As a reminder, the patent box regime taxes profits of UK companies (if elected into the regime) arising from relevant intellectual property (IP) assets at a reduced rate of 10%. This therefore presents a significant tax saving against the normal Corporation Tax rate of 19% with there being even further tax savings when the Corporation Tax rate increases to 25% from 1 April 2023.
The requirements regarding the methodology to apply for purposes of the patent box calculation has changed, with the grandfathering rules ending as of 1 July 2021. It will now be the case that only the 'new' rules can be applied, being the profit streaming method. Entrants into the patent box regime post 1 July 2016 already needed to follow the profit streaming method, but it will now apply to all companies claiming within the regime.
Some of the steps within the new streaming rules follow those that were included within the old (grandfathered) formulaic approach, however, there are some fundamental differences. These differences mainly relate to the following two changes:
- Profit streaming: These new rules require that the calculation is performed on a streaming basis, where a separate calculation (or stream) is completed for each patent. If this is not practical to do then it is possible to stream by each product or product category which uses patents. The company will therefore need to break down its income into a relevant IP income stream (which itself may need to be broken down into relevant IP income sub-streams) and a non-IP income stream.
- R&D fraction: Under these new rules the tax benefit is limited in accordance with the proportion of R&D undertaken by the claimant company in respect of the patent/product on which the patent box benefits are being claimed. The R&D fraction needs to be applied to each IP stream and is based upon in-house R&D expenditure and expenditure on subcontracted R&D to third parties, compared to the total R&D expenditure incurred and IP acquisition costs (if relevant). This fraction therefore creates a 'nexus' between the creation of the IP and the claiming of benefits under the regime.
An overview of the steps included within the new regime is set out below. We would like to thank Paul House of Azets for providing this article
The new regime therefore creates a requirement to track income and expenditure against relevant IP rights. In addition there is the need to track and trace R&D expenditure on each of the IP streams, as the R&D fraction is a cumulative calculation, taking into account past R&D expenditure from 1 July 2016 onwards.
The patent box regime is complex however, it could provide a significant tax saving if a company derives profits from qualifying IP rights, which will be further improved with the future increase in Corporation Tax rates.
Step 1: Identification of income streams
The taxable income of the company is apportioned into IP and non-IP income streams. The IP income stream itself is then divided into relevant IP income sub-streams (e.g. each sub-stream being in connection with an IP right or IP item).
Step 2: Allocation of company expenses between the income streams
The expenses of the business are allocated between the non-IP stream and each relevant IP income stream. This apportionment is to be performed on a just and reasonable basis. Expenses not treated as deductible for the purposes of the old regime continue to not be deductible within these new rules./p>
Step 3: Calculation of net relevant IP income (RIPI) This is simply step 1 less step 2.
Step 4: Deduction of the routine return
The routine return is calculated as 10% of the relevant routine expenses that have been included within the relevant IP income sub-streams. This needs to be deducted from the result of step 3 to provide the qualifying residual profit (QRP).
Step 5: Deduct the marketing assets return
The marketing assets return can be calculated via the using the small claims treatment (if the company satisfies the relevant requirements) or by using a notional marketing royalty for each of the relevant IP income sub-streams.
Step 6: application of R&D fraction to each relevant IP income sub-stream
Under these new rules the tax benefit is limited in accordance with the proportion of R&D undertaken by the claimant company in respect of the patent/product on which the Patent Box benefits are being claimed. To do this an 'R&D fraction' is applied to each IP asset's patent box profits arising from the previous steps.
The fraction to apply is the lower of:
(D + S) x 1.3) / (D + S + A + R) and 1
Where:
D = R&D costs incurred in-house
S = costs of R&D subcontracted to third parties
A = costs of acquiring or licensing IP
R = costs of R&D subcontracted to related parties
Step 7: Combine the profits from the above sub-streams to obtain the relevant IP profits of the trade
The above profits are then effectively taxed at a rate of 10% within the company's Corporation Tax return.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.