From 1 April 2013, UK companies will be able to elect into a new regime that applies a lower rate of corporation tax to profits from qualifying intellectual property (IP) rights. The relief will be phased in, culminating on 1 April 2017 in an effective corporation tax rate of ten per cent on worldwide income attributable to intellectual property within the “patent box”. Companies wishing to take advantage of the new regime should consider what they can do to maximise the benefits of the new rules, including identifying all their qualifying IP, and any sales relating to it, and making sure these assets are held in the most tax efficient way.
Background to The Patent Box
The purpose of the new regime is to provide an incentive for UK companies to maintain and commercialise their existing IP and to encourage them to “locate the high-value jobs associated with the development, manufacture and exploitation of patents in the UK and maintain the UK’s position as a world leader in patented technologies”. The UK Government hopes this new initiative will help to achieve sustainable private sector growth. The legislation implementing the patent box regime forms a new Part 8A of the Corporation Tax Act 2010.
A UK company may benefit from the regime if it owns or licenses “qualifying IP”. This includes patents granted by the European Patent Office (EPO) and the following European Economic Area (EEA) countries: Austria, Bulgaria, the Czech Republic, Denmark, Estonia, Finland, Germany, Hungary, Poland, Portugal, Romania, Slovakia, Sweden and the United Kingdom. Supplementary Protection Certificates (SPCs), certain plant breeders’ rights, plant variety rights, marketing exclusivity rights, orphan drug rights and regulatory data protection rights also qualify.
In order to qualify, a company must have created, or made a significant contribution to the creation or development of, the protected item or a product or process incorporating it. If the company is a member of a group (the term group is defined widely in relation to the regime, and includes joint venture companies), it may satisfy this requirement where another group company has undertaken the development of the protected item. A company that is a member of a group must also satisfy an “active ownership” condition, which broadly requires that the company itself takes a significant role in developing or exploiting the protected rights. Licensees of qualifying IP rights are also eligible for relief, as long as the licence confers exclusivity throughout the whole of at least one national territory. This means the regime can apply where qualifying IP is held centrally but is managed actively from the UK.
Election Into The Regime
In order to pay reduced corporation tax on “relevant IP profits” for an accounting period, an eligible company must make a written election to Her Majesty’s Revenue and Customs (HMRC) on or before the last day on which the company can amend its tax return for that accounting period. The election has effect for all subsequent accounting periods of the company until HMRC receives written revocation of the election. It is worth noting that once a company revokes its election, it is prevented from re-electing into the regime for a five year period.
Relief due is calculated on “qualifying income”, which includes licensing royalties, income from the sale of products incorporating a qualifying item (or spares or parts that are intended to form an integral part of the product), income from the sale of qualifying IP and infringement or compensation income.
Preparing For The New Regime
With the introduction of this tax relief from 1 April 2013, companies considering electing in to the new regime should start preparation now. In order to maximise the benefits of the patent box, the following IP portfolio management issues should be contemplated.
Application Policy Review
Companies may consider whether or not to increase the number of products for which they seek patents, and contemplate narrowing the scope of patent applications in an attempt to accelerate the application process to enjoy tax benefits sooner. Companies should also investigate ways of extending the life of a patent to maintain eligibility for the patent box, perhaps by pursuing SPCs. Companies that previously would only have applied for IP rights in non-qualifying jurisdictions may now want to consider protection for those items in a qualifying jurisdiction so as to claim tax benefits in respect of the worldwide sales income arising from them.
Groups that currently hold their qualifying IP in non-UK companies may wish to consider reorganising their IP management arrangements. Qualifying IP could be transferred to a UK IP holding company by assignment or exclusive licence. Development activity in relation to that IP could still be undertaken elsewhere, but the UK IP holding company would need to actively manage the qualifying IP in order to enjoy the tax benefits of the regime. The IP holding company could then grant licences or sub-licences to other group members. This would have the added benefit of all the income of the IP holding company being relevant intellectual property income, which should be subject to fewer costs and expenses in the calculation of relevant IP profits according to the patent box regime, thereby achieving the greatest possible tax savings.
Tax relief extends to companies holding exclusive licences for qualifying IP rights under the regime. Licence arrangements should therefore be reviewed by licensees to identify those that meet the requirements of the patent box and those that do not. It may be possible for licensees to renegotiate licences to make them exclusive. Similarly, groups should review their intra-group licences to ensure they are exclusive where possible. Companies must, however, keep in mind than an anti-avoidance rule has been incorporated into the regime, preventing commercially irrelevant exclusivity being introduced into licences simply to obtain corporation tax relief. If a group company elects into the patent box, there will be an incentive to shift profits to that company (perhaps, if that company licenses IP, by increasing licence fees). The group will also need to ensure that it does not fall foul of UK transfer pricing rules. The patent box should also be considered before granting licences as part of patent litigation settlements, to avoid unintentionally converting an exclusive licence into a non-exclusive licence that is no longer eligible under the regime.
Companies that elect into the patent box regime should establish systems to trace which qualifying IP rights are used in which products so qualifying income can be calculated accurately. Similarly, procedures should be put in place to ensure accounting records are available to calculate the profits or losses subject to the patent box.
Document Portfolio Management
The regime provides an extra incentive for companies to document the formulation of plans and the decision-making process as evidence of their IP portfolio management activity. Such documentation will be useful in proving a company’s eligibility for the regime, evidencing the active ownership requirement.
Having elected into the new regime, a company should keep its position under review on an ongoing basis. For example, the regime broadly provides that patent box profits should be netted against patent box losses; where a company has net patent box losses, it should therefore consider leaving the regime to avoid the losses being relieved only at the reduced patent box rate.
Companies will need to determine which of their IP rights qualify for the patent box and to identify their associated incomes and profits as defined under the regime. Where a company holds only a small number of qualifying IP rights, this process will be relatively undemanding. Where a company or group has a large portfolio, it may be more complicated.
Although regime administration may be at the more complex end of the spectrum, the patent box holds the greatest attraction for organisations that rely heavily on qualifying IP rights in their business model, such as those in the pharmaceuticals or biotechnology sectors. In terms of passive intellectual property income, the tax regime in the UK remains considerably less generous than in other European jurisdictions.
While the patent box offers significant potential benefits for qualifying companies, any election should also be considered in a wider context, in particular the impact on enforcement and future litigation concerning the qualifying IP rights. Companies should also be aware that, although the regime takes effect as of 1 April 2013, the complete extent of relief will only be available from 1 April 2017. As such, it will be a number of years until the potential benefits of election are fully realised.