From 1 April 2013, companies which own or license-in a patent and which have been significantly involved in the creation of that patent will be able to elect to enter the ‘Patent Box’ regime. The Patent Box regime will also extend to profits on products which have a patented component within them even if this is an insignificant part of the overall product.
By making such an election, the company will, subject to the phasing in of the regime, ultimately benefit from the application of an effective 10 per cent rate of corporation tax on profits which qualify under the regime. The regime is however being phased in over a number of years, with initially only 60 per cent of profits qualifying for the reduced rate of tax and this gradually increases until 2017 when all profits benefit from the reduced rate.
Once a company has made a Patent Box election, the Patent Box regime will continue to apply to the company until the election is revoked. If a company revokes a Patent Box election, it will not be able to re-enter the Patent Box regime for five years.
The company must own or licence-in qualifying intellectual property rights or have derived an income from a previously owned qualifying IP right. Special rules exist for group holding companies to prevent passive holdings of IP attracting the reduced corporation tax rate.
Qualifying IP rights
The Patent Box applies to a number of different types of intellectual property, broadly:
• patents granted by either the UK Intellectual Property Office or the European Patent Office and ultimately to patents granted by certain other EU member states;
• supplementary protection certificates;
• UK and European Community Plant Variety rights; and
• certain UK and European regulatory exclusivity rights
The company must also meet the development condition in relation to the IP right for it to be a “qualifying IP right”. The company must carry out“qualifying development” in relation to the IP although this can be before or after its acquisition.
Qualifying development is:
• creating or significantly contributing to the creation of the patented invention;
• or performing a significant amount of activity to develop the patented invention.
The above development tests will also be applied to a product incorporating the patented invention or the way in which the patented invention can be applied.
Again special rules exist for companies coming into and leaving groups.
Calculating qualifying profits
The Patent Box will apply to a proportion of the company’s overall profits. In order to calculate the profits on which the reduced rate of tax is applied, the following process is followed:
1. Calculate total gross income of the trade;
2. Calculate what proportion of the company’s income is relevant IP income. This will include items such as the sale of patented items or products containing a patented item as well as licence fees, royalties and sales income from the IP;
3. The company can then either apportion its IP income over its total income to determine IP profits or it can apply a just and reasonable apportionment of expenses against the qualifying and non-qualifying income (a streaming election);
4. 10 per cent of certain specified costs are adjusted to reflect the fact that a company would have expected to make a return if it had no qualifying IP. This is a statutory reduction of the amount qualifying for the reduced rate;
5. A further deduction is required to adjust a portion of the profits which is attributable to marketing and branding, as opposed to the actual patent. Again this is a further reduction in the amount qualifying for the reduced rate, but is much more tenuous and difficult to ascertain. Broadly the stronger the brand behind a product, the higher this adjustment will be.
The resultant figure will be included and used as the basis of an additional deduction from the corporation tax profits when preparing the corporation tax return.
While the new regime does not come into force until next year, it needs to be considered now not least to identify what qualifying patents are being exploited by the business. It can be very worthwhile putting systems in place now that will help maximise the use of the reduced rate of tax. Whether this is simple record-keeping or reorganising the business unit to maximise the impact of income streaming, this should be considered over the next few months. Unincorporated inventors also need to consider whether they should commence operation of their business through a limited company.
Please contact Michael Blair, Tax Partner at RSM McClure Watters.