The Patent Box is a generous tax incentive aimed at encouraging innovation in the UK. Many countries have adopted similar regimes to promote research and development (R&D) by providing significant tax relief on profits earned from patented inventions.
The Republic of Ireland was one of the first countries to introduce a beneficial tax regime for revenue generated from patents as early as 1973. The scheme proved to have huge benefits for the economy, playing a significant role in attracting overseas IT companies to Ireland. So much so that many other countries followed suit.
It wasn’t until 2013, however, that the UK phased in the Patent Box relief over a four year period. The scheme is also sometimes referred to as the intellectual property box regime (IP box) or innovation box. This guide will take you through all the key components of the Patent Box including:
- What is the Patent Box?
- Is your company eligible?
- What income qualifies for Corporation Tax Relief?
- How to claim for the Patent Box Scheme
What is the Patent Box?
The Patent Box works by allowing eligible companies to apply a reduced rate of Corporation Tax to revenue generated from their patents.
Corporation Tax relief
All limited companies, foreign companies with UK offices, community associations or other corporations have to pay Corporation Tax on profits from business activities. Taxable profits include money generated from trading, investments, or selling assets for a profit. All profits made abroad for UK based companies are also taxable.
The Patent Box works by reducing Corporation Tax on profits from patented inventions to an effective rate of 10%.
Is your company eligible?
First off, only companies liable to pay Corporation Tax are eligible for the Patent Box. The company also needs to be making a profit from commercially exploiting patented inventions.
To be eligible, your company must own qualifying patents or exclusive licenses for the rights to those patents. In practice, this means that you do not need to own the patents to qualify for the scheme. Many patent holders license their technology to then pass on to other parties, for them to develop. Your company can, in certain cases, still qualify for the scheme without being the patent holder.
Exclusively licensing-in patents
Some inventors may seek patents for their innovations and then wish to have others develop the product. They do this by licensing their invention. If you’re a company who holds licenses to use another person’s invention, you are still eligible to benefit from the Patent Box scheme. You must, however, satisfy the following conditions:
- your company must have rights to develop and exploit rights in the patented invention
- your company must have rights to defend the patented invention, should the terms of the patent be infringed
- your company must have exclusive rights in at least one country
On top of this, your company must have undertaken ‘qualifying development’ on the patents. This clause applies whether you are the patent holder or license holder. You can find more on this later.
Which patents are eligible?
HMRC accepts many types of patent, including any patents granted by:
- The UK intellectual property office
- The European Patent Office
- Many countries in the European Economic Area, including: Austria, Bulgaria, Czech Republic, Denmark, Estonia, Finland, Germany, Hungary, Poland, Portugal, Romania, Slovakia and Sweden.
An exclusive license needs to grant the license holder, the licensee, exclusive rights to exploit the patent in one or more countries, as well as the right to defend rights in the patented invention should any of those rights be infringed.
What counts as ‘qualifying development’?
The scheme includes a development condition to ensure that companies qualifying for the scheme have been key players in inventing or developing the patented innovation or invention. ‘Qualifying development’ is therefore defined as:
- contributing significantly to the creation of the patented invention
- having a significant involvement in the development of the patented invention
- having a significant involvement in the creation or development of a product or process which incorporates the patented invention.
To be eligible for the scheme, you must have undertaken qualifying development on the innovation, whether or not you are the patent holder or the license holder.
What income qualifies for Corporation Tax relief?
The reduced Corporation Tax only affects income generated from exploiting patented inventions. Not all of your company’s profits will qualify. ‘Intellectual Property’, or IP income, refer to the income relevant to the Patent Box. It must come from any of the following:
- the sale of patented products
- licensing out patent rights
- selling patented rights
- income from patent infringement
- insurance or compensation income relating to patent rights.
Even if a product only contains one patented component, you may still claim CT relief on all the revenue from that product.
Any income generated from these sources is eligible for Corporation Tax charged at an effective rate of 10%.
What income does the Patent Box exclude?
As seen above, only income relating directly to the patented products is eligible for the reduced CT rate. There are two types of income which the scheme explicitly excludes:
- Routine return: this is profit you’d still expect to make without the intellectual property
- Marketing asset return (MAR): income earned from the branding of the products, rather than the innovation itself.
It can be difficult to differentiate eligible and ineligible sources of income when it comes to the sale of patented products. To figure out how much of your income is routine return, how much is down to marketing, and how much comes directly from the patent, you’ll need to carry out a series of calculations. These calculations strip out the relevant profits from these excluded activities to provide you with a sum on which you can claim. You can find more detail on this further down.
How to claim for the Patent Box Scheme
To benefit from the Patent Box, you first have to elect into the scheme by informing HMRC. You can make the election in writing, but more often than not, companies elect into the scheme in the computations accompanying their Company Tax Return.
There’s no specific box to elect into the scheme on your Company Tax Return. Instead, you apply the reduced 10% yourself. However, this reduced is effective and isn’t as simple as working out 10% of the taxable sum. Instead, you must work out your tax benefit by subtracting an ‘additional trading deduction’ from your Corporation Tax profits. To do this, you first need to work out what your relevant profits are.
How to calculate relevant profits
Generally speaking, to calculate the relevant profits you identify all the profits broadly attributable to exploiting patented inventions and subtract the routine profit and the MAR from this amount. The calculations are quite complex. HMRC describes two methods for calculating relevant profits to the Patent Box scheme.
How to calculate your trading deduction
Once you’ve calculated your relevant profits, you can work out your tax relief. HMRC provides the following formula to calculate the additional trading deduction you can make from your Corporation Tax profits:
RP x FY% x ((MR – IPR) ÷ MR)
- RP is the relevant profit
- FY% refers to the appropriate percentage for the financial year
- MR is the main rate of Corporation Tax (usually 19%)
- IPR is the 10% reduced rate.
FY% depends on the tax year in question. The following percentages apply to each financial year:
- 1 April 2013 to 31 March 2014: 60%
- 1 April 2014 to 31 March 2015: 70%
- 1 April 2015 to 31 March 2016: 80%
- 1 April 2016 to 31 March 2017: 90%
- from 1 April 2017: 100%.
A company owns the patents to an innovative cooking timer. Their relevant IP income from the timer equates to £2,000 in the financial year from 1 April 2016. Instead of working out the tax charge by taking 10% of this amount, the company must follow the calculation above to work out the CT deduction. The main rate of tax for the 2016-2017 financial year is 20%.
The Patent Box deduction is then calculated as follows:
£2,000 x 80% x ((20 – 10) ÷ 20) = £800.
This amount can then be deducted from the £2,000 to give £1200. This amount is then charged at the usual 20% Corporation Tax rate, meaning the tax payable is £1200 x 20% = £240. Without the Patent Box, the company would have paid £400 in CT on the profits from their cooking timer, saving the company £160.
If your company’s accounting period spans more than one financial year, you will need to work out the proportion of profits made in each financial year and carry out two separate calculations.
When to claim?
Companies must elect into the Patent Box within two years after the end of the accounting period in which they received the relevant income.
Is it worth claiming?
The Patent Box is a complex scheme, and one of the few requiring companies to do most of the legwork. However, it’s a lucrative tax benefit: it’s a very competitive tax relief, making the UK a prime location for businesses to exploit and develop intellectual property. In other words, it’s only worth the effort when the benefits of a reduction in Corporate Tax can be significant.