is less than 10% of the profits after stage 4 then no adjustment is required

If the excess is 10% or more of the profit then one must deduct it from the figure arrived at after step 4.

 

Step 7 – where profits arise before patent granted

Where a company makes patent related profits before the grant of the patent then it can elect in to the regime to receive benefit from the Patent Box.

However, to prevent companies from gaining the benefit for products which are not patentable, the benefit of the Patent Box is not received until the patent is granted.

When the patent is granted – the accumulated profits for the pending period are then included in the calculation.

 

Calculating the deduction

Once we have gone through the steps set out above, we have calculated RIPP or patent box profit.

We now deduct any Patent Box losses.

If, after deducting those losses, we are left with an excess, we can then apply the patent box deduction

The RIPP / patent box profit x ((19%-10%) / 19%)

Calculate this for each trade.

This deduction is the deducted from the trading profits to give a revised profit figure that is to be subjected to corporation tax.

 

If you have any queries about this article or Patent Box in general, then please do get in touch.

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