The patent box is dead – long live the patent box!
The new patent box scheme received royal assent on 15 September 2016
On 30 June 2016, the patent box scheme was closed to new entrants (although those already in the scheme can continue to make use of it until June 2021). The closure was precipitated by objections from several EU member states that the existing scheme amounted to preferential tax treatment in the absence of rules that sufficiently co-located tax reductions with the activities generating the original income.
In its place we have a new scheme that provides a modified version, in principle effective since 1 July 2016 having obtained royal assent on 15 September 2016 as clause 64 of the Finance Act 2016.
The new scheme is summarised neatly by a flowchart published by the government, and in essence updates the old scheme to reflect the new internationally harmonised framework for preferential tax schemes based on the so-called ‘Nexus approach’.
The Nexus approach
The key point of this approach is that for a business to gain the benefit of a preferential tax regime in a given state, it should have conducted the substantial activities which generate the income benefiting from that regime within that same state. For the patent box, the agreed approach uses R&D expenditure as an indicator of substantial activity, and links benefits to the requirement to have undertaken the R&D expenditure incurred to develop the IP.
The patent box and R&D
What this means for the new scheme is that it reduces the benefits of the patent box by an ‘R&D fraction’, which is based on the proportion of research and development incurred by the business (in-house or contracted to 3rd parties) as opposed to that outsourced to related parties (eg, other businesses in a group). Consequently this may require some businesses to restructure their R&D activities to recover similar benefits to those under the old scheme.
Similarly, the R&D fraction discounts the proportion of research and development represented by any acquired IP. Notably though, transitional provisions will allow income from acquired IP that qualifies under the old scheme to be ‘grandfathered’ into the new scheme. Originally the cut-off for this was 2 January 2016, but fortunately this was pushed back to 30 June 2016.
Streaming patent box discount calculation
To calculate the discount, the simpler ‘standard method’ of calculation is no longer available, and so businesses will have to use the ‘streaming’ approach. The impact of this change is exacerbated by the fact that the length of time for which a rights holder must track and trace R&D expenditure to the IP has been extended from 15 years to 20 years, and is at the patent (or alternatively product or product family) level; meaning in turn that each represents a sub-stream requiring its own R&D fraction, making the process more administratively complex.
Whilst these changes would appear to place a greater administrative burden on SMEs, the government’s argument is that in general SMEs are UK-based with only in-house R&D, making these new rules comparatively simple to implement in practice.
Benefits of the patent box
Finally, although the regulations have been tightened by the above changes, the option to reduce the tax burden on products, services and licences covered by patent rights is still clearly beneficial. With this in mind, we are pleased to note that the basic principles governing what patented products, services and royalties can contribute to income eligible for the scheme remain largely unchanged.
Contact us for further advice
If you wish to investigate whether an existing patent, or a new patent application, could make income from a product or service eligible for the patent box, please feel free to contact Doug Ealey or a member of the D Young & Co patent group; and we can discuss how your business might benefit from the reduced tax of the patent box.