From April 2013 it will be possible for income attributable to patent rights to be subject to corporation tax at a special rate, ultimately falling to 10%. Whilst no doubt the large pharmaceutical companies of this world will have all of the accounting systems necessary to isolate all relevant income at the touch of a button, how is the smaller company patent holder likely to compute the level of relevant income?
The patent box is the technical name for the amount of profit eligible for the 10% rate. In order to determine the amount of that profit, it is necessary to distinguish it from routine return and marketing asset return on patents or products containing them, as well as from non-patent income.
The patent box comes into effect on 1 April 2013, and for that purpose company accounting periods overlapping that date will be divided into two. In 2013 60% of patent box profits will be eligible for the 10% rate, increasing to 70% in 2014, 80% in 2015, 90% in 2016 and 100% for 2017 and subsequent financial years.
The types of income eligible for the special rate are:
- Income from sale of patented items, those that incorporate a patent somewhere, or the sale of spares in respect of such items;
- Licensed-in patent rights; and
- Compensation for infringement of patent rights
This income is determined by stripping out profits considered routine (i.e. those that would be made regardless of the patent) and profits attributable to the brand value of the item. For smaller companies there is a formulaic approach to permit this exercise to be carried out without a detailed accounting system to generate all the required figures in detail.
There are various conditions to satisfy in order for profits to get into the patent box:
- The organisation must be a company, not a sole trade, partnership or LLP.
- The company must hold a patent or a countrywide exclusive licence to exploit one. This includes a variety of industry-specific rights similar to patents, specified in the legislation.
- The patent must be granted by the UK patent office, the European patent office or the patent office of one of 13 specified European countries.
- The company must have actively developed the patent or a product incorporating it.
- In the case of a group of companies, where a specific company holds all intellectual property, its income will only qualify for the patent box if it takes an active role in managing the IP portfolio. The definition of a group includes associated companies as well as subsidiaries.
- The company must elect into the regime.
- Although the patent box only applies from the date of grant of a patent, it is possible for a company to bring into the patent box all relevant profits that have accrued while the patent is pending, which will happen as of the date of grant (see below for details).For this to happen the company must have had the patent box election in force for all earlier accounting periods from which profits are re-allocated, and must be a qualifying company for such periods.
- Companies may go back for this purpose to the later of the date on which the patent was filed or 6 years prior to the date of grant. In this respect the current lag time for a UK patent is around 2 years, and for a European Patent Office patent 5 years.
- The deadline for an election is two years from the end of the company’s accounting period.
- An election may be revoked at any time, on the basis of the same deadline. Once a company has left the patent box, it may not re-enter for at least 5 years.
There are 3 main steps to identifying the patent box profits for the smaller company without detailed data to separately identify:
Step 1 – Identify the profit in the box
The first part of this step is to apportion turnover between that derived from patents and that which is not, identifying the patent box profits as a percentage of total turnover.
The second part is to apply that percentage to all costs, and hence to the profits.
Step 2 – Strip out the routine return
The legislation assumes that companies would enjoy a 10% mark up on all routine expenses; this mark up is apportioned as above and stripped out of the patent box profit. As a yet further incentive to take advantage of the UK’s extremely generous research and development tax relief regime, salaries forming part of an R & D claim are not included in this cost plus calculation.
Step 3 – deduct a marketing asset return
For companies with a qualifying residual profit (i.e. what is in the patent box after step 2) of less than £1 million, or in some cases £3 million divided by the number of associates, it is possible to elect for ‘small claims treatment’. This involved deducting 25% of the qualifying residual profit to take account of the brand element. As this article is dealing with the regime as it will apply to smaller companies, I will not consider the more complex alternative approach.
For profitable companies, it would be pointless to delay entering the patent box. However, if there are patent box losses, they can only be relieved at the 10% rate, and can thus only be carried forward against future patent box profits or group relieved against profits of other group patent box companies. Thus loss-making companies will wish to remain outside the patent box until they have relieved any losses that would be patent box losses.
Thus companies that benefit from exploitation of patents will need to consider whether, and at what stage, they should elect into the patent box, remembering the risk of premature election should it prove necessary to withdraw the election at some future stage. Those with patents pending will face particular urgency, not to mention difficulty. In taking this decision. Nonetheless this is a regime that will complement the research and development tax regime in establishing a tax regime under which it is attractive to develop and exploit new products in the UK.