The patent box offers a significant and ongoing tax break to businesses involved in innovation. Currently very few high-tech firms and companies which develop and use patents in their line of business use patent boxes because of the complexity surrounding the scheme.
In this article, the Smart Team explains in the plainest-possible English what the patent box is and whether it’s applicable to you and your business.
What is a patent?
A patent is granted by the government via the Intellectual Property Office (IPO) to an inventor. The patent stops anyone else from making, using, or selling the invention without the permission of the inventor. If a breach occurs, the inventor can take legal action. A patent is granted for a specific period of time after which others can make, use, or sell the invention without the need for permission.
A patent must be for something new which:
- has never been made public before anywhere in the world,
- involves an inventive step that, to an expert in the field the patent applies to, would not be obvious, and
- is capable of being made use of in an industry application or process.
What benefits does a patent box bring?
The patent box is a tax break offering in addition to R&D tax credits, covered in an earlier post by the Smart Team.
R&D tax credits are there to assist companies involved in the research and development of products. The patent box is designed to incentive their commercial exploitation.
Profits your company makes on patent box activities are taxed at 10%, less than the current corporation tax rate of 19%. Patent box activities are classed as those activities over which your company holds qualifying IP rights – more on that later.
“Sounds great. Where do I sign up?”
Your company must elect into the patent box regime. You can only use the patent box if your company is liable for Corporation Tax and your company makes money from exploiting patented inventions.
You can sign up to the patent box in writing to HMRC so for profits you’ve earned in a particular accounting period within two years of the end of that particular period.
What is a qualifying IP right?
Your company must hold or have the exclusive licence to a qualifying IP right to benefit from patent box.
Qualifying IP rights start from:
- patents granted by the IPO or European Patent Office
- patent rights granted by the relevant authorities in Austria, Bulgaria, the Czech Republic, Denmark, Estonia, Finland, Germany, Hungary, Poland, Portugal, Romania, Slovakia and Sweden
- supplementary protection certificates issued by the IPO or European Patent Office
- UK and European Community Plant Variety rights
- defined UK and European medicine or veterinarial products which have marketing authorisations and marketing or data protection
- products in plant protection with data protection benefits.
You now must meet the development condition, namely:
- your company must have created the invention
- your company must have made a significant contribution to the invention’s creation (and that can include developing ways that the invention is used or applied)
- your company carried out significant activity in the development of the invention or any item or process which uses the invention
If your company passes the development test, it will normally also automatically pass the active ownership test. If not, you will have to demonstrate that you are marketing the invention and doing everything you can to commercialise the invention.
From 1st April 2016, you will only be able to enter into your patent box inventions that have been derived from R&D activities within your (group of) companies.
Smart Team tip – if you’re selling your company, the patent box advantages may not be transferable to the new company. Take advice from the Smart Team and your solicitors in these circumstances.
Smart Team tip – if your company is one of a group of companies, the company you’re signing up to the patent box may still be eligible if it was another group company which performed the qualifying development.
Qualified IP rights also refer to licensed-in patents – that’s where a patent holder licences their inventions for others to develop. If your company has bought patents itself from inventors and essentially acts as a sales agent for the inventor, you must
- have the right to develop, exploit, and defends your rights,
- own one or more rights exclusively (no other person or company, including the inventor, can develop or exploit the invention and you can mount a legal defence against it)
- own the exclusive rights in at least one country (it has to be the whole country – e.g. USA – and not part of the country – e.g. California).
Working out your tax saving with the patent box
Income that qualifies for tax relief will be on the sales receipts from patented items, items that incorporate a patent, the licenced patent rights you own, and from money received by infringements of your rights.
There are two parts involved in working out your relief if you are claiming for the 2016 tax year onwards. From 1st July 2016, you will need to record expenditure which does and does not qualify for the patent box. Prior to 2016, only the first part of the formula applies.
The formula is RP × FY% × ((MR – PBR) ÷ MR), where:
- RP is the profits that have results out of your patent box trade
- FY is the relief given for that year (2013-2014 at 60%, 2014-2015 at 70%, 2015-2016 at 80%, 2016-2017 at 90%, and 100% from 2017 and beyond)
- MR is the main rate of corporation tax (currently 19%)
- PBR is the reduced 10% rate
For the second part of the calculation, there are five things to consider to work out the “nexus” percentage:
- D – your company’s direct research and development (R&D) expenditure
- S – R&D your company has subcontracted out to a business with no connection to you or the group your business belongs to
- R – R&D your company has subcontracted out to a business with a connection to you or the group your business belongs to
- A – the cost you incur in acquiring any IP or licensing
- U – uplift to your qualifying costs, the lower of 30% of D+S or your non-qualifying R+A costs
The formula for this calculation is N = (D + S) x 1.3 / (D + S + A + R).
You then multiply your answer from the first part of the calculation to the second part and this is the amount of patent box relief you can claim.
Patent box rules first came in from 1st April 2013. Following international consultation, the rules were amended from 1st July 2016.
Companies with IP that had been in a patent box prior to 1st July 2016 can choose to be taxed at the old rates until the end of June 2021.
If your company had filed for a patent before 1st July 2016 but were not granted the patent until after this date, you are allowed to elect that patent into the previous scheme.
All patents that you applied for on or after 1st July 2016 or which was created before that date must use the new scheme and keep track of all patent-related R%D.
All patents, regardless of whenever the patent was granted, will use the nexus fraction from 1st July 2021 meaning you’ll have to keep records on any spending related to extant or future patents from 1st July 2016.
Complicated – but worth it
If you elect your IP and patents into a patent box, your company could reduce its corporation tax bills by a substantial amount every year. It is complicated but Smart Team is here to help. Please call us on 01202 577500 or email us at [email protected].