TAX RELIEFS FOR INNOVATIONPATENT BOX & RESEARCH & DEVELOPMENT TAX CREDITS REGIME

Summary of the regimes

Dan Brookes8 May 2013

Copyright © 11 April 2023 BDO LLP. All rights reserved.

INVENTORS CLUB

PATENT BOX

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THE BASICS OF THE NEW REGIME

• 10% tax rate on patent profits

• Applies to new and existing patents – granted by HMRC approved patent offices – UK, European and some EEA.

• From the effective date – income on or after 1 April 2013

• Split year treatment for 2013 year ends

• Phase in over a five year period (60%, 70%, 80%, 90%, 100%)

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PATENT BOXPhasing in the 10% rate

Financial Year 2013-14 2014-15

2015-16

2016-17

2017–18

% of reduced tax rate in force 60% 70% 80% 90% 100%

Main rate of CT (proposed) 23% 21% 20% 20% 20%

Small companies rate of CT 20% 20% 20% 20% 20%

Effective patent box tax rates:

Large companies: 15.2% 13.3% 12% 11% 10%

Small companies: 14% 13% 12% 11% 10%

* Assumes all sales qualify for patent box benefits

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THE BASICS OF THE NEW REGIME

Conditions and computation

• Must be a ‘qualifying company’

• Computation of income in the box = three stage process

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WHAT IS A QUALIFYING COMPANY?

• Must hold relevant IP

• Qualifying IP rights, or • Exclusive licence in respect of qualifying IP rights

• Qualifying IP right

• Patent granted by UK or European Patent Office (plus certain other patent offices)

• Must meet the “development criteria”

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INTRODUCTION TO PATENTS

IPO definition (paraphrase s1 Patent Act 1977)• Invention must be

New, include an inventive step

Be capable of being made or used in some kind of industry

• Invention must not be Scientific or mathematical discovery, theory or method

Literary, dramatic, musical or artistic work

Way of performing a mental act, playing a game or doing business

Presentation of information or some computer programmes

Animal or plant variety

Method of medical treatment or diagnosis

Against public policy or morality

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INTRODUCTION TO PATENTS

• Traditionally a form of IP protection granted for up to 20 years Maximise the breadth of the monopoly protection (‘broad claim’)

Subject to ‘opposition’ and challenge

• (i) scepticism about value for smaller companies (ii) not traditional in some industries (iii) concern about public disclosure

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PATENT BOX REGIMECalculation - Follow the Steps…

Step 1Determine the part of company’s taxable trading profit that is attributable to qualifying RIPI income

• Excluding any R+D tax credit enhancement, but not R+D costs themselves• Exclude interest receipts and financing expenses• Allocate this adjusted amount between qualifying/non qualifying income

— Turnover from sale of qualifying patents (see example)— Turnover from other activities

• Allocate expenses on a pro-rata basis between qualifying/non qualifying.

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PATENT BOX EXAMPLESale of a car

Patented steering wheel

Whole of profits from sale of car qualify

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PATENT BOX REGIME

Company has trading turnover of £1,000 of which 70% is from the sale of qualifying patent products. Its tax deductible expenses of £775 include R+D, none of which qualifies for R+D tax credits, and £75 for marketing.

Step 1 Calculation: Divide taxable profit between qualifying and non qualifying income (split on a pro-rata basis though actual apportionment can also be used)

Qualifying Non Qualifying

Total

Income 700 300 1,000

Expenses- R+D (£100)- Marketing (£75)- Other (£600)

(70)(52)

(420)

(30)(23)

(180)

(100)(75)

(600)

(542) (233) (775)

Taxable trading profit

158 67 225

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PATENT BOX REGIMECalculation - Follow the Steps…

Step 2 Identify Qualifying Residual Profits (QRP)

• Take out “routine” profit that has not arisen from the ownership of the IP • Routine profit calculated using a cost plus methodology by taking 10% of the

aggregate of the following costs— Capital allowances— Premises costs (deductible rent, rates, repairs, power etc)— Personnel costs— Plant & machinery costs (deductible leasing / servicing etc)— Miscellaneous services

• Material content in product is the main excluded element of cost which is not subject to the 10% adjustment

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PATENT BOX REGIME

Qualifying Non Qualifying

Total

From Step 1:

Income 700 300 1000

Expense (542) (233) (775)

Taxable profit 158 67 225

Remove ‘Routine Profit’-10% of expenses (54) 54 -

Residual profit attributable to qualifying income

104 121 225

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PATENT BOX REGIMECalculation - Follow the Steps…

Step 3Identify patent box profits by removing ‘Marketing Assets

Return’

• Determine how much of residual profit is attributable to the patent and how much is due to non-patent IP assets – i.e. The awareness of the brand name in the marketplace

• May require a brand valuation to be performed or evaluation of what a company would pay as a ‘notional marketing royalty’ to a third party to exploit the assets

• Any actual marketing royalty paid can be deducted from the notional marketing royalty to arrive the relevant deduction from Qualifying Residual Profits

• Alternative is to elect for small claims treatment which removes 25% of Qualifying Residual Profit as a Marketing Assets Return.

• Small claims treatment places a ceiling on the profits subject to Patent Box benefits of £3million.

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PATENT BOX REGIMEQualifying Non

QualifyingTotal

From Step 1:

Income 700 300 1000

Expense (542) (233) (775)

Taxable profit 158 67 225

Remove ‘Routine Profit’- 10% of expenses (54) 54 -

Residual profit attributable to qualifying income

104 121 225

Remove ‘Marketing Assets Return’

- Assume 5% of sales (35) 35 -

69 156 225

Total tax at 10%/23% 7 36 43

Total tax under old rules at 23% 52

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PATENT BOX REGIMEPatent Box Losses• Losses in early stages of IP development could derive a ‘Relevant IP loss’• In the event of a relevant IP loss, the loss must first be offset against any other

Patent Box trades of the same company with Relevant IP Profits• After any reduction for the above, any remaining loss must be set off against

Relevant IP Profits of other relevant group companies for the relevant accounting period

• If, after the application of both of the above offsets, the company has a remaining set-off amount, this is carried forward against any Relevant IP profit arising in the following accounting period

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PATENT BOX REGIMEOther considerations• A separate calculation must be carried out for each company holding a

qualifying patent • As patent profits may be generated between application and grant, there is a

look back period between application and grant of the patent. These profits can qualify for Patent Box benefits

• Patent Box benefits can be utilised in addition to claiming R&D tax credits

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PATENT BOX REGIMEPotential Action Points• Confirm first accounting period when Patent Box applies (profits arising post 1

April 2013)• Confirm history of patents – date of grant or application and country of

registration• Extrapolation of underlying income streams • Preliminary feasibility – decision as to whether to opt into the regime

RESEARCH AND DEVELOPMENT TAX CREDITS

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RESEARCH AND DEVELOPMENTBENEFITS

• Monetary benefitsSmall companies (less than 500 employees and either turnover less than €100 million or assets of less than €86 million).

- For every £100 of qualifying expenditure, the company is entitled to an additional £125 deduction for tax purposes

- At a tax rate of 23% this equates to a benefit of £28.75 for every £100 of qualifying expenditure

Large companies (more than 500 employees)- For every £100 of qualifying expenditure, the company is entitled to an additional £30

deduction for tax purposes

- At a tax rate of 23% this equates to a benefit of £6.90 for every £100 of qualifying expenditure

• Cash repayment – available from 1 April 2013 for large companies

• Tax R&D is different to accounting R&D

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RESEARCH AND DEVELOPMENTWHICH PROJECTS QUALIFY?

Per DTI Guidelines

• The Project must be seeking to obtain an advance in science or technology.

• Activities that are qualifying R&D are those that directly contribute to the advance, through the resolution of scientific or technological uncertainty (see examples)

• Does it qualify – it is considered from the viewpoint of a ‘competent professional in the field’

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RESEARCH AND DEVELOPMENTTYPICAL QUALIFYING EXPENDITURE

• Wages and salary costs

• Consumable materials

• Utilities

• Software

• Qualifying indirect overheads

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