Corporation tax: Patent Box changes ahead

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Donald Drysdale By Donald Drysdale for ICAS

20 November 2015

Donald Drysdale discusses forthcoming changes to the UK Patent Box, and ICAS invites views.

Introduction to the UK Patent Box

The UK Patent Box, an elective tax regime, was implemented from 1 April 2013.  It offers companies a reduced rate of corporation tax on profits attributable to patents and equivalent forms of intellectual property (IP).  The benefit is being phased in gradually, with companies due to enjoy a 10% rate on such income from 1 April 2017.

The regime aims to increase the level of patenting of IP developed in the UK, ensure that new and existing patents are further developed and commercialised in the UK, and encourage manufacture and sale of those innovative products and services from the UK.

Impact of the BEPS project

The OECD’s BEPS project addresses tax planning by multinationals artificially shifting profits to low tax locations where there is little or no economic activity.

As part of the BEPS project, the Forum on Harmful Tax Practices (FHTP) has considered preferential IP regimes (Patent Boxes).  To counteract the concerns raised, the G20 nations (including the UK) and other OECD countries want to see taxing rights over profits aligned with the economic activity that generates them.

The FHTP has agreed a new international framework based on the ‘nexus approach’ which links the beneficial treatment of IP profits to R&D activities undertaken in developing that IP.  Thus a business will only be able to benefit from a preferential IP regime if it has conducted the ‘substantial activities’ which generated the income in question.  R&D expenditure will be used as a proxy for substantial activity.

The UK government recognises that legislative changes are needed to modify the UK Patent Box so that it complies with the new BEPS framework.

Changes expected

The FHTP requires that only nexus-compliant IP regimes may operate from 1 July 2016, subject to certain permitted grandfathering arrangements.  The Finance Bill 2016 will include amendments to the current Patent Box rules (rather than replacing them completely) from 1 July 2016.

The ‘nexus fraction’ will determine the proportion of profit from the IP which may be included in an IP regime.  If a company made profit (P) from an item of IP and carried out 70% of the R&D itself or by subcontracting to unrelated third parties, the nexus fraction would be 0.7 and the profit to which the preferential rate would apply would be 0.7 x P.

The new rules will permit a modified nexus approach, allowing an uplift of up to 30% of qualifying expenditure to ensure that companies acquiring IP from or outsourcing R&D to a related party won’t be disadvantaged, but this is a blunt instrument.

Consultation in progress

The government believes the current UK rules for establishing profits within the Patent Box (to which the nexus fraction will need to be applied), including the availability of the small claims election, are consistent with the FHTP’s requirements, and is therefore seeking views on whether the fundamental definition of relevant IP profits should remain unchanged.

There are currently two ways of calculating profit for the Patent Box – proportional split and streaming – but in future the government proposes that streaming will be the only method.  It’s proposed that companies will have to track expenditure and income to the level of individual IP assets unless this would be unrealistic or require arbitrary judgements or entail tracking and tracing to a category entirely unrelated to innovation or business practice.

The FHTP decided that countries could treat the nexus ratio as a rebuttable presumption, so deviation from it might be allowed in exceptional circumstances.  The government proposes to allow the nexus fraction to be revised where certain detailed conditions are met and the revision restores the link between the proportion of R&D expenditure incurred and the proportion of income eligible for the IP regime.

The consultation also requests input on: co-development by two or more organisations; the relationship between R&D expenditure recognised for the Patent Box and for R&D tax credits respectively; and the timing of expenditure for the nexus fraction.

Formulating an ICAS response

Discussions among interested ICAS members have already highlighted concerns about some aspects of the proposals.  Low take-up of the regime to date may be attributable to the complexity of the existing rules and this is likely to be aggravated by the modifications now required.

Other suggestions by members so far include extending the new R&D voluntary advance assurance scheme to Patent Box claims by smaller companies, extending the scope of the small claims election to minimise complexity for smaller companies, allowing elections in respect of individual patents rather than whole companies, and finding ways to simplify the daunting record-keeping requirements of the transition and the new regime.

This article can give you no more than a flavour of the consultation, which closes on 4 December.  You are invited to submit your views on the consultation questions to tax@icas.com.

Is the Patent Box still open to new entrants?

The UK’s existing Patent Box will remain open until 30 June 2016 and, for companies and IP already within it by that date, will continue until 30 June 2021. The new nexus-compliant regime will start on 1 July 2016.  Special transitional rules will apply, and anti-abuse rules will apply from 1 January 2016 to prevent IP being moved between related parties to take advantage of grandfathering.

Companies exploiting IP should ensure that they are benefiting from the regime where appropriate.

Article supplied by Taxing Words Ltd

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