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Not the title of the next Hollywood blockbuster but a cautionary tale showing that, in the global economy, no country has complete sovereignty over it’s tax regime.
More importantly, for those with patentable inventions or Intellectual Property (IP), there is potentially a huge tax benefit for starting this process before 30th June 2016.
One short paragraph in the 2016 UK Budget read “Patent Box – Compliance with new international rules – The government will modify the operation of the Patent Box to comply with a new set of international rules created by the OECD, making the lower tax rate dependant on, and proportional to, the extent of research and development expenditure incurred by the company claiming the relief. This will come into effect on 1 July 2016.”
To appreciate the implications, it is important to understand how the Patent Box currently works.
The Patent Box has been phased in since 1st April 2013 and enables companies to apply a lower rate of Corporation Tax of 10% to profits earned from its patented inventions. The percentage of the related profits entitled to the 10% Corporation Tax rate had been phased in as follows:
To qualify, a company must either own or exclusively licence-in patents and have performed qualifying development on them. In addition, the patent must have been granted by the UK Intellectual Property Office, the European Patent Office or by certain states in the European Economic Area.
Currently, the Patent Box excludes patents registered in countries including USA, France, and Spain due to the differences in the approval process for patent applications. Products that only have copyright or trademark protection are not covered.
A company needs to be able to demonstrate performed ‘qualifying development’ on the patent by making a significant contribution to the creation or development of the patented invention or a product incorporating the patented invention.
If a company is exclusively licensing-in a patent, it can still benefit from Patent Box so long as it has the entitlement to develop, exploit and defend rights in the patented invention plus at least one aspect is to the exclusion of all other persons and there is exclusivity in at least one entire country.
There are more relaxed criteria for a group of companies where one company may own the portfolio of patents whilst others develop and mercantile them.
It is not a requirement for all of the company profits to have been derived from patented inventions. To be germane, the income must come from at least one of the following:
Meanwhile, the Organisation for Economic Cooperation and Development published the conclusion of their OECD/G20 Base Erosion and Profit Shifting Project in October 2015 and, after a consultation, the UK government determined to adapt the Patent Box to comply with the with the modified nexus approach. The Executive Summaries can be read here.
The main thrust of the modified nexus is to ensure that the benefits of the UK tax regime are only available where the research and development (R&D) expenditure required to develop that innovation also took place in the UK.
As a result, under the new rules, for income to be eligible for the Patent Box it must be linked actual R&D expenditure. Companies will need to calculate IP profits on the basis of streaming income between qualifying and non-qualifying revenues and be able to track and trace expenditure corresponding to each stream.
For each profit stream figure, the company will apply the ‘nexus fraction’ to determine the amount subject to the reduced level of Corporation Tax.
All highly complicated and time-consuming to administer. HMRC have published an overview flowchart but if you would like the full details on the nexus approach, please email us.
On the plus side, the UK government is enveloping the nexus approach into the existing Patent Box rules, so the overall framework remains the same. However, the current method will be closed to new entrants from 1st July 2016.
Most critically, the maximum allowable transitional period has been set for existing IP so that the current Patent Box rules will continue to apply through to be 30th June 2021.
It is important to note that a patent is the most difficult form of protection to get. The process is complicated, lengthy and carries a cost. Nonetheless, a company will be treated as a qualifying company for the Patent Box if it has applied for a patent that has not yet been granted and meets the other qualifying criteria.
For those with IP either already generating revenue or likely to do so in the next five years, the benefits of exploiting the current Patent Box system are likely to far outweigh the costs.
If you would like any further information on the Patent Box or any other aspect of business taxation, please email us at tax@cooperfaure.co.uk.
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