Patent Box – Imminent Changes01 Dec 2015
The Patent Box worked by enabling UK resident companies to apply a considerably lower 10% corporation tax rate to profits from qualifying patent (and Intellectual Property (IP)) rights. Since its introduction in 2013, Patent Box has delivered over £335 million worth of benefit to companies in the UK, and has been recognised as a key influencer of investment in the country.
With multinationals like GlaxoSmithKline relocating a large number of research projects to the UK just to benefit from the tax incentives, it is evident that the Patent Box has been particularly beneficial, not only in terms of international competition but also on a local level as more and more jobs are created.
However, the generous effects of the Patent Box have been short-lived, as the European Commission recently decided, after receiving complaints from other countries that the Patent Box had become harmful to tax competition, that the scheme had provided the UK with an unfair advantage over other EU members, and as a result, just two years on from its introduction, it has been announced that the scheme will cease to be operated in its current form.
As part of its Base Erosion and Profit Shifting project (BEPS) the OECD highlighted how preferential IP regimes effectively enabled multinationals to artificially move profits to a lower taxed jurisdiction simply by choosing to locate their IP in the jurisdiction that offered the best tax incentives.
An action plan introduced by the BEPS to counter such activities involves the requirement for ‘substantial activity’ to be undertaken, effectively restricting tax relief to only those who undertake the research and development expenditure required to develop the IP in the same country in which they expect to benefit. Broadly, there must be a geographic link between the income receiving the relief and the activity which generated that income in order to benefit from an IP regime.
In order to comply with this new requirement (formally known as the Nexus Principle), the Government intends to overhaul the Patent Box and has published a Consultation to seek input on their preferred approach to modifying the scheme in advance of 4th December 2015.
The proposed changes to the scheme will involve companies having to calculate the profits that will be eligible for the relief, and this will be done by using a Nexus Fraction. The fraction effectively offsets expenditure that has been incurred on subcontracted R&D against profits, thereby reducing the level of relief that the company can obtain.
In recognition of the fact that some UK residents may ultimately be responsible for income that is created by a third party, some non-qualifying expenditure may be included in the fraction but only up to a limit of 30%.
Without delving into the intricacies of the proposals and the fractions, it is clear that the changes to the scheme will be complex to implement as applying companies will need to collect more data, maintain more detailed and thorough records of expenditure, and potentially change development processes completely. Inevitably, compliance will come at a cost, and therefore a reduction in post tax profits for those who were previously elected into the scheme
The OECD has instructed all member states to close the doors on their current IP regimes before 30 June 2016, which means that any UK patents registered after this date will be subject to the rules of the new Patent Box regime which will apply the Nexus principle. However the old scheme will continue to exist until 30 June 2021 for those companies elected into the scheme before June next year, allowing the company to enjoy the current Patent Box rules whilst the conditions of the new rules (such as tracking expenditure) are phased in.
The Government has confirmed that it is keen to help companies acclimatise to the new rules during the transitional period, and as such will allow income from UK patents elected into the scheme before 30 June 2016 to benefit from the ‘old’ Patent Box rules up until June 2021
The benefits of Patent Box will remain after the changes as we would expect that UK resident companies whose R&D is based largely in the UK are likely to go unaffected and therefore will have continued access to the lower rate of corporation tax where eligible, however, this helping hand from the Government delivers an incentive for Companies who have considered or, are in the process of obtaining a Patent to take action sooner rather than later.
If you would like to hear more about the Patent Box, and how you might go about electing into the scheme before 30 June 2016 please contact us on 0113 827 2172.