UK: Thinking Inside The Patent Box

Last Updated: 20 August 2013
Article by Andrew Priest

What's in the Box?

The Patent Box is a set of rules which enables certain companies to benefit from a lower rate of corporation tax on profits earned from the commercialisation of patents and patented products. The rules came into force on 1 April 2013. Tax relief for qualifying income is being phased in and once the full benefit of the patent box regime is in effect (on 1 April 2017), these patent-related products will be taxed at an effective rate of 10% (the current rate of corporation tax is between 20% and 23%, and will be 20% from 1 April 2015).

The idea behind the Patent Box is to incentivise technology companies in the UK to develop and commercialise new patents and patent protected products. The Government believes that this, together with the UK's generous rules relating to R&D tax credits, will encourage international companies to locate in the UK the high-value jobs associated with innovative technology development and thereby maintain the UK as a world leader in patented technologies.

Qualifying Patents

The Patent Box covers UK and European patents regardless of when they were granted, as well as patents granted in certain other countries in the European Economic Area. It does not apply to patent applications so, for example, where products are sold 'patent pending' the relevant profit from those sales (for a period of up to six years) can only be included in the tax calculations once the relevant patent has been granted. It will not normally be possible to get a patent granted more quickly because the company making the patent application wishes to take advantage of the Patent Box, but the UK Intellectual Property Office will consider accelerating the grant of a patent if the delay would have a significant impact on the company's cash flow.

Qualifying Companies

In order to benefit from the Patent Box, a company which is liable to UK corporation tax must either be the legal owner of a relevant patent or have been granted an 'exclusive licence' in respect of a relevant patent. The Patent Box rules set out a detailed definition of what will constitute an 'exclusive licence', part of which includes the licensee having a right:

  • to bring proceedings without the consent of the patent owner or any other person in respect of any infringement of the relevant patent; or
  • to receive the whole or the greater part of any damages awarded in respect of any such infringement.

This could create difficulties for some licensees as patent licensors do not always give the licensee these rights. HMRC guidance indicates that a patent licensor may have priority in deciding whether to take action, provided that in the event that it decides not to, the licensee is permitted to take the action. The exact terms of the patent licence agreement will be critical here.

In addition, the company must also satisfy the 'development condition'. This means that it must have:

  • created, or significantly contributed to the creation of, the patented invention; or
  • performed a significant amount of activity for the purposes of developing the patented invention, or any product, item or process incorporating the patented invention.

The aim of the development condition is to limit the Patent Box to companies that have been properly involved in the innovation lying behind the patent or the application of the patented invention.

Group Companies

Some of the above Patent Box requirements are relaxed for companies in a group (and the definition of 'group' is widely defined to include not only companies who are required to submit group accounts but also, for example, joint ventures where the two main joint venture companies each have at least a 40% interest and groups which are too small to be required to prepare consolidated accounts).

The Patent Box rules recognise, for example, that a portfolio of patents may be owned by one company in a group (Company A) (or that company may have an exclusive licence in respect of those patents) while another company in the group (Company B) exploits those patents. If Company A confers all of its rights on Company B, then Company B will be treated as having an exclusive licence. In these circumstances it does not matter that the rights conferred by Company A do not include the right to enforce, assign or grant a licence of any of those rights. In other words, there is no requirement that Company B must have a right to bring proceedings or be entitled to damages awarded for patent infringement (in contrast to the licence requirements when the companies are not in the same group).

In this group scenario, if Company B wishes to benefit from the Patent Box rules then it must also meet the 'active ownership' condition. This requires Company B to demonstrate either that it meets the 'development condition' (above) or that the company has performed a significant amount of management activity in relation to the patent rights in each relevant accounting period. If Company A performs all of the patent development activities, then Company B, if it wishes to benefit from the Patent Box, will need to be actively involved in managing the patent rights. The purpose of the 'active ownership' condition is to exclude from the Patent Box any companies which are merely passive IP holding companies.

Qualifying Income

The Patent Box rules specify the types of patent-related income which may be used to calculate 'relevant IP profits' (which will then effectively be subject to tax at the reduced rate of corporation tax). Not surprisingly there are detailed rules for calculating 'relevant IP profits' but the patent-rated income must fall within the following heads:

  • sales income (from patent-related products);
  • licence fees and royalties;
  • proceeds from the sale/assignment of the patents;
  • damages for infringement; and
  • other compensation (such as insurance proceeds for loss of patent-related products).

Income derived from other forms of IP (such as copyright, trade marks or know-how) is not relevant for the Patent Box.

Issues to consider

It remains to be seen whether the Patent Box will achieve its objective of incentivising further investment in innovative technologies in the UK, particularly bearing in mind the extent to which other jurisdictions across the Channel have had a rather substantial head start by offering a patent box regime for some years. The UK rules have only recently been introduced and because these are being phased in it will be a little while yet before their full benefit is felt. However, no doubt there are many technology companies who are preparing to take advantage of the tax benefits on offer. For those companies, some practical issues to consider include:

  • if you are the owner of a relevant patent, make sure that you meet the 'development condition' in the Patent Box rules;
  • if you are taking an exclusive patent licence from the patent owner or from a third party which holds an exclusive licence, make sure that the wording of the licence complies with the definition of an 'exclusive licence' in the Patent Box rules;
  • if you are a group of companies, you need to make sure that an appropriate inter-group licence is in place which documents the terms on which rights to exploit the patent are granted to the licensee. Those terms will need to be compliant with the Patent Box rules and if the licensee has not been involved in the development of the underlying invention, there will need to be evidence that it meets the active ownership condition; and
  • if you own a portfolio of patent rights, you may wish to change the way in which the IP is managed in order to obtain maximum benefits from the Patent Box regime.

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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