The beginning of July saw the first major change to the Patent Box rules since the introduction of the ‘modified nexus approach’ on 1st July 2016.
There was no major fanfare from HMRC concerning the change so it might have been easy to miss it but the change is significant and affects all companies electing into the scheme, both old and new entrants.
The Change – end of grandfathering provisions and introduction of mandatory streaming for all
Whilst there is no change to the Patent Box qualification criteria, there is a major change to the treatment of IP income and taxable profit under the rules. Whereas a claimant company that had elected into the Patent Box before 30 June 2016 had the option of following the new streaming approach or the old formulaic approach whereby a percentage of patented turnover to total turnover was used to apportion profits (the grandfathering provisions), as from 1 July 2021 all companies electing into the scheme (new or previously elected in) must follow the modified nexus and streaming approach whereby income is streamed into specific IP income and non-IP income streams.
The change in rules is significant and requires a company to track and trace IP income so that it can be married up to the most appropriate IP right, product or product family to assist with streaming. This is not always easy especially in cases of mixed income and some companies will need help in marrying up IP income into the correct IP income streams.
Modified nexus approach
In addition, all companies claiming patent box tax relief are subject to the modified nexus approach as from 1 July 2021. These rules require a claimant company to track R&D expenditure and acquisition costs to an IP right, product or product family and then calculate a R&D fraction, for each IP right, product or product family. The R&D fraction is then applied to each sub-stream to obtain the nexus profit for each sub-stream.
The modified nexus approach favours companies that can demonstrate a link or ‘nexus’ between R&D activity of the claimant company and the tax benefit that derives from the Patent Box. This change means that companies must consider the relationship between the owner of the IP and the entity conducting R&D activity if they want to maximise the tax savings through the Patent Box.
For example, a company owning an IP right and conducting R&D in-house is likely to fare better in terms of Patent Box tax savings than one group company owning an IP right and another group company member, located overseas, carrying out R&D activity. The modified nexus approach means that a review of a company’s IP portfolio is essential with consideration necessary to determine whether changes ought to be affected to the way that IP is owned and structured and R&D carried out. Again, some companies may need help and advice with this so that tax benefits are maximised.
The future
The Patent Box has received a lacklustre response from companies since it started in 2013 and one wonders whether compulsory streaming will be embraced by companies, particularly old entrants to the scheme, or even whether compulsory streaming and the modified nexus approach could be enough to kill off the Patent Box scheme for good.
Our view is that the Patent Box is likely to be more important to UK companies in the next few years than previously and that they will not be thwarted by the streaming requirements. The reason for this is the rise in corporation tax rate from 1 April 2023.
Whilst there is no doubt that more effort will be required in the future to track IP profits and trace them to relevant qualifying IP rights to enable streaming than if the formulaic approach was followed, Patent Box tax relief is likely to be more attractive once the main rate of corporation tax is increased in 2023.
It is sometimes forgotten that the UK Patent Box offers significant corporation tax savings-put in place to complement R&D tax relief and promote innovation. A qualifying company owning a qualifying IP right and earning qualifying IP income will pay 10% corporation tax on IP profit rather than the main rate of corporation tax (currently 19%).
Relevant IP income is defined within the Patent Box legislation broadly. It includes sales income from qualifying IP rights, licence income and royalties, sales income from selling IP rights and damages/compensation. In addition, it covers any other income derived from exploitation of a qualifying IP right.
In so far as sales income from qualifying IP rights is concerned, it includes the sale of items covered by qualifying IP rights. Profits derived from sales income, generated nationally and worldwide, attracts the low rate of corporation tax payable- an attractive proposition indeed.
It should not be forgotten either what qualifies as a qualifying IP right for Patent Box purposes and how easy and accessible it can be to obtain such a right. A qualifying IP right includes a UK or a European patent. A UK patent can be obtained in less than two years and for under £10,000. The time is minimal, the cost not prohibitively excessive and the corporation tax savings for a qualifying company cannot be under-estimated.
The fairly low corporation tax saving (9% currently) and complexity in claiming the relief has previously been blamed for the low uptake in companies claiming Patent Box tax relief however with rising corporation tax rates, that will be no longer the case. In our view, mandatory streaming from 1 July 2021 will not be the death of the Patent Box and it will go on to thrive in the next few years. Perhaps then, the scheme will do what was originally intended and patenting and innovation will increase after all.
