The new "Patent Box" tax regime provides companies with the option of applying a reduced 10% corporation tax rate to the proportion of profits derived from the exploitation of patents granted by the UK Intellectual Property Office, the European Patent Office or certain other specified EEA countries ("Patents") (the regime also extends to other similar intellectual property rights but for the purpose of this article we will refer to Patents only).
Background information
The Patent Box enables companies to apply a lower rate of Corporation Tax to profits earned after 1 April 2013 from its patented inventions and certain other innovations. The relief is being phased in from 1 April 2013 and the lower rate of Corporation Tax to be applied will be 10 per cent.
Qualifying for the Patent Box regime
In order for a company (the "Company") to benefit from the Patent Box certain conditions must be met:
1. Patent ownership requirements The Company must be the owner or an exclusive licensee of the Patents
2. Development condition The Company, or subject to certain conditions another company in the Company's group, must have carried out "Qualifying Development" in respect of the Patents. (See box overleaf for a definition of Qualifying Development)
"Qualifying Development"
Qualifying Development" means either:
(i) creating, or significantly contributing to the creation of, the invention; or
(ii) performing a significant amount of activity for the purposes of developing the invention or any product or process incorporating the invention. Merely commercialising a fully developed product or process incorporating the invention will not be enough by itself.
3. Active Ownership condition In the event that the Company is part of a group of companies, the Company must meet the "Active Ownership" condition. The Active Ownership condition is met if either:
(i) the Company performs a significant amount of management activity in respect of the Patents, where "management activity" means formulating plans and making decisions in relation to the development or exploitation of the Patents; or
(ii) the Company has itself carried out Qualifying Development in respect of the Patents, rather than it having been carried out by another group company. The upshot of this condition is that if the Development Condition has only been met by virtue of a company within the Company's group having carried out the Qualifying Development, then in order for the Company to benefit from the regime it must be playing an active role in the management of the Patents.
Therefore, in certain circumstances an IP holding company within a group will be able to benefit from the regime.
Relevant IP income
The following categories of income are taken into account when calculating the profits which will benefit from the Patent Box regime:
1) Income from all sales of the patented item, or an item incorporating a patented item.
2) Licence fee and royalty income received under any agreement granting third parties: (a) a right in respect of the Patents; (b) any other right in respect of items or processes protected by the Patents; and/or (c) in the case an agreement granting rights alongside (a) or (b), any other right granted for the same purpose as those rights.
The income in the above two categories includes income from sales made, and licences granted, in territories outside of the protection of the Patents.
3) Income from the sale or disposal of the Patents.
4) Amounts received in respect of infringement, or alleged infringement, of the Patents - i.e. damages or settlement payments.
5) Other compensation paid in respect of items falling into category 1 or other lost relevant IP income. This, for example, would include damages from an overseas infringement claim in respect of items covered by the Patents.
Notional royalty
There is an additional way a company may benefit from the regime if it is using an invention which is covered by a Patent to generate income but such income does not fall within categories 1 or 2 above. For example, where a company uses a patented tool to produce the items it sells, or uses a patented process to provide a service to customers. In this event, the Company can claim the benefit of the regime in respect of an amount equivalent to the royalty the Company would expect to have pay if it needed a licence from a third party in order to exploit the Patent in such manner.
Example scenarios
Can the company in question benefit from the Patent Box in each of the scenarios overleaf and, if so, how?
Scenario 1
Company A is a member of a group of companies. Company A invents and subsequently patents a product, which it then markets.
1) Company A meets the Patent Ownership Requirements as it is the owner of the Patent covering the product.
2) Company A meets the Development Condition as, having created the invention, it will have carried out Qualifying Development in respect of the Patent.
3) As Company A is a member of a group of companies the Active Ownership Condition must be met but as Company A carried out the Qualifying Development itself this condition will be met automatically.
Company A will be able to benefit from the Patent Box in respect of income derived from the sales of the product as it will be Relevant IP Income (category 1).
Scenario 2
Company B invents and subsequently patents a process which it then uses to provide services to its customers.
As above, conditions for qualifying for the regime will be met but in this scenario the income received from customers in return for the service does not fall within the categories of Relevant IP Income. However, Company B will be able to benefit from the Patent Box regime by attributing a notional royalty in respect of the patented process.
Scenario 3
Company C invents and patents a product and then grants a non-exclusive licence to a third party permitting it to manufacture and sell the product.
As before, the conditions for qualification are met.
Company C will be able to benefit from the Patent Box in respect of income derived from the any licence fees and royalties received as they will be Relevant IP Income (category 2). Note that the licence that Company C grants does not need to be exclusive.
Scenario 4
Company D buys a Patent from a third party and then sells items incorporating the patented invention.
1) Company D meets the Patent Ownership Requirements as it is the owner of the Patent covering the product.
2) With respect to the Development Condition, Company D did not create the invention covered by the Patent. Therefore, in order to meet this condition Company D will need to have performed a significant amount of activity for the purpose of developing the product which incorporates the invention.
If Company D meets the Development Condition it can benefit from the Patent Box and income received from sales of the products will be Relevant IP Income (category 1).
Scenario 5
Company E buys a Patent covering a product from a third party and then grants a licence to another third party permitting it to manufacture and sell the product.
1) Company E meets the Patent Ownership Requirements as it is the owner of the Patent covering the product.
2) Company E does not meet the Development Condition so will not be able to benefit from the Patent Box (in respect of the royalties received under the Patent licence, or otherwise).
Scenario 6
Company F and Company G are members of a group of companies. Company F creates an invention. In accordance with the group's IP strategy, the rights to the invention are assigned to Company G which obtains a Patent in respect of it.
Company G then grants Company F an exclusive licence to exploit the Patent. Company F sell products covered by the Patent.
Company F:
1) Company F meets the Patent Ownership Requirements as it is an exclusive licensee under the Patent.
2) Company F meets the Development Condition as it created the invention.
3) Company F automatically meets the Active Ownership Condition as it created the invention itself.
Income received by Company F from product sales will be Relevant IP Income (category 1) hence Company F can benefit from the Patent Box.
Company G:
1) Company G meets the Patent Ownership requirements as it is the owner of the Patent.
2) Company G meets the Development Condition as, although it did not carry out Qualifying Development itself, Company F did whilst they were part of the same group.
3) As Company G did not create the invention itself, in order to meet the Active Ownership Condition it needs to be performing a significant amount of management activity in respect of the Patent (see above).
Provided that the Active Ownership Condition is met the royalty Company G receives from Company F under the licence with be Relevant IP Income (category 2) and Company G can benefit from the Patent Box. This is an example of how an IP holding company can benefit from the regime provided that it can satisfy the Active Ownership Condition.
Mixed sources of income
A further issue for companies when putting the regime into practice is what happens if there are mixed sources of income. For example, what if: (a) items which give rise to Relevant IP Income and items which do not are sold together as a single unit for a single price; or (b) income is derived under a single agreement which covers the sale of items or the grant of rights which would give rise to Relevant IP Income and others which do not?
With respect to items the first issue may be for the company to establish that the item covered by the Patent is 'incorporated' into the larger item which is being sold. HMRC's view is that incorporation means that the item is physically part of the larger item and is intended to be for its operating life (provided that it has not been incorporated merely to bring the regime into play). HMRC gives the example of a conservatory which contains a patented hinge as being a larger item which incorporates a patented item, and hence all income from the sale of that conservatory would be Relevant IP Income.
HMRC's example of a single unit which would contain items giving rise to Relevant IP Income and items which do not, is a home entertainment system where the TV is protected by Patents but the blu-ray player and surround sound system are not. In this case, the sale proceeds of the home entertainment system must be apportioned between Relevant IP Income and nonqualifying income on a 'just and reasonable basis'. The same type of apportionment would be required if the sales price for the conservatory mentioned above included installation.
It is this apportionment which may prove difficult for companies and where specialist accountancy input is likely to be required.
More information
For more information about the Patent Box regime see the HMRC's guide at http://www.hmrc.gov.uk/ct/formsrates/ claims/patent-box.htm
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
