The Patent Box tax regime – a brief insight into its application
The Patent Box enables companies to apply a lower rate of Corporation Tax to profits earned after 1 April 2013 from its patented inventions and certain other innovations. The relief is being phased in from 1 April 2013 and the lower rate of Corporation Tax to be applied will be 10 per cent.
Qualifying for the Patent Box regime
In order for a company (the "Company") to benefit from the Patent Box certain conditions must be met:
Patent ownership requirements
The Company must be the owner or an exclusive licensee of the Patents
The Company, or subject to certain conditions another company in the Company's group, must have carried out "Qualifying Development" in respect of the Patents.
"'Qualifying Development'" means either: (i) creating, or significantly contributing to the creation of, the invention; or (ii) performing a significant amount of activity for the purposes of developing the invention or any product or process incorporating the invention. Merely commercialising a fully developed product or process incorporating the invention will not be enough by itself."
Active Ownership condition
In the event that the Company is part of a group of companies, the Company must meet the "Active Ownership" condition.
The Active Ownership condition is met if either:
- the Company performs a significant amount of management activity in respect of the Patents, where "management activity" means formulating plans and making decisions in relation to the development or exploitation of the Patents, or
- the Company has itself carried out Qualifying Development in respect of the Patents, rather than it having been carried out by another group company.
The upshot of this condition is that if the Development Condition has only been met by virtue of a company within the Company's group having carried out the Qualifying Development, then in order for the Company to benefit from the regime it must be playing an active role in the management of the Patents.
Therefore, in certain circumstances an IP holding company within a group will be able to benefit from the regime.
Relevant IP income
The following categories of income are taken into account when calculating the profits which will benefit from the Patent Box regime:
- Income from all sales of the patented item, or an item incorporating a patented item.
- Licence fee and royalty income received under any agreement granting third parties: (a) a right in respect of the Patents; (b) any other right in respect of items or processes protected by the Patents; and/or (c) in the case an agreement granting rights alongside (a) or (b), any other right granted for the same purpose as those rights.
The income in the above two categories includes income from sales made, and licences granted, in territories outside of the protection of the Patents.
- Income from the sale or disposal of the Patents.
- Amounts received in respect of infringement, or alleged infringement, of the Patents – ie damages or settlement payments.
- Other compensation paid in respect of items falling into category 1 or other lost relevant IP income. This, for example, would include damages from an overseas infringement claim in respect of items covered by the Patents.
There is an additional way a company may benefit from the regime if it is using an invention which is covered by a Patent to generate income but such income does not fall within categories 1 or 2 above.
For example, where a company uses a patented tool to produce the items it sells, or uses a patented process to provide a service to customers.
In this event, the Company can claim the benefit of the regime in respect of an amount equivalent to the royalty the Company would expect to have pay if it needed a licence from a third party in order to exploit the Patent in such manner.
Mixed sources of income
A further issue for companies when putting the regime into practice is what happens if there are mixed sources of income.
For example, what if: (a) items which give rise to Relevant IP Income and items which do not are sold together as a single unit for a single price; or (b) income is derived under a single agreement which covers the sale of items or the grant of rights which would give rise to Relevant IP Income and others which do not?
With respect to items the first issue may be for the company to establish that the item covered by the Patent is 'incorporated' into the larger item which is being sold. HMRC's view is that incorporation means that the item is physically part of the larger item and is intended to be for its operating life (provided that it has not been incorporated merely to bring the regime into play).
HMRC gives the example of a conservatory which contains a patented hinge as being a larger item which incorporates a patented item, and hence all income from the sale of that conservatory would be Relevant IP Income.
HMRC's example of a single unit which would contain items giving rise to Relevant IP Income and items which do not, is a home entertainment system where the TV is protected by Patents but the blu-ray player and surround sound system are not.
In this case, the sale proceeds of the home entertainment system must be apportioned between Relevant IP Income and non-qualifying income on a 'just and reasonable basis'. The same type of apportionment would be required if the sales price for the conservatory mentioned above included installation.
It is this apportionment which may prove difficult for companies and where specialist accountancy input is likely to be required.
For some examples scenarios please click here.
You can access the HMRC's guide here.
This article was written by Ian Wood.
For more information please contact Ian on +44 (0)20 7203 5124 or firstname.lastname@example.org