Putting tax back in its box

If you or your company hold a patent on a scientific innovation then Rhian Osborne thinks the Patent Box scheme could save on your tax bill… In April 2013 the UK Government rolled out new legislation enabling companies to opt into a scheme in order to apply a lower rate of tax to profits derived from patented inventions and certain other medicinal or botanical innovations. Through the ‘Patent Box’ regime, companies that have patented products, such as new scientific products, can now reduce the corporation tax payable in relation to profits generated from the patented product from the main rate of 23% currently applied in the UK to 10%. The Patent Box will be phased in over four financial years initially applying to 60% of the relevant profits and increasing to 100% in 2017. The scheme has been introduced with the aim of incentivising companies developing new intellectual property (IP) rights in the UK to keep their business here and therefore boost the economy. The reduced tax rate available under the scheme is not automatically applied to the relevant profits of a company; the patent box regime is optional so in order to benefit from the reduced tax rate qualifying companies must elect into it. While this new regime provides potentially significant tax savings for companies that have patented products or parts of products within their portfolios, a specific protocol is required to ensure companies are maximising the benefit of the new relief. Income eligible for tax relief To qualify for the application of the reduced rate of income tax, income must be derived in one or more of the following ways:

• Sales income arising in respect of:
  • eligible patented items;
  • non-patented products that incorporate an eligible patented item (or are designed to incorporate an eligible patented item so long as the non-patented item is sold together with the eligible patented item as a single unit and for a single price); and
  • certain other products that are wholly or mainly designed to be incorporated into the two types of items referred to above (for example, bespoke spare parts).
  • Licence fees and royalties received pursuant to licences granted under eligible patents.
  • Proceeds from the sale of eligible patents.
  • Monies recovered following infringement proceedings in relation to the eligible patent.
  • Damages, insurance proceeds and other compensation relating to eligible patents.
  • Income derived from the sale of services or goods which are themselves not the subject of a patent but which are produced using a patented process, referred to as "IP-derived income".

Worldwide income subject to corporation tax in the UK from a product or process covered by, or incorporating, an eligible patent qualifies for tax relief. A particularly attractive feature of the patent box is that it extends to the entire income derived from the sale of goods incorporating an item/part covered by an eligible patent, irrespective of the value of the patented item/part as compared to the overall value of the product. However, it is important to note that this is subject to anti-avoidance rules aimed at preventing taxpayers from abusing the patent box regime by the inclusion of patented items into products in order to access patent box benefits when there is no significant commercial reason for their inclusion. Furthermore, although the concept of "incorporation" has no statutory definition, it is HMRC's view that, in order for an item to be treated as incorporated, it must physically form part of the larger item and intended to be so throughout its operating life. Qualification requirements Businesses can only benefit from the Patent Box tax relief if they are liable to Corporation Tax and make a profit from exploiting patented inventions. If your business is not currently incorporated you may wish to consider this in order to take advantage of the regime. The UK patent box will apply only to certain types of patents, together with specified rights the government considers are akin to patent rights. These include patents granted by:

• The UK Intellectual Property Office (UKIPO).
• The European Patent Office (EPO).
• Specified EEA countries, namely Austria, Bulgaria, the Czech Republic, Denmark, Estonia, Finland, Germany, Hungary, Poland, Portugal, Romania, Slovakia or Sweden.

The company or another group company must also have undertaken qualifying development for the patent by making a significant contribution to either:

• the creation or development of the patented invention
• a product incorporating the patented invention

“Developing” an invention includes such things as coming up with the initial idea for the product, contributing to the application of the product or novel methods of use. So, simply acquiring rights to a patented product would not be sufficient to satisfy the development condition. If a company acquires a company that satisfied the patent box requirements, that company is able to benefit from the reduced rate of tax in relation to the patented product as long as that company continues to develop the patented product for a minimum period of 12 months following the acquisition. Another key requirement to benefit from the patent box regime is that a company must either own or have an exclusive licence of an eligible patent. A qualifying licence must:

• Be granted by the person that holds the eligible patent or an exclusive licence in respect of that eligible patent (that is, an exclusive licensee could grant an exclusive sub-licence).
• Confer on the licensee (or on persons authorised by the licensee) one or more rights to the exclusion of all other persons (including the licensor). Such rights need to be commercially effective at excluding competitors operating in the same market from exploiting the patented invention.
• Confer on the licensee exclusivity throughout at least an entire national territory. "Territory" is not defined in the legislation. However, the licence cannot be granted for part of a country only (as opposed to the whole country). A licence may grant the same rights under the same patent to more than one entity in the same territory and each such licensee may qualify for the patent box, provided that each licence is exclusive to a particular market. For example, a patent covering a process is granted in the UK. The patent owner grants an exclusive licence under that patent to a business that will use that patent for agricultural purposes in the UK. A second licence is granted to another business to use the patented process for medical purposes, also in the UK. Given that the licensees' exclusive rights extend to different markets, such licensees will be treated as having different rights under the patent box and so both may benefit from the patent box, even though both have the rights to use the relevant patent in the same territory.
• Give the licensee the right to bring proceedings in respect of any infringement of the licensed (eligible) patent, or to receive the whole, or the greater part, of any damages awarded in respect of any such infringement.

Companies should pay careful attention when drafting future licences in order to ensure that the licence is patent box compliant. Similarly, it would be beneficial for licensors of patented products to review existing licences which will be in operation moving forward to take a view as to whether it would be worthwhile amending the contract to make it compliant. If they do not, licensees should consider whether it is possible to renegotiate their licences to make them exclusive. Similarly, group companies should review their arrangements and, if it is commercially viable, ensure that any intra-group licences are exclusive licences. However, companies must ensure that their activities do not fall foul of anti-avoidance legislation and take care not to insert exclusivity provisions with no commercial benefit or justification into licences simply to benefit from the regime. Opting into the scheme The regime applies to accounting periods beginning on or after 1 April 2013. If the company qualifies for the regime, it may elect (in writing) to pay a corporation tax rate of 10% on its "relevant IP profits" of a trade. To elect, the company must give notice on or before the last day on which the company can amend its tax return for that accounting period. The election has effect for each trade that the company carries on and for the accounting period specified in the election and all subsequent accounting periods of the company. Maximising the benefits It is advisable to review your IP portfolio to determine whether changes could be made to the way the IP is managed in order to gain the maximum benefits from the patent box regime. For example, businesses may consider obtaining a patent in respect of smaller innovative components of a larger product manufactured by that business, so that the sales income derived from sales of the end product fall within the patent box. Impact on groups It is expected that where the licensor and the licensee are in the same group, both parties may have an interest in ensuring that the licence meets the conditions required by the patent box so that a credible patent box claim can be established, allowing the group to, on an overall basis, benefit from the advantages that the patent box offers. Pricing A patent owner or head-licensor may introduce a higher royalty charge when granting a patent box-compliant licences to reflect the fact that the licensee (or sub-licensee) is subject to corporation tax at 10% (once the patent box is fully in force). In this way, the patent owner or head licensor may share in the benefit of the patent box (in addition to any benefit it derives from the fact that its licence fees and royalties may also be subject to UK corporation tax at 10%). Although having a patent box-compliant licence may result in a licensee being willing to pay more for the licence, the patent owner will still need to carefully consider whether he wants to give the licensee the augmented rights needed to qualify for the patent box scheme, perhaps most importantly having to grant the licence exclusive country wide rights in relation to the patented product. Timing It is not yet clear whether HMRC will offer advance clearance on whether the terms of a licence meet the exclusivity (or other) tests. If clearances are sought, this may have an effect on the timing of successful licence negotiations. For example, appropriate clearance could be a condition precedent to the completion of a licence.   While it is still early days for this new regime, it is essential that companies are made aware of the tax relief available on the profits generated from exploiting patented inventions and take time to consider opting into the patent box regime in order to take advantage of the tax savings available. Companies should assess their IP portfolio and, as long as the activities undertaken in order to qualify are commercially sound, revise or establish their IP strategy to ensure they qualify for this tax relief – it is essentially money for nothing, after all. This article provides basic information. The requirements to qualify and maximise from this tax relief are complex. It is recommended that you consult a specialist lawyer and an accountant who can advise you on if/when to opt in to the scheme; whether eligibility criteria are met, including whether existing patents qualify for the Patent Box; and whether to make any modifications to existing intellectual property prosecution strategies. Author Rhian Osborne is a director of corporate and commercial law firm Greenaway Scott. Contact commercial@greenawayscott.com www.greenawayscott.com