Patent Box – a 10% tax rate as reward for innovation
- Is any of your company’s income derived from a patented invention?
- Does your company have any pending patent applications, or plans to submit a patent application?
- Is your company undertaking a Research & Development (R&D) project or has it already completed a successful R&D project?
If your answer is yes to any of the above, you should consider the company’s current and future eligibility for the valuable Patent Box tax relief, accessing up to 15% tax saving on certain Intellectual Property (IP) related profits.
It may be that applying for patents is not a part of your current R&D strategy, perhaps because of the complexity of the process and the limitations of the protection it offers. It still may be worth exploring whether a simpler application could be made for a smaller component of the invention to gain access to the Patent Box regime.
It is never too early to start thinking about the Patent Box. Decisions made in the very early stages of the innovation cycle can affect the company’s eligibility for the Patent Box regime for the many years ahead.
4th October 2022
Marketa Pasova See profile
The Patent Box is a tax incentive designed to reward companies for driving innovation. Complementing the existing R&D tax relief schemes, it aims to encourage the development of new products and processes to boost economic growth in the UK.
It is a generous innovation tax relief which reduces the Corporation Tax rate to 10% on profits derived from UK and EU patents and certain similar IP rights. With the main Corporation Tax rate currently at 25%, this translates into an effective 15% tax saving on the relevant IP profits.
To be eligible, the company must:
- own a qualifying IP right or have an exclusive licence over it, and
- the IP-related profits must come on the back of the company’s (or group’s) own R&D efforts, whether the R&D led to the invention itself, or commercialisation or alternative application of someone else’s invention.
“OK, that sounds straightforward, how do I claim?”
The Patent Box claim is made on a back of an intricate multi-step calculation, and the relief is subject to highly complex legislative rules which are hard to navigate. Historically, this seems to have discouraged many companies and their advisers from making use of this relief. The Patent Box has been around since 2013 and so far, the uptake has been surprisingly low.
However, as always, with the right advice, accessing the Patent Box relief does not need to be a daunting task.
What kind of income is covered by the Patent Box?
Most often the Patent Box is claimed on profits from sales of products or services utilising patented inventions. It may be that the entire product or process is patent protected, but only a minor patented component is needed to bring all the worldwide profits generated by the product within the Patent Box regime. For example, a car manufacturer can include all income from sales of cars incorporating a patented gearbox in their Patent Box claim.
Other IP related income such as licencing and royalties, sale of patent rights, or damages and infringement receipts can also qualify.
Groups – the pitfalls
The Patent Box regime has many complexities, one of which is the interaction of the R&D costs incurred in connection with the invention, IP ownership, and IP income.
The most straightforward position is for the same company which undertook all the qualifying R&D activities, to hold the qualifying IP right, and receive the qualifying IP income. However, this is not always the way how groups organise their operations.
The way that certain intra-group arrangements are structured, including for example R&D subcontracting or IP ownership and licencing, may affect the individual companies’ eligibility for the Patent Box.
The Patent Box eligibility considerations can be quirky, and some aspects are assessed on a historical basis, not only from the point of entry into the Patent Box regime. For example, whether the underlying R&D was subcontracted to another group company, or the intra-group R&D assistance was limited to the provision of workers, can affect the % of the IP income eligible for the Patent Box relief years after the R&D project took place.
If there is any prospect of claiming the Patent Box relief in a group scenario, whether imminently or in the more distant future, the group IP structure should be reviewed and ‘futureproofed’ for the Patent Box regime.
Electing into the Patent Box – don’t elect too early or too late!
To access the relief, companies must elect into the Patent Box within two years from the end of the first accounting period in which they wish to make a claim. The timing of the Patent Box election is one of the subtleties of the regime which may require careful analysis.
The overall tax position of the company itself and any companies in the same group must be considered, as well as whether the Patent Box calculation itself results in Patent Box loss or profit.
For example, a company which is profitable overall can show a Patent Box loss, particularly in the early stages of IP exploitation. Once elected in, Patent Box losses can only be offset against future Patent Box profits. Electing into the Patent Box regime in such circumstances can put the company at a disadvantage.
As a rule of thumb, the best time to enter the Patent Box regime is when the company’s qualifying IP starts generating taxable profits.
Once the Patent Box election is made, the company will stay in the Patent Box regime for the subsequent periods. The Patent Box election can be revoked, but re-entry is not allowed during the five years following the withdrawal.
It is possible to benefit from the Patent Box relief while the patent application is pending. A retrospective claim for up to six years can be made once the patent is granted, but the company must have been elected into the Patent Box regime for all the periods included in the retrospective claim.
Therefore, the Patent Box election must be considered as soon as the patent application is made. Don’t wait for the patent to be granted first.
Not so new ‘New Patent Box’ rules
In 2016, the Patent Box rules were significantly updated to ensure that the regime only benefits companies with material R&D activities linked to the qualifying IP.
The new rules introduced two fundamental changes to the calculation:
- The ‘streaming’ methodology becomes mandatory, and
- An introduction of an R&D fraction into the calculation, together with the ‘track & trace’ requirement.
Pre-2016 entrants were allowed to use the ‘old’ rules for an additional five years, but the transitional period came to an end with effect from 1 July 2021.
The companies that were making claims under the grandfathering rules now face preparing their first Patent Box calculations fully under the new rules.
The Patent Box has never been simple, and the 2016 changes brought even more complexities. Transitioning to the new rules will inevitably require some additional effort but once the new calculation methodology is set up, making claims in subsequent years should become a relatively straightforward process again.
When is a good time to start thinking about the Patent Box?
It can be too early to enter the Patent Box regime in some circumstances, but it is never too early to start thinking about it!
The importance of continuous close evaluation of the company’s innovation efforts to identify patenting opportunities goes without saying. It may be that only a minor element of a product or process is patentable, but this still may bring all associated worldwide income under the Patent Box regime.
These are some other key areas you may need to consider in the earlier stages of the innovation cycle:
- You should start tracking and tracing your Research & Development (R&D) expenditure as soon as possible to support the R&D fraction element of your future Patent Box calculations.
- If you are a member of a group, is the group structure ‘futureproofed’ for the Patent Box?
- If you are incurring ‘bad’ R&D fraction expenditure, is it possible to make some changes to how your operations are organised and make these more Patent Box friendly?
- When negotiating terms of Intellectual Property (IP) licensing agreements, do they qualify for the Patent Box?
And do not forget that companies can benefit from the Patent Box from the point of submission of the patent application, as long as they elected into the Patent Box regime at the right time.
Whether you are a Patent Box veteran who needs support with transitioning to new rules, or a novice exploring your options for a new IP in development, our specialist team can provide tailored advice at any stage of the company’s innovation lifecycle, including:
- Assessing your eligibility for the Patent Box
- Determining the potential benefit of electing into the Patent Box
- Advising on the optimal timing of the election
- Assisting with the Patent Box calculations including identification of qualifying IP and revenue streams and developing cost allocation methodology, ensuring the benefits of the claim are maximised
- Updating your Corporate Tax return with all relevant disclosures and submitting the Patent Box claim to HMRC
- Assisting with transitioning from old to new Patent Box rules
- Evaluating different operational structures and optimising or futureproofing these for the Patent Box
- Putting you in touch with a patent attorney to discuss the viability of patenting your inventions to gain access to the Patent Box regime
- Offering comprehensive innovation tax relief services, assisting you with both Patent Box and R&D claims.