UK: Briefing Note: Patent Box - March 2013

Last Updated: 18 March 2013
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 in 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.
  • 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 which 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.

To read this Briefing Note in full, please click here.

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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