Making connections

Changes are coming to the UK Patent Box to meet new international standards

The UK Patent Box was introduced to give companies a corporation tax break on profits earned after April 2013 from patented inventions. The base level of 20 percent was cut in half to 10 percent on all profits arising from inventions protected by UK and European patents, including those that are exclusively licensed.

To date, the UK government says 639 companies have used the Patent Box to receive £335 million in tax breaks. But this regime came under fire from the UK’s allies, most notably Germany, for encouraging artificial profit shifting.

The Organisation for Economic Co-operation and Development’s (OECD) Base Erosion and Profit Shifting project took a keen interest in preferential intellectual property regimes and recommended amendments that would harmonise systems around world and prevent abuses.

Crucially, the OECD proposed adoption of the nexus approach, which would limit Patent Box tax breaks to income directly connected to research and development (R&D) activities. The UK launched a consultation on 22 October following the OECD’s recommendation, seeking comments on how the nexus approach should work in practice.

Colin Hailey, chair of the UK BioIndustry Association’s (BIA) finance and tax advisory committee, and partner at Confluence Tax, which worked with the BIA to develop a briefing paper to explain the government’s proposed approach, says the OECD’s investigation into preferential IP regimes stemmed from reports of multinational companies plowing profits into jurisdictions where they had to pay little or no corporation tax.

“There was a lot of talk about large multinationals stuffing profits into jurisdictions where they paid little or no corporation tax. The OECD took this on as a project and decided to do something about what it called harmful tax practices, and this included preferential IP regimes.”

Before patent owners should consider the impact of the change, they must remember that the Patent Box only applies to those with profits on which corporation tax in the UK must be paid.

Hailey says: “Of course, the Patent Box will only continue to be relevant for companies that have tax liabilities, or taxable profits. So a biotechnology start-up that is yet to break even sees no benefits from the Patent Box—it’s irrelevant because those sorts of patent owners are not liable for any corporation tax. But for the large pharmaceutical companies based in the UK, the Patent Box is hugely attractive.”

The crux of the changes is that any income put through the Patent Box must be linked to R&D expenses. “So a UK-based company that does all of its R&D in the UK and earns all of its profits from patents in the UK in the future has a complete nexus between income and expenditure. Under the revised Patent Box, that company should be able to claim the lower rate of corporation tax.”

“On the other hand, a UK company with an R&D subsidiary in the US, where all of the R&D work is done, but all of the income from that work is earned in the UK, cannot benefit because it won’t be able to show that connection between the expenditure and the income. That broad concept is going to be applied in all OECD member countries.”

Patent owners wondering exactly how an ‘R&D expense’ will be defined in the UK’s revised Patent Box can look to the consultation with confidence. Hailey says: “There is the existing R&D tax credit regime. The consultation is proposing using the same definitions under the Patent Box, so what is considered to be R&D under that regime will be R&D under the Patent Box. Companies that are familiar with the R&D system won’t see the proposed changes too negatively. The next step is understanding how to actually track those R&D expenses and link them to the income that they actually earn.”

He explains: “In an industry like the life sciences, there could be 10 or 15 years between incurring R&D expenses and earning a profit from any patented product. And R&D expenses are never tracked by patent, because it’s never clear which innovations are going to be protected in the future.”

“It becomes quite difficult to manage. But the basic concept of nexus has to be applied and the idea is that patent owners will do the best they can. The consultation is asking how much all of that can be approximated so they can approach something close to nexus, the bottom line being that you cannot claim the tax break if you incur the expense in one jurisdiction and earn the income in another.”

The UK consultation on the changes runs until 4 December. Updated guidance on how the new Patent Box will work are expected before the end of year, with the OECD-compliant regime coming into force on 1 July 2016, although this is subject to a grandfather period that will allow patent owners to use the current system until 30 June 2021.

Given the swiftness with which these changes to the Patent Box are being introduced, Arun Birla, Matthew Poxon and Paul Oumade-Singh, lawyers at Paul Hastings, suggest that the time is now for patent owners considering the UK as a destination for their rights to make their moves.

Birla, Poxon and Oumade-Singh wrote in a client update published on 24 November: “There are certain anti-avoidance rules and companies wishing to transfer any patents into the UK from a related party, either through acquisition or licensing, must do so before 31 December 2015 in order to benefit from the current regime until 2021. It is therefore critical that companies assess their current global patent portfolio and act quickly to transfer any valuable patents to the UK.”

They added: “Note that the 31 December deadline is only relevant to patents that are being transferred into the UK from related parties. The current regime is still open to new entrants (ie, those developing new intellectual property or not currently opted into the regime) until 30 June 2016. These new entrants will also benefit from the grandfathering provisions.”

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