Patently clear tax benefits?
The Patent Box regime offers the potential for substantial corporation tax savings, but a low volume of claims are being submitted to HM Revenue and Customs.
Introduced on 1 April 2013, the Patent Box allows companies to pay a lower rate of corporation tax on relevant intellectual property (IP) profits.
The aim of the Patent Box is to provide an additional incentive for companies to:
- Increase the level of patenting of IP developed in the UK, and ensure that new and existing patents are further developed and commercialised in the UK;
- Manufacture and sell those innovative products and services from the UK; and
- Locate the high-value jobs associated with the development, manufacture and exploitation of patents in the UK.
Despite a slow start, with benefits introduced incrementally over a four year period, the full savings have been available from 1 April 2017 to deliver the headline 10% corporation tax rate on qualifying profits. Compared to the current standard corporation tax rate of 19%, a saving of 9p for every £1 of profit is very attractive. For example, based on £2m of relevant IP profits, the corporation tax saving would be £180,000.
The latest statistics released by HM Revenue and Customs show 1,170 claims were made throughout the UK in 2016/17 and 1,120 in 2017/18, although figures for this latter year are expected to be revised upwards once further statistics are released in Autumn 2020. Northern Ireland companies accounted for just 35 claims in 2016/17. Compare this to the number of patents granted by the UK Intellectual Property Office (IPO) – 5,602 in 2016 and 6,311 in 2017.
Reasons for an apparent low uptake most likely include:
- it is a corporation tax regime only, so individuals and partnerships cannot make claims;
- the costs and timescale for registering patents. Although the corporation tax savings will usually outweigh the legal and admin costs, it is possible to make claims in relation to relevant IP profits for the period between patent application and grant (the ‘patent pending’ period);
- the complexity of calculations and reduced benefits during phase-in, however a number of simplifications and elections are available to reduce this complexity and the phase-in period is now over;
- for companies which initially make relevant IP losses, it will be better not to elect into the regime; and
- a lack of awareness about the regime and how it works.
How to qualify
UK companies liable to corporation tax are potentially eligible to make a claim. The company must either hold or exclusively licence-in a qualifying patent and this patent must have been granted by the UK IPO, the European Patent Office (EPO) or certain countries in the European Economic Area (EEA). The company, or group of companies of which it is a member, must also have carried out the qualifying development (R&D) on the patent. Additionally, the company must meet an active ownership test in the case of a group company claimant, by being able to demonstrate that it has performed a significant amount of management activity in relation to the IP rights held.
Relevant IP Income
Income earned from exploiting patented inventions can be derived from:
- sales of patented products – it is important to note that the full sale value of a larger product into which a patented item is intended to be physically incorporated over its full operating life will qualify. For example, even if only the braking system of a car is patented then the full sale value of the car would be within the regime;
- licencing out patent rights;
- selling patented rights;
- infringement income; and
- damages, insurance or other compensation related to patent rights.
Calculating relevant IP profits
At a basic level, the approach to calculating relevant IP profits is as follows:
- Allocate taxable profits to either a patent box income stream or a non-patent box income stream;
- Deduct a ‘routine return’ – this reflects the fact that a business would be expected to earn a profit even if it had no access to patented technology or intellectual property; and
- Deduct a ‘marketing asset return’ for an element of profits associated with intangible assets, such as brand or other marketing assets – this required as the Patent Box is not designed to reward other forms of IP. The marketing asset return figure is calculated by deducting the Actual Marketing Royalty (‘AMR’) the company incurs from a Notional Marketing Royalty (‘NMR’) that has to be computed. While the calculations can be complex, the marketing asset return figure can often be nil for business to business sales driven by technical requirements.
Despite its relative infancy, the Patent Box rules were modified from 1 July 2016, following recommendations from the OECD Forum on Harmful Tax Practices. The ‘New Regime’ requires R&D expenditure to be tracked and traced on a cumulative basis at a qualifying IP right, product or product family level and a ‘modified nexus’ fraction potentially restricts the patent box deduction where there is significant R&D subcontracted to connected companies or significant expenditure on the acquisition of qualifying IP.
It is possible for a company to elect to use a start date for its R&D fraction up to 20 years before the last day of the current accounting period. Such an election would be beneficial if it produces a lower restriction as a result of applying the R&D fraction, with the caveat that the company must have the records for any relevant earlier periods to an appropriate level of detail.
‘Grandfathering’ provisions also allow companies elected into the ‘Old Regime’ to continue to use the old rules until 30 June 2021.
It is important to note that a company must actively elect into the regime. The deadline for doing this is two years from the end of the accounting period for which a claim is to be made. Submitting a first claim on the corporation tax return counts as making an election.
An increased risk that the election deadline will be missed arises in relation to the ‘patent pending’ period, for which a claim can only be made on the corporation tax return for the accounting period in which the patent is granted. It is not uncommon for a patent to take 3, 4 or 5 years or more to be granted, but the election into the regime must be made within two years of the end of the accounting period in which the ‘patent pending’ profits arose or the potentially valuable tax benefits will be lost for that period.
A further election is required for the accounting period in which a qualifying right is granted to allow a claim for ‘patent pending profits’ arising in earlier periods. This election is made on a right by right basis, and covers the whole of the period from the application for grant of the right (or date the licence is granted to the company) to the date the right is granted. This period is limited to up to six years before the right is granted.
Care is required not to elect into the regime too early, as where a company has an IP loss, this loss will be carried forward to reduce the IP profits of a subsequent period (or for a group of companies, the loss will first reduce IP profits of another group company in the current period). This loss offset can be avoided by simply electing into the regime once a company is in an IP profit-making position.
Once in the Patent Box regime, a company can opt out, but then cannot elect back in for five years.
In the current economic climate, businesses are placing ever more importance on their innovation strategy to enable them to grow, adapt or even simply survive. Maximising the available tax benefits from IP should be a key part of this strategy, and it would appear likely that there will be an upward curve in the number of Patent Box claims submitted to HM Revenue and Customs.
At ASM Chartered Accountants, we assist companies across a range of sectors with both their R&D and Patent Box claims. We also work alongside Patent Attorneys to help clients identify products, parts of products or processes which may be suitable for a patent application, with a view to maximising the tax savings and where possible minimising the details that get released into the public domain.
The content of this article is for information purposes only and advice particular to your circumstances should be sought from a professional adviser.