What does the Patent Box mean to your business? Relevant profits taxed at 10% and not 24% for starters. But is it for pharma alone, or all manufacturing companies? Carmen Aquerreta of Deloitte explains how to calculate the savings.
The draft legislation on the Patent Box was issued last week, together with a detailed technical note published by HMRC.
In a nutshell, it will allow the taxation of the relevant profits at 10%, as opposed to 24% in April 2013, and 23% in the future. Funnily enough, the word patent is hardly mentioned and the word box is not at all. Instead, a new world of expressions and acronyms comes into play.
Having said that, this should not be taken as a negative – the potential to use it is there, some key concepts have been clarified and most important, it is now clear this is not just a ‘pharma’ box! The Government has costed it at £950 million – a real incentive.
So, if it’s not just a ‘pharma box’, is it a ‘manufacturing’ box? Well, not too far from it actually, mainly for three reasons:
- Process patents are included, just as much as product patents;
- One single patent is enough to qualify a full product (including very complex items such as engines); and
- Spares, while not patented, are also included.
On top of this, the overall legislation is aiming at making the claim process relatively easy.
First of all, a company needs to be ‘inside the box’. For this, it needs to have ownership (legal or beneficial) of a patent or an exclusive right to use it, granted by the European Patent Office or the UK. The company or the group must have been involved in developing the patent or its market applications. And, if in a group, the company must be making the business decisions in relation to the exploitation of the patent. All this will be fulfilled by many companies in the manufacturing space, whether parented or not in the UK.
Now, once in the box we need to calculate the size of the profit. This is a process of five steps (the legislation calls it seven, but it is really five…):
Step 1 – Calculate your Total Gross Income (TGI), which is effectively the turnover adjusted for income from financial assets and sale of intangibles.
Step 2 – Calculate your Relevant Intellectual Property Income (RIPI). RIPI is made of the royalties that companies make by licensing their patents, the proceeds of the sale of patents, the payments for damages from the infringement of patents, and (this is the real deal) the income obtained through the sale of products that contain a patent (and spares). For a number of companies this will be a very significant part of their turnover, if not all!
If you don’t sell patented products, but rather unpatented products you produce through patented processes, RIPI may be zero, but there is a RIPI-equivalent: notional royalty. This is the royalty that another person would pay for the use of the company’s patent and would count as RIPI.
The ratio RIPI/TGI gives the company the qualifying percentage of its profit.
Step 3 – Apply the ratio to your taxable profit, adjusted (mainly) for the R&D super-deduction.
Step 4 – Deduct the routine profit element (the standard profit the company would make from its non-IP operations), through applying a 10% mark-up to a list of operational costs . After step 4 the company would have calculated the IP related profit. Getting near now…
Step 5 – Clean-up the brand associated element of the profit so the only profit left is the one related to the patents. Small claims (a number of smaller companies may have these) have an interesting shortcut in step 5: simply take 75% of the profit. Also in a B2B context, Step 5 is likely to be avoided if the company does not spend substantial amounts in marketing related activities. In the consumer business environment it will not be quite as simple and will require an analysis of the notional royalty associated with the brand of the company.
I said up-front I feel quite positive about this piece of legislation. Together with R&D it can make a difference to the technology make of this country. It may require some work to understand its real implications company by company. Still, I would encourage all companies to go through it and assess the impact. It is money you are entitled to.
Carmen Aquerreta is a tax partner and head of the Patent Box team at Deloitte