UK expecting no changes to Patent Box regime

HMRC, the British tax authority, has no current intention of making changes to the UK’s Patent Box system. The Patent Box has been under investigation by the European Commission, but the UK is confident that the arrangement is consistent with international guidelines and therefore will not require further tweaking.

The Patent Box regime

The Patent Box regime is a patent protection system for firms, giving more benefits to firms with patented inventions. The regime allows firms to enjoy a lower tax rate (10%) for their corporate tax on profits earned after 1 April 2013 from the firms’ patented intellectual property. This rate will apply to profits made from royalties received from licensing patent rights, selling the patent, compensations for patent right infringement, or indirectly from products using the patent.

In order to be eligible for the Patent Box regime a firm must pay corporate tax and must make a patent that qualifies it for the regime. The firm must also own or exclusively license-in the patent and must have taken qualifying development on this; otherwise, a firm may also qualify when belonging to a group that owns the patent.

Patents eligible for the regime include patents granted by:

  • UK Intellectual Property Office
  • European Patent Office
  • The following countries inside the EEA: Austria, Bulgaria, Czech Republic, Denmark, Estonia, Finland, Germany, Hungary, Poland, Romania, Slovakia and Sweden.

Contest in the EU

Despite the UK’s confidence in the system, there were questions raised in the European Union as to the legal nature of the regime. Specifically, the regime may be in violation of EU Code of Conduct on harmful corporate taxation in two principles:

  • Economic substance. The UK’s Patent Box requires that patents developed abroad must have some form of domestic substance: they may either be improved in the UK or managed inside the UK’s jurisdiction in order to qualify a firm for the lower tax rate. The EU found that this was too vague and left open the option for firms to exploit the system.
  • Establishing a tax base. As described in the regime, the Patent Box does not directly follow the calculations of a tax base as instructed by the OECD and does not consider calculation on an accounting basis. Instead it uses complex formulas that may leave room to arbitrary interpretation and calculations[1].

Such scrutiny for the abidingness of the OECD’s Code of Conduct is rare and is likely to be the consequence of the OECD’s late action against BEPS.

Benefits of the Patent Box regime

Considering the confidence of HRMC that the Patent Box regime is here to stay, one should consider the potential benefits taxpayers can derive from it. The lower tax regime will apply to any profits made from the patent owned. This allows a firm to find some benefits when doing business abroad; for one, it applies to profits made abroad but taxed in the UK, and, in addition, the 10% rate will apply for profits from royalties received from firms abroad, including subsidiaries.

The benefits taxpayers will enjoy from this legislation point toward an interest of the British government in stimulating patent development and R&D investment. Simultaneously, however, the UK is fighting BEPS alongside other countries and must fulfil its part in international relations. For now, taxpayers must await clearance on the Patent Box regime and hopefully enjoy the lower tax rates if it’s approved.

[1] RP × FY% × ((MR - IPR) ÷ MR)

In the formula:

  • RP is the profits of a company's trade relevant to Patent Box
  • FY% is the appropriate percentage for each financial year
  • MR is the main rate of Corporation Tax
  • IPR is the reduced rate of 10 per cent
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