The UK's 'Patent Box' proposals: Tax breaks on some IP-based profits

A reduced rate of corporation tax of 10% will apply from April 2013. Helen Jones looks at the details and implications.

December 2011

On 6 December 2011 the UK Government revealed the next phase in its plan to provide a reduced corporation tax (CT) rate for companies exploiting patent and related IP rights (Supplementary Protection Certificates, regulatory data protection and plant variety rights, but not design or trade mark rights). The details of these 'Patent Box' proposals are the subject of ongoing consultation, but the main concepts are now fixed and have been published as draft legislation. The measures will apply to profits made on or after April 1st 2013 and will be introduced in the Finance Act 2012.

A reduced rate of corporation tax of 10% will be applied to a proportion of profits derived from the licensing or sale of the qualifying IP or from sale of products that incorporate the IP. The 10% rate is to be compared to the headline CT rate of 30%, or 20% for small companies. The calculation of the relevant proportion of the profit is designed to exclude profits derived from routine manufacturing or development functions (set at a level of 10%) and profits derived from exploitation of trade marks and other marketing intangible assets. Companies will decide whether to opt in to the regime, taking into account the extra administrative burden that may be imposed, as well as the potential benefits.

There are certain requirements of the scheme:

1. The company must actively own or in-license UK or EP patent (or other examined patents granted by EU national patent offices, yet to be named). Active ownership requires that the company must have developed the product covered by the patent, or for a licensee, must have exclusive rights. Special provisions apply to company groups, where management of the rights and development my be conducted by different entities while enabling benefit still to be taken.

 

2. The profits are calculated as a proportion of the corporation tax. The relevant IP income is first determined, which can include income from sale of a patented item, licence fees and royalties received from third parties, income from sale of the IP, damages awarded for infringement of the IP, and a notional arm’s-length royalty for use of the IP under certain circumstances. The income is not restricted to sales within the jurisdiction of the qualifying patents. The proportion of profits derivable from income are then apportioned using one of two routes. Then a routine return on certain costs has to be removed, set at 10% (after consultation). Lastly either a return on marketing (eg trade mark) assets used to derive profit or, if allowable, a small claims flat rate reduction (25%) is applied. The final figure is called the Relevant IP Profits.

 

3. The Patent Box taxes RIPP at the reduced rate. If a negative figure is produced, it can be offset against other RIPP of the company from other trade, or of other group companies, or against future RIPP. The patent must be granted for the benefit to be taken, but retrospective benefit going back six years before grant of a relevant patent may be taken, aggregated over the six years and added to the RIPP in the year of grant.

 

4. There are anti-avoidance provisions, eg to stop commercially irrelevant patented items being included in a product or spurious exclusive rights being added to licence agreements solely to enable income to qualify.

The full benefits are being phased in over five years, starting at 60% in year 2013, raising by 10 percentage points per year to 100% in 2017. When the policy was first proposed in 2009 it was indicated that it would apply only to patents for products commercialised for the first time after 29 November 2010, but in response to consultation the rules will apply to existing IP.

Business implications

Some commentators have suggested the administrative burden for companies opting into the scheme will outweigh the tax benefit such that the Government’s objective of encouraging innovative companies to establish and exploit their rights in the UK will not be achieved. However we believe that the rules will favour medium as well as large companies, and the concessions for small companies should allow even these to benefit from the regime. Many companies will already be seeking patent protection for their innovative products in the EPO or the UKIPO such that no extra cost will be incurred for putting such rights into place. Obtaining grant of a UK patent and maintaining it in force for the full term is low cost, official fees amounting to less than £5000, while total attorney fees typically range from between £5,000 and £10,000.

The active ownership requirements mean that companies expecting to earn income from licensing out their rights for a royalty will need to ensure the agreement gives them adequate management control to benefit. The removal of a return for use of marketing assets, may indicate that patent owners should consider carefully whether any trade marks should be included in the rights granted or whether this will increase the administrative burden in the tax calculation. The active ownership requirement is intended to exclude from the beneficiaries non-practising entities that have not contributed to the creation or development of the IP.

Industries the Government clearly hopes to attract by this scheme are both the pharmaceutical and agricultural technology industries. The inclusion of SPCs, which extend the period of IPR for plant protection and medicinal and veterinary products, and plant variety rights ensures these sectors will benefit. The UK is competing for such businesses with Netherlands, Belgium, Luxembourg and Spain who have schemes with possibly more generous tax savings. GSK has already indicated that decisions on major investment in the UK will be positively influenced by this new regime. Although the current economic climate is harsh, we believe that IPR holders can be confident that this scheme is set to stay on the tax legislation for many years, as it is supported by all three major political parties in the UK. We do not believe there is a high risk that the scheme will be shelved as happened in 2011 to a similar scheme in Ireland. The Government has committed to continue its consultation on the detail and to publish guidance on the scheme in summer 2012, and will review and assess the scheme alongside its other tax reforms.

Implications for practitioners

For patent advisors it will be important to understand some aspects of the scheme, for instance it may be relevant at the grant of a qualifying patent to assess whether the claims protect products sold or processes used that give rise to profits. Since retrospective benefit for pregrant profits may be claimed, it will be important to ensure that patents are granted within 6 years of first filing to maximise the tax benefit. Coordination with company’s tax advisors will be wise at all stages, to ensure applications for protection are filed at the appropriate time to ensure validity, and with legal advisors to ensure agreements for transfer of rights take into account the requirements of the regime. IP plans should include a consideration of the benefit of the regime against the administrative burden and other costs. There may be benefit in pursuing patent protection in UK and EPO, with narrow claims being sought in one jurisdiction to allow the scheme to be followed while keeping prosecution costs low.

Tax advisors will need to assess the Patent Box and its relationship to the R&D tax credit scheme, in advising companies whether to opt into the scheme. Consultation with patent advisors will help in the assessment of the scope of patent rights and/or if the timing of grant of such rights becomes significant for the opt-in. The impact of the scheme on intra-group transactions as well as acquisitions and divestments will also need to be considered.

An overview of the draft Finance Bill can be found at:
http://www.hm-treasury.gov.uk/d/overview_draft_legislation_financebill2012.pdf,
discussion of the Patent Box measures begins on page 95.

You can also find a useful Treasury presentation that sets out Patent Box's practical working here: http://www.hm-treasury.gov.uk/d/patent_box_presentation120112.pdf.