Thinking Outside of The Box: Patent Box Changes

ETC Tax discusses the Patent Box rules and how companies should ensure that they comply with the recent changes in rules to benefit from this generous relief.

Background

The UK patent box regime was originally introduced in 2013. It is a generous tax incentive regime that enables companies to pay an effective 10% corporate tax rate on profits derived from certain qualifying patents.

The patent box regime will become even more beneficial with the proposed increase in the UK corporation tax rate to 25% from 1 April 2023. 

The aim of the patent box regime is to provide additional incentives for companies to:

• Ensure that new and existing patents are developed and commercialised in the UK;
• Manufacture and sell those innovative products and services from the UK; and
• Locate the high-value jobs associated with the manufacture and exploitation of patents in the UK.

Broadly, a company qualifies for the UK patent box regime if:

• It legally owns or exclusively licenses in a ‘qualifying IP right’;
• It meets the development condition; and
• Where a company is part of a group, it meets the active ownership condition.

Assuming that a company qualifies, it must elect into the patent box regime and carry out calculations that identify ‘relevant IP profits’, which are essentially the company’s taxable profits relating to its exploitation of qualifying IP, subject to a number of specific adjustments. 

The taxable profits allocable to qualifying IP are taxed at an effective rate of 10%, as opposed to the main rate of corporation tax (currently 19%). The relief is given via a deduction from total taxable trading profits for the respective accounting period.

The ‘new’ patent box regime

Certain changes were introduced to the patent box regime from 1 July 2016. The five-year transition into the new rules came to an end on 30 June 2021 and companies that have ongoing claims under the old pre-1 July 2016 rules will now have to apply the new rules to all claims. 

The methodology of the new patent box regime

While the new regime is mostly based on the old patent box regime, the two main changes are to the calculation of a company’s relevant IP profits.

Briefly, these changes are:

• The streaming of profits has become mandatory (as opposed to being elective under the old regime);
• All patent box claims must now follow the ‘nexus’ approach, linking relevant R&D expenditure to the patent or patented item. This requires an R&D fraction calculation to be undertaken for each type of IP (assets, products, or product families) to which relevant income is attributable.

We look at the above in further detail.

1. Streaming profits

Streaming requires a company to calculate patent box profits by allocating costs to patented income sub-streams. Under the old regime, the default approach was to apply the percentage of patented turnover to total turnover to apportion profits. 

The legislation permits sub-streams to be defined on a ‘product family’ basis. This enables the grouping of IP item or IP process sub-streams, taking into account the purposes for which the IP items or processes are intended to be used.

2.     Calculating the R&D fraction

This essentially requires the application of an ‘R&D fraction’ to each sub-stream. This fraction takes a value between 0 and 1 and is defined as the lower of 1 and:

 (D+S1)  x 1.3 
_________________

D + S1 + S2 + A

The categories of expenditure within the R&D fraction are:

• D: In-house qualifying relevant expenditure on R&D;
• S1: R&D costs sub-contracted to unconnected parties;
• S2: R&D costs sub-contracted to connected parties;
• A: acquisition costs of qualifying IP rights.

The requirement to track R&D expenditure

With the UK corporation tax rates set to increase from 19% to 25% from 1 April 2023, it couldn’t be a better time for companies to take appropriate advice and ensure that correct methodologies are in place to benefit from this generous relief.

Companies that are eligible make patent box claims do not necessarily have to develop sophisticated systems to identify the qualifying profit streams that relate to their IP. Whilst the first claim might require effort and time commitment, with our assistance and with appropriate planning of the design of processes, subsequent year claims should become less complex. 

Practical points

Given the significant tax savings which can be achieved by electing into the patent box regime, qualifying companies should consider the following points in respect of their patent box claims:

• Companies considering Patent Box claims should start reviewing their accounting systems to ensure all the relevant information can be captured. 
• Companies with licences over patented information should consider whether those licences qualify for patent box purposes. If they do not, it could be worth considering amending the licence agreement to make it compliant with the patent box rules. 
• Determine the historic R&D expenditure profile of the company to establish the R&D fraction.
• Track R&D expenditure in order to build up the R&D fraction for each sub-stream, or where the R&D fraction is 1 and therefore not required, ensure sufficient records are maintained should it be needed in the future.
• Build a methodology for tracking R&D expenditure on an ongoing basis and streamline this with the data available for the R&D claims process.
• The timing of elections should also be considered, as relief can be claimed when a patent is pending, but only if the company has elected into the regime. 
• Any group reorganisation should consider the impact on the Patent Box relief, particularly in terms of the development and active ownership conditions.
• Continue to monitor opportunities to patent technology resulting from the company’s ongoing R&D efforts. 
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If you have any questions about this article or patent box in general please do not hesitate to get in touch with our expert tax advisers.