1. Background
The UK patent box rules, which come into force next April, have been introduced in the wake of certain high-profile corporate emigrations from the UK to jurisdictions with more appealing IP tax regimes.
The stated aim of the new regime is to provide an incentive for companies to retain, commercialise and develop existing patents and new innovative patented products in the UK, and to locate the high-value jobs in development, manufacture and exploitation of patents in the UK.
The result is a 10% tax rate, given by means of a deduction from trading profits, phased in, over a 5 year period, for accounting periods beginning on or after 1 April 2013.
2. The new rules
a) What will the rules apply to?
The rules will apply to "Qualifying Income", being a wide range of royalty income, including profits arising from the sale of not just patented products, but products which include patented inventions. Also included are profits from supplementary protection certificates (which extend the protection afforded by qualifying patents) and certain non-patentable rights, such as regulatory data protection.
The 10% rate will also apply to profits arising in respect of products developed, and patents obtained, before that date.
To qualify, the patents must have been granted by the UK Intellectual Property Office, the European Patent Office, or under the law of certain specified EEA states.
b) Who will the rules apply to?
To "Qualifying Companies" – broadly companies which hold (or, in certain circumstances, held) the relevant IP rights or an exclusive licence in respect of such rights.
The rules will also apply to acquired and collaboratively developed IP.
As would be expected, having regard to the stated purpose of the new regime, the rules will only apply to companies or groups who actually create and develop. Those who do no more than finance innovation are not included.
c) How do you determine which profits will fall within the patent box?
- Stage 1 – identify that portion of a company's profits that are attributable to qualifying income. Luckily, this involves identifying income from patented products rather than attempting to identify income from individual patents. There is also a streaming method for when this standard formula would produce distorted results.
- Stage 2 – identify "residual profits" by deducting a return equal to 10% of certain costs and expenses (to reflect the fact that a certain level of profit would have been realised even without the valuable IP).
- Stage 3 – determine what portion of this residual profit is attributable to the relevant patent (as distinct from profit attributable to other IP, such as the brand). That amount qualifies for the Patent Box.
There is also a simplified regime for companies with residual profits below a certain threshold.
3. The Positives
The general consensus at an industry level appears to be that the new regime is a positive step towards encouraging innovation within the UK (or, perhaps more importantly, keeping IP-rich companies within the UK). Indeed, HMRC claim that they are already getting increasing numbers of multinationals looking at the UK as a preferred place to do their high value investment.
HMRC seem to have shown a different, more inclusive, approach to the consultation process, and have genuinely listened to industry concerns. They made a number of changes to the rules following the initial consultation process. For example, they lowered the multiplier used to determine routine profits from 15% to 10%, which increases the amount of profit which will benefit from the reduced rate.
And although there are a number of advantageous regimes in Europe for business to choose from, comparative to its European equivalents, the new UK regime is quite flexible in certain respects. For example, although the types of IP that qualify are restricted, the patent box will encompass all types of income which relate to that IP.
4. Any negatives?
Administrative burden
One concern is that companies who could benefit from the patent box regime are unaware of the administrative requirements involved. For example, for a company with a large portfolio of patents granted by a number of patent offices, simply identifying all of its patents (ones it owns as well as ones over which it has an exclusive licence), and ascertaining which of those patents has been granted by a qualifying patent office, could be a huge undertaking. As could identifying the income from the sale of products incorporating qualifying patents.
These administration requirements could necessitate liaison between corporate departments, with other companies and with outside advisors. This process is inevitably going to take time.
The message here, is not to underestimate the amount of work it will take to be ready for the introduction of the regime next April. To do so could mean missing out when the rules come into force.
Complexity of legislation
This is in many ways linked to the above. The concern is that the (perhaps necessary) complexity of the legislation, and the familiar but ever so slightly different rules regarding, for example, groups and the treatment of losses, will catch companies out, or may in fact deter companies from electing into the regime.
For example, (other than in a group situation) patent box losses are to be carried forward to set against future patent box profits. This leads to the situation where it may be better for a company to delay entry into the regime until such time as it has patent box profits. By way of illustration, for a company with patent box losses in year one, that loss will be carried forward to, at least in part, reduce any patent box profit in year two which would otherwise be able to benefit from the reduced rate.
Again, companies need to be taking advice now on how the new rules are likely to apply to them, and what needs to be done to be ready. The concern is that many companies are not doing that.
Limitation of scope
The regime does not apply to copyright or trademarks in isolation. Design rights would also seem to fall outside the scope of the rules, although they are not specifically mentioned. Furthermore, profits from unpatented trade secrets and most un-patented technology are excluded. This is disappointing, and it has been noted that, in particular, this limitation could make the new rules less accessible to SMEs, whose IP is often unpatented. The hope is that once the new regime is bedded down, there may be scope for its application to be broadened somewhat in this respect.
In the meantime, companies should consider whether to seek patents for items which are currently unpatented. It would also be worth checking whether there is any know-how bundled together with patented products, as this know-how may constitute Qualifying IP.
The requirement of exclusive licensing may also be problematic for some industries, such as Telecomms, in which licensing is generally non-exclusive. It would, therefore, be worth considering drafting licensing contracts to provide, where possible, for exclusivity.
Tapered tax reduction
The 10% rate will only apply to 60% of the qualifying profits in 2013/14, rising to the full 100% in 2017, which seems to be the Government's way of managing the impact on tax receipts as required in the current financial environment. In fact, this feature does seem to have been accepted as a necessary evil, although undoubtedly it would be more beneficial for the full benefit to be available from day 1.
5. Conclusions
The introduction of the patent box is undoubtedly a welcome development, which should help UK firms compete with their European counterparts.
Of course, the Patent Box is only part of the story. R&D tax credits remain, and can be used in conjunction with, the new regime. They have also been made more generous, particularly for smaller firms, and are now simpler to obtain.
Of course the proof of the pudding is in the eating, and it will certainly be interesting to observe over the next few years how the rules work in practice and, in particular, how many companies actually elect into the new regime, how the rules interact with existing R&D credits and whether companies are able to adapt to the limitations of the legislation.
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.