1. Introduction
The UK government has produced draft legislation for the implementation of its proposals for a new 10% rate of tax under the "Patent Box" regime. The Patent Box regime will (broadly) provide an effective 10% rate of corporation tax on profits arising from the sale or licensing of patent rights, profits from the sale of patented inventions or products and also a notional arms-length royalty for the use of patents which generate certain types of income. This effective rate of tax will apply to profits attributable to qualifying patents which arise anywhere in the world..
Unfortunately, certain classes of profits are excluded, such as profits from design rights, profits from unpatented trade secrets and generally most un-patented technology, which can be quite important sources of profit in some industries.
The government has conducted two consultations on the operation of the Patent Box (the latest running from June-September 2011) and the draft legislation it has produced takes into account some of the points raised by respondents to these consultations. The final legislation will be contained in the 2012 Finance Act.
A company will need to elect into the Patent Box regime if it wishes to claim the benefit of the reduced rate of tax. Once an election has been made the Patent Box regime will continue to apply until the election is revoked – however, if a Patent Box election is revoked, the company will be prevented from filing a further election for 5 years.
The new regime will have quite wide application, as it will apply to both new and existing patents. However, as a quid pro quo for the wide application of the regime, the benefits will be phased in over a five year period. The Patent Box regime will apply from 1 April 2013, but only 60% of the benefit will be available in the 2013 financial year, rising by 10% in each subsequent year until the full benefit of the new tax rate becomes available in the 2017 financial year.
2. Qualifying IP
Whilst the application of the benefits is quite wide, the government has retained a fairly restrictive approach to the types of IP which qualify for the Patent Box regime. Only profits attributable to UK and European Patent Office patents and certain ancillary rights such as supplementary protection certificates, plant variety rights and regulatory data protection will qualify for the benefit of the regime. However, the government has confirmed that it will extend the regime to include patents filed in other EU member states with comparable patent regimes, and it will publish a draft list of qualifying countries in spring 2012.
Patents filed in other jurisdictions, such as the US or Japan, will not qualify. Income from products made by patented processes (such as patents for an industrial process) and income arising from the provision of services is also not eligible, although some benefit can be obtained through the use of a notional arm's length royalty (see section 4 below).
3. Ownership of Qualifying IP
In order for a company to make use of its qualifying patents in the Patent Box, it must either be the legal owner or the exclusive licensee of the patent right. In the latter case, the licence need not grant worldwide exclusivity, but at least country wide exclusivity to use the patent in its business is required.
The company must also satisfy the development conditions for the IP right to constitute qualifying IP. To satisfy the development conditions, the company must demonstrate that it has actively developed the patent or its application either by creating or actively developing the patent or the patented product or a product which incorporates the patented product. The legislation sets out guidelines as to how this condition is assessed.
A group company may pass the development condition where it owns the patent right in question but another member of the group has conducted the relevant development work. In such circumstances the group company which has elected into the Patent Box regime must also show that it is actively involved in the management and decision making in respect of the qualifying patent.
4. Calculating Qualifying Profits
The legislation sets out a formulaic approach to the calculating Patent Box profits, which the government hopes will minimise the cost in complying with the legislation, and also reduce the likelihood of disputes arising. What follows is a brief overview of this methodology.
The first step is to identify the gross income of the trade and also the income attributable to qualifying IP rights ("RIPI"). There are five broad areas of income which qualify as RIPI, namely:
- income from the sale of patented inventions or products incorporating such inventions;
- income from the licensing of qualifying IP rights;
- income from the sale or disposal of qualifying IP rights;
- damages in respect of patent infringement (where these represent lost income attributable to the patent); and
- where income is ineligible for the Patent Box (such as service income or income from process patents) a company can include a notional arm's length royalty fee for use of the patent to generate the ineligible income.
Once the total income from qualifying IP rights has been identified, the company must calculate its qualifying profits deriving from qualifying income. This is done either by apportioning its total profits for the year (net of expenses, finance profit and certain other items) between its qualifying and non-qualifying income, on the basis of the ratio of its qualifying income to its total income, or by allocating profits between qualifying and non-qualifying income according to 'streaming rules' set out in the draft legislation (in certain circumstances this latter option is mandatory).
A 'routine return' on certain costs must then be removed from the streamed or apportioned profits – this is set at 10% of the costs, and is an entirely arbitrary deduction. This then gives the "qualifying residual profit" ("QRP").
The next step is to deduct a return on marketing intangibles (such as branding) from the QRP. Once a company has managed to work its way through this somewhat complicated set of calculations, the remaining profits are eligible for the 10% effective rate of corporation tax.
The Patent Box effective rate of 10% can only be utilised once the qualifying patent right has been granted. However, companies can use a mechanism in the Patent Box calculation to receive the benefit of the 10% effective rate against profits attributable to the patent between application and grant, up to a maximum of six years preceding grant.
Comment
In the main, reaction to the government's draft legislation has been positive, with many business leaders and commentators praising the government for making positive changes following the June 2011 consultation. However, disappointment has been expressed that patent rights from other major jurisdictions, such as the US or Japan, are not included, whilst the requirement that the claimant be an exclusive licensee of the patent right in question could prejudice industries with a high level of technological collaboration, such as Telecoms, in which non-exclusive licencing remains the norm. Furthermore, the extremely complex and somewhat arbitrary calculation of the profit that can benefit from the 10% rate of tax could act as a disincentive to elect into the Patent Box regime.
The UK is one of many European countries with either a specific regime to provide a favourable rate of tax for patent income or a low rate of tax which generally applies to patent income. Whilst the UK Patent Box regime is competitive with other jurisdictions, companies will need to consider carefully which regime is the most appropriate for their business, taking into account the benefits and costs of participation as well as their own strategic and logistic requirements.
Nevertheless, a majority of companies are likely to see positive results from participation in the UK Patent Box regime, and as a result should consider planning patent strategies which will allow participation once the regime comes into effect in 2013.
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.