Johnston Carmichael: What’s in the Patent Box?

Posted by Sandie Mowat, Big4.com Guest Blogger

In amongst all the changes that the Government has implemented which, it hopes, will enhance the UK’s position as an attractive place to do business, the introduction of the patent box is possibly the single most important for manufacturing technology and life science businesses. This new initiative is meant to encourage businesses to develop and exploit their new technologies by offering them a lower tax rate. It is a welcome development which should help UK firms in competing with their European counterparts, already benefitting from similar incentives.

From 1 April 2013, companies that develop and exploit their own patents, or ones for which they have an exclusive licence, will be able to gradually reduce the rate of corporation tax on the profits generated from these to just 10 per cent. This is, however, a phased tax break with its full benefit only becoming available from 2017.

It may sound simple, but it has taken years to design a system that enables companies to calculate those profits reliably and prevent them from artificially manipulating their results to exploit the regime. While there is still some fine-tuning to be done, the draft legislation has now been published which forms the meat of this year’s Finance Bill (along with other reforms that are currently in progress).

A detailed explanation of the new rules can prove to be very complex so I would suggest that focusing on the top-line of ultimately paying just 10 per cent tax from any patent-related profits is the simple and least stressful way of interpreting them.

The legislation applies to patents granted by the UK Intellectual Property Office (UKIPO); patents that UKIPO would have granted but for a prohibition on publication on the grounds of national security or public safety; patents granted by the European Patent Office and any similar right that HMRC specifies by order.

It’s also important to be aware of the types of income, subject to anti-avoidance rules, that will qualify for patent box relief. These include licence fees; sales of products that are (or contain) patented items; sales of the patents themselves and any notional royalties from the exploitation of qualifying patents in some other way.

Brands, know how, design rights, copyright or trade secrets will not qualify and there may have to be an adjustment to exclude profits derived from these from the patent box. There will also be an adjustment to exclude a 10 per cent mark-up on basic costs such as labour and premises costs (but excluding research costs). What’s left will be taxed at 10 per cent.

A number of years may lapse between applying for a patent and its grant. The draft legislation therefore allows the company to recognise patent box profits arising once the application is made and for up to six years before the patent is finally granted.

Originally, this incentive was only going to apply to patents first exploited from 2011, however, following consultation it will now apply to older patents as well, a significant benefit to those companies which can utilise this initiative.

Interested companies should get their house in order now in preparation for next year’s implementation of the patent box. Firstly, as it will only apply to companies, now might be the time to incorporate a growing technology or manufacturing business. Existing companies need to review their accounting procedures and patent-related decision making processes to make sure they get the best out of the regime and ensure they can produce the information necessary to support their claims. Groups may even consider moving high profit patents into special purpose subsidiaries.

This new initiative, combined with the Government’s extension of research and development (R&D) tax relief last year, will make a positive impact in the important technology and life sciences sectors.

The challenge now is for more firms to grasp these opportunities. At present we have a very generous tax incentive through R&D relief yet only a fraction of Scottish companies are applying for it. Many businesses are not identifying what actually qualifies for R&D and we’ve seen an often inaccurate perception amongst some SMEs that they do not qualify and that it is not financially viable to make a claim. As a result they are losing tax relief. We’ve secured £23m in R&D tax savings just amongst our own client base with no rejected claims from HMRC so there is surely further scope for more firms to benefit.

With both R&D relief and the forthcoming patent box it’s important that companies get some expert advice or they could miss out. Of course, as with so many of the tax reforms currently under way, the devil is in the detail and the Government is under pressure to simplify its proposals before they are finalised. In the meantime the patent box is a welcome development which should give many companies a much needed boost in these challenging times.

Written by Simon Burton, Tax Director at Johnston Carmichael.