Authors: Virginia Mariscal-Rios and Will Sweeney

Qualifying companies can elect for a reduced effective rate of corporation tax of 10% to apply to the profits generated from the relevant IP, which represents a significant saving on the standard 25% corporation tax rate.

Who can benefit from Patent Box?

 You are a UK resident trading company, liable to corporation tax.

• You will need to own a qualifying IP right or hold an exclusive license over a qualifying IP right – this includes patents granted by the UK IPO, European PO or any of the following countries: Austria, Bulgaria, Czech Republic, Denmark, Estonia, Finland, Germany, Hungary, Poland, and Portugal
• Developing the patent:
  • If your company is a standalone company, it must have been involved in the development of the patented invention
  • If it is a member of a group, it must meet the development condition itself or undertake a significant amount of management activity in relation to the qualifying IP rights held
• In addition, although it is not a condition of the rules, you will need to make profits from the ‘patented’ IP to actually benefit from Patent Box (see details below).

A common issue for smaller businesses is that the patent might have been applied for in the name of the inventor, even though the patent is being exploited by the company. Patent Box requires that the company needs to have legal rights to exploit the patent.

What income qualifies for the Patent Box tax relief?

 Qualifying income for UK Patent Box must come from at least one of the following activities:

• Selling patented products, products incorporating the patented invention or bespoke spare parts
• Licensing out or selling patent rights
• Infringement income, damages, insurance or other compensation related to patent rights
• Using a patented process or tool to generate goods or service income (IP Derived Income).

How does the calculation work?

 A complex multi-step calculation is necessary to determine the amount available for patent box relief.  At high level, the five steps for calculating qualifying profits include:

 Identifying relevant IP profits using a ‘streaming’ methodology, which requires a just and reasonable apportionment of a company’s expenses.

1. Deducting a ‘routine profit’, which is a notional 10% return on certain operating expenses
2. Deducting profit derived from the company’s marketing assets/ brand
3. Multiplying each IP sub-stream by a relevant R&D fraction (between 0 and 1), which is designed to cap the benefit of the Patent Box where the company was not responsible for carrying out the research and development (R&D) to create the patent itself
4. The resulting figure is the amount eligible for the reduced 10% corporate tax rate.

Link between Patent Box and R&D tax relief

Both tax incentives are closely linked, as the Patent Box calculation is linked to the company’s cumulative R&D expenditure in creating the relevant qualifying IP right/patent.

While having or applying for a patent is a good sign that a company has undertaken R&D, HMRC does not currently require a company to apply for patent protection over the outcome of the R&D in order to be able to claim R&D tax relief. Instead, companies must demonstrate they meet the specific R&D qualifying criteria. It is also worth noting that it is not necessary for the R&D expenditure to be included in an R&D tax relief claim first for this to be included in the R&D fraction for a Patent Box election, but the company will need to show that the patent development costs would have met the R&D rules.

Historical R&D expenditure incurred on the development of a qualifying IP right must therefore be tracked and traced in order to calculate the relevant IP profits for a Patent Box election. To avoid having to re-prepare your R&D claim, we strongly recommend tracking your R&D costs from 1 July 2016 and monitor the link to a specific IP right going forward.

When should I elect into the patent box regime?

• Companies must elect into the Patent Box, specifying the first accounting period for which you wish the Patent Box regime to apply. Elections into the patent box must be made to HMRC by putting a statement in writing. This can be a letter to be sent to HMRC or included within your corporation tax return submission. Once elected in, the company remains within patent box until it puts in writing that it is choosing to elect out (but then it will be barred from re-entering the Patent Box regime for five years)
• It is not possible to benefit from this relief until a qualifying Intellectual Property (IP) right or patent has been granted. The company can elect into the benefits of the Patent Box while the patent is pending and the tax benefit will then be accrued and taken in the year of grant (relief can be given for the profits in relation to the qualifying IP rights up to six years prior to the grant of the patent). However, this election must be made within two years of the end of the accounting period that the income relates to, and so it is important that you do not wait until the Patent is granted to make the election as you may miss out on the benefit of some years
• Unlike R&D tax relief, Patent Box is a tax relief designed to reduce taxable profits and therefore, a loss-making company cannot claim or receive any immediate cash payment from HMRC. The calculations require income streams to be created for each patent, with a final ‘catch all’ non-IP stream incorporating all profits not related to a patent. If the calculations result in a loss-making company having a profitable patent stream or streams, then making a Patent Box claim will reduce the taxable profits in the patent stream, thus preserving tax losses in the ‘non-IP’ stream
• A Patent Box loss will be offset against any Patent Box profits of the same company, against Patent Box profits of group members then any remaining amounts will be carried forward and used to reduce the company’s future Patent Box profits. Any offset will limit the amounts available to be taxed at the lower rate
• Some loss-making companies will therefore find Patent Box is worthwhile but, as a rule of thumb, an election would be best made at a point in the business life cycle, where profits exist on products that are covered by the patents.

If you believe the Patent Box regime could be beneficial for your company, you should take into consideration the following steps before claiming relief:

• Track your patent-related income and expenditure (allocate costs to IP revenue streams)
• Maintain an up-to-date list of patents (both pending and granted)
• Keep records of any R&D spending related to your relevant IP
• Consider whether it is worthwhile making an election into the patent box regime for profits earned in a particular accounting period within two years of the end of that period.

How can we help?

The calculations and methodology involved in identifying specific revenue streams, assessing each IP right individually, looking at the R&D involved, and applying a complex HMRC formula are far from straightforward.

At Shaw Gibbs we can provide expert advice to help you decide when it is the right time to elect into the regime and guide you through the process of making a claim. If you would like to discuss further, please do feel free to get in touch with your usual Shaw Gibbs contact or arrange a call to discuss.