The UK Patent Box is a tax relief available to companies and is intended to encourage innovation. It can reduce a company’s corporation tax liability on relevant profits by up to 10%, so qualifying companies should get up to speed with it now, says Will Stirling.
Do you innovate? Does your company own patents, or are you using patents acquired under license from another company? Is your company profitable?
If the answer to these is yes, your business should be eligible for the Patent Box (PB), a form of tax relief that is being phased in from April 1.
To qualify, a business must make profits from exploiting patented inventions, and will either own or license-in the patents and will have further developed them, or products or processes that incorporate them.
Worth the effort
TM found little evidence of a stampede of companies joining the PB regime. But tax professionals are urging companies to take notice.
“The Patent Box regime promises to be as generous at the established R&D Tax Relief scheme, which pumped £1.1bn back into British industry in 2010/11 as a reward for innovating,” says Barrie Dowsett, managing director at tax consultants Myriad Associates, which specialises in making R&D tax relief claims.
The core rationale of the PB is to stimulate companies to invent and patent more products. But will this work in practice?
If a company can attribute a good chunk of its profits to qualifying rights, and the part of its business where those rights are active is profitable, the savings are handsome – more than enough to offset the cost of filing patents.
“With patents typically costing £5k to £10k to file a ‘narrow’ patent in the UK and costs in excess of £10k for a European Patent, the PB incentive will help support an SME’s financial justification to invest in patents in order to protect their IP,” says Mr Dowsett.
Losses and streaming
The catch with the PB is it limits the use of losses from qualifying rights. If the part of a company that uses these patents is lossmaking, there’s no benefit in the PB. “If a group of companies – with some profitable, others not – was looking to move into profit, you might leave it until the loss-making part was in profit and then opt in to the PB regime,” says DLA Piper’s Thompson.
“Then you might find losses prior to the opt-in could be used to shelter profits and the mainstream rate. Once operations are in profit, the lower rate of corporation tax under PB becomes beneficial.”
The Key Facts
- The PB will provide a reduced corporation tax rate of 10% for companies eligible for UK corporation tax
- The tax relief will be phased in from April 1 2013 over five years. By the 2017/18 tax year the patent box will be 100% effective
- The regime will apply to UK, European Patent Convention and corresponding national rights in the European Economic Area and to other rights– termed qualifying rights (see HMRC website: www.hmrc.gov.uk)
- Revenues from worldwide royalties, license fees, sales of products incorporating patented technology will all be allowable
- Tax relief can be claimed retrospectively. The regime allows profits arising up to six years before the grant of a Qualifying Right (e.g. in the period between application for and grant of a patent) to benefit from the 10% rate.
How it works
- Confirm your company has qualifying rights
- Calculate what proportion of the gross income is attributable to the patented items
- Apply this percentage to the profits (after applying certain adjustments to exclude enhanced R&D tax credit relief and the effects of financing arrangements)
- Deduct the return on routine activities (the profit the company might make applying a simple mark-up to its overheads). Remove the effect of any brand value (a simple 25% attribution can be applied for small claims)
- The resulting relevant profit is subject to 10% corporation tax.
In 2013/14 a company records £25,000,000 turnover and approximately half (£12,500,000) qualifies for the Patent Box i.e. sales derived from patented inventions and sales of products incorporating these qualifying rights.
After adjustments the trade profit from this activity is £1,000,000. Routine expenses (staff costs, raw materials etc) amount to £6,000,000, of which 50% is deemed attributable to the relevant profits. Apply a notional 10% mark up so that the profit attributable to the routine activities is £300,000.
This leaves £600,000 attributable to relevant activities. Deducting a further 25% for the brand profit leaves £450,000. In this year, the corporation tax rate is 23% so total corporation tax liability would normally be £230,000.
In the PB regime, in the first year 60% of the £450,000 is eligible at the 10% rate, so £270,000 is taxed at £27,000 and the balance at the normal 23% rate. The total saving from the PB is 13% of £270,000 = £35,100 (23% of £270,000 minus 10% of £270,000). In subsequent years, an additional 10% of tax relief on qualifying profits will apply per year. So by 2017/18, this company would get the 10% rate on all £450,000 of qualifying profit, saving £49,500 (by 2017 corporation tax will be 21%).
It sounds good, but companies are regularly put off applying for R&D tax relief claims because the bureaucracy involved, including expensive accountants’ time, eats into the benefit received.
“The Government has tried hard to keep the PB calculation simple enough to be carried out with the minimum of professional help,” says David Thompson, a partner at DLA Piper, who adds: “if you are already claiming the R&D tax credit there are some additional issues to address here. But it is worth the effort.”
The way to optimise this is to stream companies by qualifying right and profitability. “The secret to optimising the Patent Box incentive is to adopt the ‘streaming’ option as typically sales of patented products or services attract higher profit margins,” says Myriad Associates’ Dowsett.
“You might think about isolating the profitable IP and related trade in another company, so that you are a) maximising the benefit of the reduced rate without prejudicing the utilisation losses of non-PB businesses other items, and b) making it easier to demonstrate to the Inland Revenue where these profits are coming from,” adds Thompson.
Who is using the Patent Box?
One listed engineering company in the south of England said their tax structure was too complicated to opt-in to the Patent Box, although they admitted that shareholders had been eager for them to assess it because of the potential effect on profits and dividends.
At the other end of the spectrum, some SMEs assume that the PB is only designed to benefit big companies. Will Butler-Adams, MD of London-based Brompton Bicycle was among them but further investigation and a visit from Inland Revenue proved him wrong.
“It’s completely relevant to my business even though for competitive reasons we try to limit the number of patents we file to a minimum,” he says. “It seems a straightforward process and we have opted in. Based on our patent pipeline and turnover, it could be worth up to £100,000. That is £100k of free money,” he adds.