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Introduced in the Finance Bill 2012, Patent Box Relief – or PBR – is a tax break for businesses that is designed to promote innovation. Profits that businesses make from exploiting patents will attract a reduced corporate tax rate from 24 per cent to 10 per cent. At the time of its passage, this legislation was hailed as a key to making sure manufacturing continues to thrive in the UK.

Who Qualifies for Patent Box Relief?

To qualify for PBR, your company will need to satisfy two conditions. First, your company must have undertaken a qualifying development project by making significant contributions to the creating of a patent invention. Your contribution could also be from developing a product that incorporates the patented invention.

Lastly, if your company licences-in qualifying patent rights, the licence should be country wide and exclusive. The reason for this is so that a company can only claim PBR when it actively develops new technology.

Another way to qualify is if your company is within a group where one of the group companies satisfies the qualifying development aspect. The company that claims Patent Box Relief must play a significant role in the management of qualifying IP rights. This measure is designed to prevent passive IP holding companies from benefiting from this tax incentive.

It is a matter of judgment in determining what amounts to a significant contribution. However, HM Revenue & Customs has indicated that it would add language to clarify what is considered significant. It may include language such as coming up with an original idea, developing a new application for an existing invention or testing the invention as significant contributions. Simply finding a new market for an invention that already exists does not apply.

What Profits Apply to PBR?

Eligible profits from worldwide sales are currently eligible for Patent Box when the products are protected by the European Patent Office or the UK Intellectual Property Office. These are the ones, granted a patent by one of these offices, which are eligible for the 10 per cent rate. The patent must be active and could also be granted by equivalent IP offices in other EEA countries that qualify.

In addition, the company must receive income that is related to the patent. “Holding a patent” is a widely drawn definition that includes partnerships, income earned from selling a patent, cost-sharing arrangements and exclusive licence to exploit a patent.

Typically, the cost of obtaining a UK patent is a few thousand pounds. However, SMEs could see tremendous savings several times the cost of a patent under this new scheme. In addition, SMEs will gain valuable protection for their patent.

Patent Box Relief is being phased in by a 10 per cent increase each year from 1 April 2013 to 1 April 2017. Only 60 per cent of qualifying profits receive the reduction during the first year.

Profits from PBR are derived from licensing or selling of patent rights. When a company sells a product anywhere in the world and the patented invention is involved, PBR applies. Known as notional royalties, a patented invention from a company’s trade that is used may also be eligible for this tax break. Any compensation that a company receives when third parties infringe upon patent rights is also included in the tax break.

How Does Patent Box Work with Tax Relief for R&D?

If your company qualifies for the Patent Box, it is also likely that you are undertaking research and development activities. This makes you eligible for R&D tax credits and the Patent Box legislation is designed to complement R&D tax relief. You will not be penalised for claiming R&D tax credits and calculating Patent Box profits.

For every £10,000 of R&D expenditure that qualified for the credit, you can claim a £22,500 deduction from taxable profits. This has been the case for qualifying R&D expenditures since April 2012. A company that is loss-making can choose to increase the value of carry forward losses. Alternately, the company can surrender qualifying tax credits in exchange for a cash payment. HMRC repays £25 for every £100 of expenditures that qualify.

Calculating Income Eligible for the Reduced Tax Rate

To calculate eligible income for the reduced rate, you must use the formulaic approach within the Patent Box legislation. With any other approach, you face an arduous process and miss the whole purpose of having a straightforward way to claim the credit.

Gross income is the starting point for calculating the Patent Box credit. Next, you will need to identify how much of that income was earned from patents. Do this by mapping patents to products to make sure only qualifying streams of income are identified. Once you have established these two figures, calculate the amount of patent income as a percentage of the Gross Income, also known as GAAP.

Now, you will need to apply the percentage to Relevant Profits, which are taxable profits that are subject to adjustments. The assumption is that a percentage of income coming from patents is most likely the same percentage of profits also comes from patents.

In the final stages of calculating eligible income, you – or your accountant – will strip out profits that did not come directly from patents. The Routine Return, which is broadly calculated as 10 per cent of general administration and sales, will be eliminated. Profits that anyone could make from a non-patented version of a product, service or process represent the Routine Return.

How to Overcome Some Complexities

Does this tax credit sound too good to be true? Well, there are some complexities that could cause problems for the unsuspecting. However, your company can overcome these problems if the right steps are taken in advance.

There are common issues that companies have reported having since the bill’s passage. At times, companies lost the reduced rate of tax. Some administrative burdens, which can cause problems, include: • A patent registration in the name of an individual owner instead of the company name. Even if one company is the only one exploiting a patent, no Paten Box tax applies when no licence exists in the company name. The company does not satisfy the exclusive licence and ownership requirement. • Some companies have had to adapt their accounting system and recordkeeping processes to correctly identify costs and relevant income for a patent. The goal is for companies to get the maximum profit possible from the 10 per cent Patent Box rate. • Not meeting the definition of an exclusive licence for group licences according to the Patent Box legislation.

Your tax adviser can help you through the process if your company exploits a patent. The new Patent Box legislation will prompt discussions throughout many companies about eligibility and clarification of income requirements. In some cases, the Patent Box Relief credit might not be worthwhile for every company. In addition, speaking with a tax professional will ensure that if this is a feasible option, you actually meet the requirements with proper patent licences.

Some Additional Know-How

Here are more points to consider if you want to take advantage of the Patent Box legislation to help your business save on taxes.

Patent pending? – The new scheme does not apply to profits your company earns from inventions that have a pending patent approval. However, if approval is granted, you can add profits from the last six years to the first year of calculations after approval. Acquisitions – Your qualifying company is still eligible after a change of ownership. The company can receive tax relief for at least a 12 month period where development activities continued after the purchase. 4

Non-Exclusive Licences – Granting or receiving any non-exclusive licenses may apply if they are converted to exclusive agreements since PBR only applies to exclusive licences.

Tech Haven – Qualifying patents for technology pay apply if your company is a UK-based IP management company. You do not have to develop the technology in the UK.

Conclusion

UK companies that to not currently hold patents should reconsider policies on licensing or using patents if they want to be included in the Patent Box Relief. Receiving a 14 per cent corporate tax break can be significant for UK businesses that exploit patented products. The government website provides plenty of useful information for your company. Talk to your accountant, solicitor or patent agent for more information and guidance on the best route for your business.