UK: Briefing Note - Patent Box

Last Updated: 18 September 2012
Article by Smith & Williamson

1. Summary

The Patent Box regime introduced by Finance Act 2012 (which will become new Part 8A of CTA10), provides that on election a company's qualifying patent box profits will be taxed at broadly an effective 10% rate of corporation tax (though this rate is to be phased in equally over the years from introduction (April 2013) until it is fully effective from April 2017). The actual effective rate will depend on the marginal rate of the taxpayer.

It will apply to profits generated from qualifying IP rights. This encompasses licensing or sale of patent rights, sales of the patented invention or products incorporating the patented invention, use of the patented invention in the company's trade and infringement & compensation rights. Patents can only qualify if they are granted by the UK Intellectual Property Office, the European Patent Office, or specified EEA countries. To be qualifying IP rights, a development condition must be met. In the case of a group company, an active ownership condition must also be met.

The computation of profits to which the rate applies will exclude certain costs and income, including a routine return on manufacturing and development functions and the exploitation of marketing intangibles. The computation follows a formulaic approach, although it is possible to use a bespoke calculation. A Simplified computation process can apply for companies with smaller levels of patent box profits. The patent box rate will be delivered by an additional deduction in the corporation tax computation.

Some points to consider when contemplating entry to the patent box, or once within it are:

  • How and where IP is held within a group. It may be more effective to locate this in one entity, provided the development and active ownership conditions can continue to be met.
  • In respect of qualifying IP rights, a company will need to meet the development condition. HMRC interpret the legislation in s357B(2) and (4) with respect to exclusive licence as meaning that although the company holding the exclusive licence does not need to hold the qualifying IP right, it must still meet the development condition in relation to the right.
  • A group company will always need to meet the active ownership condition.
  • The interaction of the patent box regime with the R&D tax relief regime. If there is 'insufficient' R&D activity in the first four years of entry to the patent box regime, ie when compared to R&D activity in the period of up to four years prior to entry, there may be a reduction in the profit allocated to the patent box rate.
  • The enhancement element of R&D tax relief can be fully offset against profits chargeable at corporation tax rates other than the patent box.
  • There are several stages to determining the profits qualifying for the patent box tax rate. These are covered in much greater detail below but in principle:

– income and profits need to be apportioned between qualifying and non-qualifying;

– 'routine' profit needs to be deducted from qualifying profit to leave qualifying residual profit; and

– qualifying residual profit needs to be split broadly between intellectual property profit and marketing profit.

  • In certain circumstances (where there is either: (i) a substantial amount of deferred income of any category, or (ii) a significant licence income that is not relevant IP income, or (iii) both income that is not relevant IP income and a substantial amount of licence income granted in respect of qualifying IP rights or qualifying items or processes), streaming of profits between (a) relevant IP income and (b) income that is not within (a), is required to determine qualifying patent profit. The taxpayer can also choose to stream profits instead of applying the formula mentioned above to then whole trade.
  • Provided qualifying residual profits (those relevant IP profits determined after deduction of routine return (see 6.6 below)) are within certain limits, it is possible to avoid the potentially complex calculations for deduction of a marketing return (see 6.7 below), by electing for small claims treatment.
  • Election into the regime will carry certain compliance obligations, though this should not be overly onerous for those businesses which already analyse their income and expenditure lines in sufficient detail for management purposes. Where a company does not do this, it is likely that additional analysis will be required.

2. Administrative and entitlement issues

The patent box regime is only available to qualifying companies (s.357B) that hold qualifying IP rights or exclusive licences over those rights, which have made an election to apply the regime and satisfy the development condition. If the company is a member of a group it must also meet the active ownership condition.

The election is made by giving notice to HMRC specifying the first accounting period for which it is to apply. The time limit for making the election is the last day on which an amendment can be made for that accounting period under para 15 Sch18 FA98. The election has effect in relation to each trade carried on by the company and is effective until revoked. The time limit for revoking the election is the same as for making the election. However once an election has been revoked, it is not possible for a company to re-enter the regime within five years from the end of the first accounting period for which the revocation is to be effective (i.e. in effect a six year time limit).

The regime is available to corporate partners in a partnership (s357GB), elections and revocations having effect in relation to each corporate partner separately. –For the purposes of determining qualifying IP in respect of partnerships, the development condition (see below) is met if either the firm has at any time carried out qualifying development in relation to the IP right, or if there is a corporate partner with a 40% or more interest in the profits or losses of the partnership for any accounting period who meets the development condition in relation to that IP right.

The regime is also available to cost sharing arrangements (s357GC). This applies where for example one party to the arrangement holds the qualifying IP right, and each party contributes to the cost of or performs an activity and each share in the revenue from the IP. For this purpose each company which is a party to the arrangement is treated as if it held the qualifying IP right or licence.

3. Qualifying intellectual property rights and exclusive licences over them

3.1. Qualifying IP rights

Provided the company meets the development condition, a qualifying IP right (s.357BB) can include:

a) a patent granted under the Patents Act 1977. This also includes the situation where a UK patent has not been granted on the grounds of national security or public safety;

b) a patent granted under the European Patent Convention;

c) a right of a specified description which corresponds to a right within paragraph (a) or (b) and is granted under the law of a specified EEA state. This includes Austria, Bulgaria, the Czech Republic, Denmark, Estonia, Finland, Germany, Hungary, Poland, Portugal, Romania, Slovakia, and Sweden;

d) a supplementary protection certificate. This applies for medicinal and veterinary products with marketing authorisations in respect of a product in accordance with any EU legislation, and either (i) marketing protection (see s375BB(4)) or (ii) data protection (see s357BB(5));

e) any plant breeders' rights granted in accordance with Part 1 of the Plant Varieties Act 1997;

f) any Community plant variety rights granted under Council Regulation (EC) No 2100/94;

In respect of the qualifying IP right, the company must meet the development condition.

3.2. Exclusive licence in respect of qualifying IP

An exclusive licence (s.357BA) is a licence which has been granted by the person who holds the principal right or an exclusive licence in respect of it, and which confers on the licence holder rights to the exclusion of all other persons (including the proprietor) in one or more countries or territories (an exclusive right to use the licence in a part of a country will not qualify). In addition the licence holder must have the right to bring infringement proceedings, or the right to receive the whole or greater part of any damages awarded in any such infringement.

While anti-avoidance determines that an exclusive licence is not a patent box exclusive licence if the main purpose of conferring the rights was to come within the patent box regime, it is possible for a group company holding a right or exclusive licence to grant an exclusive licence to another group company and for that licensee to be within the regime.

The rules recognise that a patent holder may grant licence rights in different fields of application or in different territories. A licensee does not need to be given all rights in the patented invention, but must be given one or more rights to the exclusion of all other persons. A "right" in relation to a patent could be limited to a particular commercial field of use.

3.3. Qualifying development and development condition

Qualifying development (s357BD) requires that in relation to the right the company carries out:

  • work that creates or significantly contributes to the creation of the invention; or
  • performs a significant amount of activity for the purpose of developing the invention (which includes developing ways in which the invention can be used) or any item or process incorporating the invention.

It does not matter whether the qualifying development was carried out before or after the company or group member acquired the right. The 'development condition' in relation to the right can be met if any of the following apply (see s357BC):

  • A – The company has at any time carried out qualifying development in relation to the right and has not ceased to be or become a controlled member of the group since that time (see below).
  • B – This condition permits a company that performed qualifying development as a member of one group to qualify following a change of ownership (i.e. the controlled group member requirement of condition A is failed) provided it continues to perform development activity of the same description (although not necessarily on the same invention) for at least 12 months after a change of ownership. The company must remain a member of the new group, or (if the test applies) must not become a controlled member of any other group.

This prevents a group which acquires a patent complete with the shell of the company which developed the patent from benefiting from the Patent Box where there is no further development of the patented invention. However, it does allow the Patent Box to apply where the group acquires a company with a patent that requires no further development so long as that company continues to be engaged in the activities that led to the creation of the patented invention for at least 12 months after it is acquired.

  • C – This condition permits a company owning IP to qualify if it is a member of a group and another company in the group carries (or carried) out the qualifying development, and that other member was a group member at the time it did that work.

This accommodates arrangements within groups where for example one group company carries out R&D activity, but the IP arising out of that activity is owned by, or transferred to, another group company which holds the group's intangible assets. In this context it is worth bearing in mind that the Patent Box definition of a group in section 357GD is wider than for many other tax purposes, so that development activity carried out by a company that is a CFC, for example, would be regarded as carried out by a member of the group.

A company may qualify under condition C even if it was not a member of the group at the time that the qualifying development was performed. All that is required is that the qualifying development was performed within the group of which the Patent Box company is currently a member.

  • D - Condition D extends condition B to allow a group which acquires a company which developed the patent to transfer the qualifying IP to another company in the group. Activity done in the acquired company before acquisition can satisfy the development condition if the acquired company continues with the same description of qualifying development for at least 12 months after acquisition.

This condition also allows an acquiring group to transfer the qualifying IP to another company in the group and transfer the trade of the acquired company also, either to the same company which acquires the qualifying IP or to another group company which for example might be the entity in which the acquiring group habitually locates its R&D work. It will also cater for situations where one group acquires another group and wishes to reorganise its R&D activity and IP holdings.

4. Group companies

  • The test for group companies for patent box purposes is different from most group tests and needs to be considered carefully.
  • A company is a member of a group if any other company is at that time associated with it. Associated (s357GD) is defined according to five tests including consolidation, connection, the existence of a major interest, a combination of consolidation and major interest and a combination of connection and major interest. Connection and major interest are determined as for the loan relationship rules (CTA09 s466-474), rather than the connection and control definitions contained in CTA2010.

5. Active ownership

A group company needs to meet the active ownership condition. It will do so if either of the following requirements is met (s357BE) in respect of all or almost all of the qualifying IP rights and exclusive licences held by the company:

  • the company performs a significant amount of management activity (see below) in relation to the right during the accounting period; or
  • the company meets either of qualifying development conditions A or B (see above).

A company which satisfies the development condition only because of the activity of a fellow group company must show that it plays an active role in managing the qualifying IP rights it holds. This means it must be involved in the planning and decision making activities associated with developing or exploiting substantially all of its qualifying IP portfolio (it does not have to undertake all decisions relating to IP management).

Management activity covers activities such as deciding whether to maintain protection in particular jurisdictions, grant licences, research alternative applications for the innovation or licensing others to do so. Similarly, where the rights are being exploited by incorporating the item into products, activities such as deciding which products will go to market, what features those products will have and how and where they will be sold will also count as management activity.

6. Calculating eligible profits

The calculation starts by identifying how much of the company's total gross income (TI) includes "relevant IP income" (RIPI), which is income derived from its qualifying patents. The company can then normally choose one of two routes to calculate how much of its profits derive from this qualifying income. It can either:

i) apportion its total profits according to the ratio of RIPI to total gross income; or

ii) allocate its expenses on a just and reasonable basis to the two "streams" of income (RIPI and non-qualifying income), to arrive at an appropriate profit derived from its RIPI stream.

Two further stages are necessary in the calculation. The first is to remove a routine return on certain specified expenses from the apportioned or streamed patent-derived profits. The return is set at 10% of the relevant expenses and the profit is reduced by this amount. This leaves an amount called "Qualifying Residual Profit" ("QRP"). The final stage is to either:

  • to remove a return on marketing assets used to derive RIPI , by deducting a notional marketing royalty for use of the assets; or
  • provided the company's QRP is less than a maximum amount of £3m, to apply small claims treatment to the QRP. The small claims treatment removes 25% of QRP as a deemed marketing return, leaving the remaining 75% (up to a maximum £1m "small claims threshold") inside the Patent Box.

6.1. Total gross income (TI)

The total gross income (s.357CA) of the trade is used as a denominator to calculate the percentage of IP profits to which the patent box applies. The items to be taken into account are:

  • Revenue or credits from the trade for the accounting period recognised in the profit & loss account or income statement under GAAP;
  • Compensation, damages, proceeds of insurance etc that have not been brought into account as revenue;
  • Amounts brought into account on a change of basis under CTA09 s181, so far as not already brought into account as revenue;
  • Any credits brought into account as realisations under the intangible asset regime (CTA09 part 8 chapter 4);
  • Any profits from the sale of pre April 2002 patent rights (taxable through s912 CTA09).

TI does not include finance income (s.357CA(2) & s357CB).

6.2. Relevant IP income (RIPI)

Relevant IP income forms the numerator to calculate the percentage of IP profits to which the patent box applies. It consists of the categories below that have been included in gross income, and cannot therefore include finance income or amounts which are not taxable. Neither can it include income from oil extraction activities or oil rights, nor income attributable to licences that are not exclusive licences in respect of a qualifying IP right. The categories of RIPI income (s357CC) are:

  • Sales income from qualifying items, or items incorporating one or more qualifying items, or items that are wholly or mainly designed to be incorporated in either of these. Qualifying items are items in respect of which a qualifying IP right (or exclusive licence over a qualifying IP right) held by the company has been granted. An item and its packaging are treated separately unless the packaging performs a function essential for the use of the item for its intended purpose;
  • Licence fees or royalties under agreements relating to:

– a right in respect of any qualifying IP right held by the company;

– any other right in respect of a qualifying item or process; and

– in the case of an agreement granting any right within paragraph (a) or (b), a right granted for the same purposes as those for which that right was granted.

  • Income from the sale or other disposal of a qualifying IP right or exclusive licence over such a right (the technical note explains this is credits brought into account in respect of the defined assets under CTA09 Part 8 chapter 4 and profits under CTA09 s912).
  • Damages for infringement, which includes any amount received in respect of an infringement or alleged infringement of a qualifying IP right or exclusive licence held by the company at the time of the infringement (provided the company was a qualifying company when the event occurred and had made an election effective for that time).
  • Other compensation, which includes any amount received as damages, proceeds of insurance or other compensation in respect of a qualifying IP right or licence, resulting from a loss or in respect of income within the first bullet above (provided the company was a qualifying company when the event occurred and had made an election effective for that time).

HMRC's understanding is that it is usual for a manufacturer holding a patent to dispose of any products it wishes to offer on lease terms to a separate leasing company which will then arrange lease terms with end users. In these circumstances RIPI will be the price paid by the leasing company to the manufacturer provided it is on arm's length terms, and the lease arrangements between the leasing company and the end user will be a financing arrangement that will fall outside the regime.

Where apportionments are required, there are provisions for there to be a just and reasonable apportionment.

6.3. Mixed income

Income arising in the circumstances noted below is designated as either mixed income or income paid under a mixed agreement (see s357CF). Such income should be apportioned between qualifying and non-qualifying elements on a just and reasonable basis. If any non-qualifying elements of such income comprise only a trivial proportion of it (trivial is not defined, but HMRC guidance indicates figures in excess of 5% are unlikely to be trivial), then the whole of the income is to be regarded as RIPI, so no apportionment will be necessary. The circumstances are:

  • items which would give rise to RIPI are sold together with other items as part of a single unit and/or for a single price; and
  • a single agreement is made which covers the sale of items or the grant of rights some of which would give rise to RIPI and some of which would give rise to other income.

Examples of mixed income situations are described in the HMRC technical note as follows:

Example 1

  • The owner of the patent rights over a silicon chip licenses others to manufacture and sell products containing the chip. At the same time it licenses them to use designs, trademarks, know-how and technical information to allow them to manufacture and market those products effectively.
  • These other rights granted are not themselves in respect of qualifying IP rights. But they will be other rights licensed for the same purpose as the licence over the qualifying IP right. Fees and royalties in respect of these other rights will therefore be relevant IP income in the same way as fees and royalties received in respect of the right to exploit the patented invention.

Example 2

  • The owner of the IP rights over a range of pharmaceutical products licences all of their rights to another entity for manufacture and sale. The licence includes the rights to use qualifying patents, but also includes the rights to use know-how and technical information for products which are no longer covered by any patent.
  • Income from this licence will not all qualify as RIPI. Instead the company must apportion income between qualifying and non-qualifying products on a just and reasonable basis.

6.4. Notional royalties

Operating leases where the lessor retains ownership of the leased item will not give rise to relevant IP income under any of the 5 categories above (see 6.2). However, provided the lessor satisfies the necessary conditions, it will normally be able to compute a notional royalty under 357CD, subject to the condition of not exceeding the amounts of the receipts included in total gross income.

If there is income relating to qualifying IP rights which are patents and exclusive licences over them, but where the income does not fall into any of the above categories, it may be possible to elect for this income to be treated as a notional royalty. In particular, this is expected to cover patents used in processes that create non-patented products or to provide services. The form of election is not specified, but would presumably be evident from the computation or RIPI.

6.5. Adjusted profits of the trade

The fraction RIPI/TI is applied to adjusted profits to calculate the relevant IP profits before deduction of routine return and marketing return. Adjusted profit is the profit of the trade as adjusted by the following:

  • Adding back of debits in respect of trade loan relationships and derivative contracts (CTA09 s297 & 573).
  • Adding back of any additional deduction arising from the R&D tax relief regime (CTA09 part 13) for expenditure on R&D in relation to the trade.
  • Deducting any finance income of the trade (credits arising from CTA09 s297 and s573, amounts recognised under GAAP that arise from a financial asset, any return economically equivalent to interest arising from an arrangement to which the company is a party).
  • Deducting any amount required to be taken into account as a result of any "shortfall" in R&D expenditure (s.357 CH) in accounting periods which begins within the first four years of the start of the company's first accounting period of being within the patent box regime.

There is a shortfall in R&D expenditure if the amount of expenditure in any of those accounting periods is less than the average of R&D expenditure in a defined period before entry to the patent box regime. That defined period is the shorter of four years and the period from commencement of trade and the start of the first patent box period. If there is an excess of actual expenditure in the period, then the amount of any excess can be carried forward until it is used up.

If there is a shortfall, then the amount required to be deducted is the difference between 75% of the average R&D expenditure in the pre-patent box period, and the actual R&D expenditure for the period, the latter calculated after taking account of any unused excess in earlier patent box periods. If there is no deduction as a result of applying the 75% figure, then there is no adjustment for that year, nor to any balance of excess that may be carried forward. A summary of how this works is shown in the table below:

Assume average R&D expenditure in the pre-patent box period is £1,000 (so 75% is £750).

– There is no adjustment in yr 1 as actual R&D spend is greater than the average for the previous four years. However the excess is used to determine whether there is a shortfall in future years.

– There is no adjustment in yr 2 as although actual R&D spend is below the average for the previous four years, it is not less than 75% of the average.

– There is no adjustment in yr 3 as although the actual expenditure is less than 75% of the average of the previous four years, there is an excess arising from yr 1 expenditure which can be added to bring it up to the 75% level. The amount of the brought forward excess (£500) used in this way is £400, leaving £100 to carry forward.

– There is an adjustment in year 4 to increase the amount of actual R&D expenditure (£200) as adjusted by the brought forward excess of £100), totalling £300, by £450 to 75% of the average of the R&D spend of the previous four years.

The impact of any R&D adjustment on the amount of profit subject to the patent box rate will only be a proportion (RIPI/TI). I If the aim is to avoid such an adjustment, the planning point would be to either ensure R&D spend in each of the first four years is at least equal to 75% of the pre-patent box average, or to ensure that the company which entered the patent box regime incurred little or no R&D spend in the four years prior to entry to the patent box regime (subject to the company being able to meet the qualifying company conditions).

6.6. Routine return

From the adjusted profit x RIPI/TI, it is then necessary to deduct an amount representing a routine return (s.357CI) on routine costs. This is a flat 10% of amounts determined to be routine costs, multiplied by RIPI/TI. Routine deductions are:

  • Capital allowances (this will include anything in CAA 2001, and in addition to allowances on plant or machinery, will include mineral extraction allowances and business premises renovation allowances amongst others).
  • Costs of premises (note if the premises is shared with other group companies, a reasonable apportionment of costs must be made).
  • Costs in respect of company employees and directors and any externally provided workers (this includes NI and pension costs).
  • Costs in respect of plant or machinery (e.g. leasing, hiring, maintaining, operating etc).
  • Costs in respect of professional services (legal, financial, valuation, accountancy, administration and management).
  • Costs in respect of miscellaneous services (these are defined as water, fuel and power; telecoms; computing and software; postal; transportation; collection, removal and disposal of refuse).

Where the patent box company is a member of a group and other group members incur routine costs that would be deducted by the patent box company, the patent box company is to be treated as if it had made those deductions itself.

The following deductions are not treated as routine, despite potentially coming within the above expense headings:

  • Debits in respect of trade loan relationships and derivative contracts (s297 & s573 CTA09).
  • R&D expenditure qualifying for deduction under CTA09 part 13 and the additional deduction.
  • CAA01 allowances under part 6 (R&D allowances) and part 8 (patent allowances).
  • Deductions allowed under CTA09 part 12 (relief for employee share acquisitions), where the employee is engaged in R&D activities by the company.

Having deducted the appropriate amount for routine return, and assuming the amount left is greater than nil, the amount left is termed "qualifying residual profit" (QRP). Depending on its size, the company will have to consider whether the next stage of the computation should be carried out under the small claims treatment, or whether a more formal deduction for marketing return should be made.

6.7. Marketing asset return

If no election for small claims treatment is made, then a deduction from QRP must be made in respect of the marketing asset return. The marketing asset return is the notional marketing royalty (NMR) in respect of the trade, less the actual marketing royalty (AMR) for the trade, but if the amount is less than zero, or less than 10% of QRP, the amount is zero.

6.7.1. Small claims treatment

Small claims treatment (s.357CJ) permits, subject to election, a flat deduction from qualifying residual profit as a substitute for undertaking the more detailed marketing asset return adjustment. A company is eligible for small claims treatment if either:

  • The aggregate amount of QRP of each trade of the company for the current accounting period does not exceed £1m (regardless of the number of associated companies), or;
  • The aggregate amount of QRP of each trade of the company does not exceed £3m (divided by the number of associated companies) and the company has not had to apply the marketing asset return calculation in any accounting period beginning within four years immediately before the current accounting period.

The small claims amount will mean that the deduction from qualifying residual profits of each trade is:

  • 25% of QRP if 75% of the aggregate QRP (ignoring any amounts less than nil) is less than £1m (in this case the monetary limit is divided by the number of associated companies). For companies with no associated companies, this calculation will apply if aggregate QRP is lower than £1.333m. This leaves 75% of QRP of each trade subject to the patent box rate; or
  • In any other case (i.e. if 75% of aggregate QRP is £1m or more as adjusted for associated companies), the QRP of the trade less [£1m (divided by the number of associated companies), divided by the number of trades]. This means the amount of profit subject to the patent box rate will be £1m (divided by the number of associated companies) in total, regardless of the level of QRP.

If an accounting period is less than 12 months, the monetary limits are reduced accordingly.

6.7.2. Notional marketing royalty (NMR)

The NMR (s357CO) is the appropriate percentage of the relevant IP income for the accounting period that a company would pay a third party for the exclusive right to exploit the relevant marketing assets if they were not otherwise able to exploit them. Relevant marketing assets are those that are exploited in generating the relevant IP income and which come under the following headings (s357CO(7)):

  • trade marks within the meaning of the Trade Marks Act 1984;
  • equivalent rights recognised under the law of another country;
  • signs or indications of geographical origin of goods or services; and
  • information about actual or potential customers which is used for marketing purposes.

The legislation requires the assumption to be made that an agreement can be made for the company to exploit the assets to the exclusion of all others including the notional owner, even if the assets cannot in fact be separately transferred or assigned. In determining what an arm's length royalty will be, certain assumptions need to be made to set the conditions under which the parties are deemed to transact.

These assumptions include:

  • the company and the notional IP owner are dealing at arm's length;
  • the company has the right to exploit the marketing assets, to the exclusion of all others including the notional IP owner;
  • the right to exploit the marketing assets is conferred at the start of the accounting period, or if later when the relevant assets were acquired;
  • the rights to the assets being notionally considered are the same as in fact exist; and
  • the appropriate percentage figure for the royalty, as a percentage of relevant IP income is determined at the start of the accounting period and it will be assumed that it will remain unchanged for the time that the company holds the rights in fact. In other words, as for the notional royalty, the marketing assets royalty is deemed to have an even profile over its life.

Note that the royalty needs to be reassessed for each accounting period, using the same assumptions. In practice it is expected that the percentage royalty might well stay the same for several years.

The NMR must be calculated in accordance with Article 9 of the July 2010 OECD Model Tax Convention and the OECD's Transfer Pricing Guidelines or any successor documents.

Where it is necessary, the determination of the appropriate arm's length royalty rate is likely to require application of either the comparable uncontrolled price methodology or profit split methodology as detailed in the OECD Transfer Pricing Guidelines.

6.7.3. Actual marketing royalty (AMR)

The actual marketing royalty (s357CP) to be deducted from NMR, is the part of the return to marketing assets which accrues to third parties for the trade, as adjusted by RIPI/TI.

AMR is defined as a proportion of the aggregate amounts paid in order to use the relevant marketing assets (see definition above) and brought into account as debits in the corporation tax computation for the accounting period. This amount could be a royalty paid to use a marketing asset or an amortisation charge in relation to an acquired marketing asset.

6.8. Profits arising pre-grant

The legislation allows a company to claim additional relief in the accounting period in which a patent is granted in order to recognise any qualifying income and profits from exploiting the patented invention after application for the patent, for up to six years prior to the grant of the patent (s.357CQ)

A company is entitled to elect to add an additional amount to its relevant IP profits in any accounting period in which a patent is granted to it or in which a patent for which it holds an exclusive licence is granted. A company is also entitled to make such an election if it received income while the patent is pending, but disposes of its rights before the patent is granted.

The additional amount is the difference between:

  • the aggregate of the relevant IP profits of the trade for each accounting period for which the patent application was pending and which ended no more than 6 years prior to the grant; and
  • what the aggregate of the relevant IP profits of the trade would have been for those accounting periods, if the patent had been granted at the date of application (or 6 years before the date of grant if later).

Any profits that are not taken into account in the Patent Box because they are off-set by a relevant IP loss amount are disregarded in this computation. Additionally any accounting periods where the company was not elected into the regime or was not a qualifying company are disregarded. However where a company would have been a qualifying company for an accounting period but for the fact that the patent in question had not been granted, it is to be treated as a qualifying company for the purposes of s357CQ.

6.9. Giving effect to patent box rate

The patent box rate is given effect by deducting an amount in calculating the corporation tax liability for the company. For example assume the total profits chargeable to corporation tax are £5m and the calculations to determine the amount to which the patent box applies has come to £1.5m. The calculation using the CT rate for 1 April 2013 to 31 March 2014 is:

£5m - [£1.5m x (23%-10%)/23% x 60%] = £4,491,304.

The CT liability is therefore reduced from £1,150,000 (£5m x 23%) to £1,033,000 (£4.491m x 23%).

(i.e. £3.5m x 23% + (£1.5m x 10%)x 60% + (£1.5m x 23%) x 40%).

The proportion of patent box rate given effect increases by 10% each year until it is fully effective from 1 April 2017.

It should be noted from the formula (see s357A(3)) that it uses the main rate of corporation tax, irrespective of the size of company. This has the effect of a patent box tax rate of less than 10% for a company subject to the small profits rate. For example, assume the total profits chargeable to corporation tax are £200k and the calculations to determine the amount to which the patent box applies has come to £100k. The calculation using the CT rate for 1 April 2013 to 31 March 2014 is:

£200k – [£100k x (23% - 10%)/23% x 60%] = £166,087.

The CT liability is therefore reduced from £40,000 (£200k x 20%) to £33,217 (£166k x 20%).

(i.e. £100k x 20% + (£100k x 8.696%)x 60% + (£100k x 20%) x 40%).

7. Streaming

Where the proportion of profit generated from a particular income stream is significantly different between relevant IP income and non-IP income, the RIPI/TI ratio may in some cases work to the disadvantage of the company. In such a case the company may make a streaming election to determine relevant IP profits. In this case instead of using the ratio of RIPI/TI, the income and expenses are divided into two streams, one of relevant IP income and the other non relevant IP income. Allocation must be on a just and reasonable basis. The profits of the relevant IP income stream then form the basis for deducting the routine return and any small claims treatment or marketing asset return adjustment.

Where the streaming election has been made, it is effective for that accounting period and all future accounting periods unless there is a change of circumstance which makes the use of the streaming method of allocation inappropriate. For the accounting period of change, the company may then either use a different method of allocation, or elect not to use the streaming allocation method. If subsequently the company wishes to return to the streaming method it may do so by making a fresh election.

Mandatory streaming is required where one of three circumstances applies. These are:

  • Where an amount brought into account as a credit in calculating the profits of a trade for an accounting period is not fully recognised as revenue in that accounting period and the amount is substantial. Substantial is an amount greater than either £2m or 20% of total gross income of the trade, whichever is the lower. However a deminimis limit applies so that amounts of £50,000 or lower are not substantial.
  • Where total gross income includes relevant IP income and a substantial amount of licensing income that is not relevant IP income.
  • Where total gross income of the trade for the accounting period includes income that is not relevant IP income and a substantial amount of licence fee or royalty income that is relevant IP income (within the second bullet of RIPI above, but see also s357DC(7) – s357DC(9)).

If mandatory streaming does not apply it may be worth examining the categories of income and expenses that are or could be recognised in the company to ensure the most effective allocation of profits to the patent box rate. If the allocation formula based on income is disadvantageous compared to the streaming calculation, it is possible to elect to apply the streaming calculation, though this carries consequences as noted above.

8. Relevant IP losses

Where a company has a relevant IP loss instead of a profit, it will be able to use that loss to offset against other profits subject to its normal rate of corporation tax. However, in relation to the patent box regime, the relevant IP loss must be identified for patent box purposes, and applied to reduce patent box profits as follows:

  • The relevant IP loss is used first against relevant IP profits of other trades of the company in the same accounting period. Any relevant IP profits that are matched by an amount of relevant IP loss do not attract the patent box rate.
  • If there is any balance of relevant IP loss left over, then if there are other group companies with relevant IP profits, the loss is offset against those profits. If there is more than one company against which the loss can be used, it is up to the companies to determine to whom the losses are allocated.
  • Any relevant IP loss not used up under the above two set-offs are carried forward and applied against future relevant IP profits of the company.

There are provisions to deal with cessation of trade and transfers of trade between group members. Payments between group members for the use of these losses are not taxable.

Group members are the extended members of the group as defined above.

The patent box reduction is applied in calculating the profits of the trade for corporation tax purposes (s357A(2)).Thus if there are brought forward trade losses on entry to the regime, then these are offset against future trade profits after any patent box deduction.

9. Anti-avoidance

Chapter 6 of the schedule (s357F to s357FB) includes anti-avoidance rules which deny the benefit of the patent box in certain situations where the main purpose of arrangements entered into (for example concerning licences conferring exclusive rights, or the incorporation of a qualifying item in order to generate relevant IP income, or a scheme entered into in order to secure a deduction under the patent box regime) is to secure the benefits of the patent box.

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.

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