Intellectual property and the Patent Box

Transcription

1 Intellectual property and the Patent Box

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3 Contents Background to the Patent Box regime 2 Qualifying companies 3 Qualifying IP rights 4 Qualifying development 5 Calculating qualifying profits 6 Patent Box deduction 11 Patent Box losses 12 Anti-avoidance provisions 14 Conclusions 15 Contacts 16 Publication date: June 2016

4 Background to the Patent Box regime The UK Government has been keen to improve the UK s competitiveness in the high-tech arena. Companies have been able to elect to enter the Patent Box regime since 1 April Any company within the charge to UK corporation tax with income from patents (and other specified intellectual property) will, subject to phasing-in rules, potentially be able to benefit from a 10% effective rate of corporation tax. The regime is intended to apply to the worldwide income arising from the exploitation of inventions which benefit from a qualifying patent. The phasing-in rules mean that the full benefit of the 10% effective rate will be phased in over 5 years, with 90% of the full benefit being available in The proportion of the full benefit will then increase such that the full benefit of an effective 10% corporation tax rate on Patent Box profits will be applicable from 1 April The UK s Patent Box regime is attractive to high tech and life sciences corporates and groups, particularly where such corporates and groups can also benefit from enhanced UK research and development ( R&D ) credits and are able to manage the complexities of applying the regime. The main concepts of the regime are summarised below: Patent ownership requirements Rights included Development Conditions Active Ownership Profit Calculation Relevant IP Income Profit apportionment / income streaming Routine expenses return Marketing return / small claims election New entrants, and new IP apply R&D Fraction Other features 10% rate formula Negative Patent Box Amounts Anti-avoidance rules Partnership & cost contribution arrangements 2

5 Qualifying companies As it is an optional regime, a company can only benefit from the Patent Box if, for an accounting period, it elects into the Patent Box regime. The election must be made in writing within two years of the end of the accounting period to which the election is intended to apply. Once a company has made a Patent Box election, the Patent Box regime will continue to apply to the company until the election is revoked. If a company revokes a Patent Box election, it will not be able to re-enter the Patent Box regime for five years. A company must meet one of the following conditions for the regime to apply: XXthe company (at any time in the relevant accounting period) owns or licenses-in qualifying intellectual property ( IP ) rights. Where IP rights are licensed, the licensing rights must be exclusive (at least as regards one or more countries) and must exclude all other persons (including the person granting the licence); or XXthe company previously owned or licensed-in qualifying IP rights, it has received income in respect of an event (in relation to the IP right or licence) which occurred both when the company was a qualifying company and had elected into the Patent Box regime and that income falls to be taxed in the relevant accounting period. For group companies, the regime will only apply where, in addition to satisfying one of the above conditions, the company applying the Patent Box regime satisfies the active ownership condition. The aim of the active ownership condition is to ensure that passive IP holding companies within a group do not benefit from the Patent Box. To satisfy the active ownership condition, the company must have either: XXcarried out qualifying development itself; or XXperformed a significant amount of management activity, in either case, in respect of all or almost all of the qualifying IP rights held by the company in the relevant accounting period. Management activity includes formulating plans and making decisions in relation to the development or exploitation of the IP rights. There are also rules allowing certain partnerships and cost sharing arrangements to qualify for the Patent Box. 3

6 Qualifying IP rights The Patent Box applies to: XXpatents granted by either the UK Intellectual Property Office or the European Patent Office, or corresponding patent rights granted under the laws of the following EEA States: Austria, Bulgaria, the Czech Republic, Denmark, Estonia, Finland, Germany, Hungary, Poland, Portugal, Romania, Slovakia and Sweden; XXsupplementary protection certificates which are granted by the UK Intellectual Property Office or the European Patent Office, including paediatric extensions; XXUK and European Community Plant Variety rights; and XXcertain UK and European medicinal and veterinary products with marketing authorisations and marketing or data protection and plant protection products with data protection benefits. It is noted that the Government will not, at this stage, extend qualifying IP rights to copyrighted software which is novel, non-obvious and useful. 4

7 Qualifying development For an IP right to be a qualifying IP right, the company must also meet the development condition in relation to the IP right. This means that the company must carry out qualifying development in relation to the IP right (before or after its acquisition) by either: XXcreating or significantly contributing to the creation of the patented invention; or XXperforming a significant amount of activity to either develop the patented invention or any item or process which incorporates the patented invention or to develop the way in which the patented invention may be used or applied. The development condition will only be met if either: XXthe company itself carried out the qualifying development and has not left nor joined a group since it did so; or XXthe company itself carried out the qualifying development, it has left or joined a group since it did so, but has performed the same type of development activities for at least 12 months since the change in ownership; or XXanother group company has carried out qualifying development in relation to the IP right and the qualifying development was performed within the group of which the Patent Box company is currently a member; or XXanother company (the acquired company) which has developed the patent is acquired by a group and the qualifying IP is then transferred to a different company in the group, provided that the acquired company (or another group company) continues with the same qualifying development carried on by the acquired company for at least 12 months after the acquisition by the group of the acquired company. The implication of this requirement is that a buyer can acquire either the qualifying IP or a company holding the qualifying IP and continue to benefit from the Patent Box provided that the development condition is met. 5

8 Calculating qualifying profits The Patent Box will apply to a proportion of the taxable profit of a company s trade. If a company has more than one trade, the Patent Box deduction for each trade is calculated separately. As the conclusions reached by the Organisation for Economic Co-operation and Development ( OECD ) as part of the Base Erosion and Profit Shifting ( BEPS ) project would treat the UK s existing Patent Box rules as a harmful preferential regime, the UK is amending its rules in order to comply with OECD requirements. This means that companies who have elected into the Patent Box regime before 1 July 2016 ( existing entrants under the grandfathered regime ) will generally be entitled to apply the more favourable existing rules for a transitional period until 1 July However, companies that first elect into the Patent Box regime after 1 July 2016 ( new entrants ) and existing entrants who acquire qualifying IP rights (or receive an exclusive licence of such rights) after 1 July 2016 ( new IP ), will be subject to the new rules. In the case of existing entrants, the new rules will apply only in relation to that new IP. Existing entrants will be subject to the new rules from 1 July Broadly, under the new rules, in order to actually benefit from the Patent Box, substantial R&D activity and investment will need to be undertaken by the company that actually owns or exclusively licenses-in the IP rights. There are several stages to the process of identifying the proportion of profits within the regime and there are two methodologies which can be used. These two methodologies are referred to as a standard method and a method involving streaming of income. However, the streaming of income methodology is the only methodology available to new entrants and existing entrants with new IP. The steps broadly involve: Step 1: calculate the total gross income of the trade for the accounting period excluding finance income. 6

9 Step 2: identify relevant IP income by identifying what proportion of the company s total gross income is relevant IP income from qualifying IP rights. For new entrants, it is necessary to divide the profits of the trade for the accounting period into two streams the relevant IP income and standard income. For both existing and new entrants, relevant IP income broadly comprises: XXworldwide income from the sale of the patented invention or an item incorporating it (even if the income arises in territories where the item is not protected by a patent); XXworldwide licence fees and royalties from rights that the company grants to others out of its own rights over the qualifying IP right; XXincome or gains from the sale or disposal of the qualifying IP right; XXamounts received from others accused of infringing the qualifying IP right; XXcompensation, damages or insurance proceeds received in respect of the loss of relevant IP income; and XXan optional notional arm s length royalty for use of the patent to generate the otherwise nonqualifying part of the company s total gross income (if some or all of that income is derived from exploiting the patented item). Ring-fenced oil extraction income and income from non-exclusive patent rights cannot qualify as relevant IP income. For new entrants and existing entrants with new IP, it will become necessary to divide the relevant IP income stream into relevant IP income sub-streams so each substream consists either of income attributable to an individual IP right or attributable to a multi-ip item ( a product sub-stream ) which essentially allows the tracking of product families. It will only be possible to allocate income to a product sub-stream if it would not be reasonably practicable to apportion the income between individual IP right sub-streams or to apply any of the remaining steps. Moreover, for existing entrants with income from a product incorporating both old IP rights and IP under the new rules, the company is to apportion income between the old IP rights sub-stream and new IP rights sub-stream (to which the R&D Fraction would then apply). Profits from multi-ip items will only be treated as being entirely related to new IP where the core IP has changed and less than 20% of the IP in the product is old IP. 7

10 Step 3: profit apportionment OR streaming. The company can choose one of two methods to calculate how much of its profits are derived from the qualifying income identified at step 2. It can either: XXapportion its total profits of the trade for corporation tax purposes according to the ratio of relevant IP income to total gross income ( profit apportionment ). This methodology will not be available to new entrants or existing entrants with new IP; or XXallocate its expenses on a just and reasonable basis between relevant IP income and non-qualifying income, to arrive at an appropriate profit derived from its relevant IP income stream ( streaming ). This method will be used where the company makes a streaming election or where it is required to do so because one of the mandatory streaming conditions is met. For example, mandatory streaming would be required where a company receives substantial patent licensing income from the IP rights which it holds through an exclusive licence from another person. The company would have to stream the fees paid for those exclusive rights against the income generated as a means of preventing conduit arrangements from benefitting from the Patent Box regime. In addition, for new entrants and existing entrants with new IP, they will be required to allocate expenses on a just and reasonable basis between the standard income stream and the relevant IP income sub-streams determined in Step 2. Finance income, expenses and any additional deduction above actual expenditure for R&D costs (given under the R&D tax credits regime) are excluded when calculating taxable profits. In addition, certain adjustments are made to the amount of R&D expenditure deducted when it is less than 75% of the average R&D expenditure over the four year period before the company entered the Patent Box regime. Step 4: deduct, from profits within the regime, a 10% routine return based on certain specified costs including costs of personnel, premises (if tax deductible), plant and machinery (including capital allowances) and services such as legal, financial and administration services. This adjustment is intended to take account of the fact that a business would still be expected to make a return even if it did not have access to IP rights. In response to consultation, the legislation clarifies that the routine deduction will not include legal costs relating to acquiring, maintaining or protecting patents, loan relationship and derivative contract debits. Certain R&D costs are also excluded even if they would otherwise be viewed as routine deductions. The routine deduction is set at 10%. For new entrants and existing entrants with new IP, they are required to deduct from each relevant IP income sub-stream the expenses allocated to the sub-stream in Step 3 and the routine return for that substream. As for existing entrants with old IP, the routine return for the substream is 10% of the aggregate of the routine costs made by the company in calculating the profits of the trade and allocated to the sub-stream in Step 3. 8

11 Step 5: deduct a marketing assets return which involves either: XXdeducting a return on marketing assets (such as brands, trademarks and customer information) in all relevant jurisdictions used to derive profits. This would involve deducting a notional marketing royalty (intended to represent what the company would pay a third party for exclusive use of the marketing assets), net of the appropriate proportion of any amounts actually paid for the use of marketing assets. The same broad principle applies to new entrants or existing entrants for their new IP, save that the deduction is made from each relevant IP income sub-stream determined in Step 4 and the amount actually paid to acquire or use the marketing assets is determined by reference to the amount allocated to that substream in Step 3; or XXelecting to apply a simplified calculation where the company s profit as determined in Step 4 for the aggregate of its trades does not exceed 3m (or such proportion of 3m as is attributed to the relevant company when it is split between that company and its associated companies). This simplified calculation election to apply the small claims treatment to the profit determined in Step 4 would remove 25% of that profit as a deemed marketing return, leaving the remaining 75% (up to a maximum of 1 million, shared equally between any associated companies) inside the Patent Box. This would remove the requirement for companies to value their brand. For new entrants and existing entrants with new IP, the rules are broadly in line with this, but the small claims figure is deducted from each relevant IP income sub-stream which is determined in Step 4, although the thresholds are calculated by aggregating the relevant IP income sub-streams. For existing entrants with old IP (broadly acquired prior to 1 July 2016) the resulting figure is the Relevant IP Profits which is the amount which will benefit from the Patent Box. Step 6: apply the R&D Fraction. This step is only applicable to new entrants and to existing entrants as regards new IP (as the R&D Fraction will not be applied to the sub-streams relating to old IP). Under this step, where applicable, each relevant IP income sub-stream determined after Step 5 must be multiplied by the R&D Fraction for the relevant IP or product sub-stream. The R&D Fraction calculation is set out below, although there can be an increase in the Fraction in exceptional circumstances where the R&D Fraction is at least (or 25% prior to the 1.3 uplift). An election can be made to increase the R&D Fraction where the R&D Fraction calculation does not correctly reflect the company s contribution to the IP and essentially would otherwise give rise to an unfair result. 9

12 The R&D Fraction is the lesser of 1 and (D + S1) x 1.3 where: (D + S1 + S2 + A) XXD = company s own qualifying expenditure on relevant R&D undertaken in-house (such as staffing costs, software or consumable items, externally provided workers or relevant payments to the subjects of clinical trials) where the expenditure is attributable to the qualifying IP right or multi-ip item. The relevant R&D must create or develop the invention or the ways in which that invention may be used, it must develop any item or process incorporating the invention; XXS1 = 65%* of qualifying expenditure on relevant R&D sub-contracted to unconnected persons; XXS2 = 65%* of qualifying expenditure on relevant R&D sub-contracted to connected persons; and XXA = qualifying expenditure incurred by the company broadly since 1 July 2013 (for new entrants) for the acquisition of a qualifying IP right or multi-ip item to which income in the sub-stream is attributable or an exclusive licence for such a right. * The 65% is the same percentage as is used for small and medium-sized enterprises ( SME ) R&D tax relief and is intended to cover the cost of performing the R&D but exclude profit and other non-qualifying costs. There is an effective 30% uplift reflected in the formula to allow some non-qualifying expenditure to be added. An uplift of up to 30% of the qualifying expenditure is permitted by the OECD. As the R&D Fraction looks at cumulative expenditures over a period of up to 20 years, tracking and tracing of qualifying R&D spend will be required from 1 July Even for existing entrants, they will need to be able to track and trace expenditures from 1 July 2016 in order to calculate this Fraction when the new rules apply from 1 July After this step, all amounts of relevant IP income sub-streams are aggregated to determine the Relevant IP Profit which benefits from the Patent Box for new entrants and for new IP held by existing entrants. 10

13 Patent Box deduction The benefit of the Patent Box is achieved by including an additional deduction in the company s corporation tax computation, based on the Relevant IP Profit amount. The resulting profit is charged at the normal corporation tax rate (currently 20% reducing to 19% in April 2017) but the extra deduction has the effect of reducing the effective tax rate on the Patent Box income. A company cannot benefit from the Patent Box until patent approval has been obtained nor can it benefit from the Patent Box in respect of income arising after the expiry of the patent. Once a patent is granted, a company can calculate what the additional Relevant IP Profit would have been (for up to six years before grant) if the patent had been granted on the date of application and include that amount as Relevant IP Profit when calculating the Patent Box deduction for the year in which the patent is granted. The company must make a Patent Box election in the accounting periods in which the patent is pending in order to take the income for those periods into account for the purposes of the Patent Box. 11

14 Patent Box losses Where a company has Patent Box losses rather than profits, the amount of the losses reduces the amount of Relevant IP Profits of any other trade the company carries on which are entitled to benefit from a Patent Box election. Any excess losses will reduce the Relevant IP Profits of group members which can benefit from the Patent Box or the future Relevant IP Profits of the company or other group members. The definition of group is very broad, with no geographical restrictions. It would bring within its scope joint ventures and companies which would not normally be considered to be members of a group. For some of the provisions in the legislation, this wide definition could be helpful, such as in the case of establishing active ownership or satisfying the development condition. However, it would make it more difficult to determine the amount of routine deductions to be brought into account and the ability to benefit from the Patent Box regime in the event that another group company has losses. Members of a group (companies A and B) is defined to include: XXcompanies that meet the consolidation condition. This includes, within a group, those companies that are required to be or are consolidated in accounts prepared under the Companies Act 2006 or under a corresponding law (or would be but for the application of an exemption); XXcompanies that are connected for the accounting period; XXcompanies that, at the relevant time, one has a major interest in the other; XXcompanies where the financial results of one company (A) and a third company meet the consolidation condition and the third company has a major interest in the other company (B); or XXcompanies where there is a connection between one company (A) and a third company for the accounting period in which the relevant time falls and the third company has a major interest in the other company (B). A company (C) will have a major interest in another company (B), if C and another person (D) together control B and, in effect, C and D each own 40% of the shareholding in B. When considering the holdings, rights and powers of C and D, any such shareholdings, rights or powers over B held by companies controlled by C or D are also taken into account. 12

15 The breadth of what constitutes a group for these purposes could make it difficult for large groups with significant corporate shareholders (who have interests in other companies) to ascertain all the members of the group which may be electing to apply the Patent Box regime. This uncertainty could make it difficult for groups to be certain that they have correctly determined their Patent Box profits for a particular period. Companies may be unaware that a company with Patent Box losses is actually within the same group, which could lead to potential disallowance of Patent Box profits anticipated by that company. It may even be the case that HMRC could require a company to show that it has undertaken sufficient due diligence to confirm that there are no Patent Box losses within the group before HMRC allows a Patent Box claim. The legislation allows a company which has a Patent Box loss which must be set against a Patent Box profit of another group company to compensate that other group company for the resulting restriction in its Patent Box profits. Any such compensation payment will not be taxable to the company with the Patent Box profits. Given the need to offset Patent Box losses against Patent Box profits of group companies (and carry any excess forward for use against future Patent Box profits), it is likely to be preferable for companies with Patent Box losses to delay their entry into the Patent Box regime until these companies have Patent Box profits. For companies which are eligible but have yet to elect into the Patent Box regime, this will need to be balanced against the more onerous requirements under the new regime which apply if a Patent Box election is not made in time for the Patent Box to apply to the 2016 accounting period. 13

16 Anti-avoidance provisions The legislation contains three broad anti-avoidance rules which provide that the Patent Box will not apply where: XXthe main purpose, or one of the main purposes, of granting an exclusive licence is to obtain the benefit of the Patent Box. This is to avoid spurious exclusive rights being added to a licence agreement solely to enable the income to qualify for the Patent Box; XXthe main purpose, or one of the main purposes, of incorporating a patented item into a product is to bring income from sales of that product within the Patent Box. This is designed to stop commercially irrelevant patented items being included in or with a product; or XXthe company seeking to make the Patent Box deduction is party to a scheme and one of the main purposes of the scheme is to increase the Patent Box deduction using one of three specified types of scheme. In its guidance, HMRC stipulates that it would not seek to apply these rules to practical and commercially appropriate transactions, even if they have the effect of creating or enhancing Patent Box benefits or where a group takes reasonable and commercially appropriate steps to restructure group arrangements in order to benefit fully from the Patent Box if current arrangements are accidentally disadvantageous. The Government is considering further changes to the legislation to deal with collaborative developments and cost contribution arrangements as well as to deal with acquisitions of companies with qualifying IP rights. Given that expenditure to acquire IP which qualifies for the Patent Box can have an adverse effect on the R&D Fraction (and consequently can reduce Relevant IP Profits), the Government is continuing to consider the introduction of measures aimed at removing incentives for larger companies to merge or acquire smaller ones as an alternative to acquiring IP. 14

17 Conclusions The Patent Box regime has generally been welcomed and some multinational companies have restructured their IP holdings in order to benefit from the regime. Compared with other regimes across Europe, although limited to patented IP, the Patent Box is advantageous in applying to profits arising from the sale of products with embedded IP rights as well as being applicable to income from the licensing of the patented rights. In addition, the regime also applies to proceeds from the sale of qualifying IP rights or the grant an exclusive licence in respect of such rights. Unfortunately, the calculation of the profits to which the Patent Box deduction can apply are complex and the uncertainty generated by the wide definition of groups could deter some companies from electing to apply the Patent Box regime. The rules applicable to new entrants and new IP rights will also introduce more onerous requirements for a company to fully benefit from the Patent Box as it will require the company holding qualifying IP rights to undertake its own R&D activities. Given that the changes to the rules are to ensure compliance with OECD recommendations, it is anticipated that favourable IP regimes in other jurisdictions will shift to include such a requirement in order to avoid such regimes being viewed as harmful. Consequently, we consider that this could encourage more multinationals to establish IP holding companies, together with R&D functions, in larger jurisdictions such as the UK which benefit from access to a highly skilled workforce. 15

18 Contacts About us Taylor Wessing is a full-service international law firm, working with clients in the world s most dynamic industries. We take a single-minded approach to advising our clients, helping them succeed by thinking innovatively about their business issues. Our focus on the industries of tomorrow has enabled us to develop marketleading expertise in: XXTechnology, Media and Communications XXLife Sciences XXPrivate Wealth uu Energy At Taylor Wessing we are proud of our reputation as a forward-thinking firm. We support clients wherever they want to do business. Our 30 offices around the world are not token presences they blend the best of local commercial, industry and cultural knowledge with international experience to provide proactive, integrated solution for our clients. Key contacts Other contacts u Nikol Davies Partner, London T: +44 (0) E: n.davies@taylorwessing.com u Peter Jackson Partner, London T: +44 (0) E: p.jackson@taylorwessing.com u Michelle Williamson Professional Support Lawyer, London T: +44 (0) E: m.williamson@taylorwessing.com u Robert Young Partner, London T: +44 (0) E: r.young@taylorwessing.com 16

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20 Europe > Middle East > Asia taylorwessing.com Taylor Wessing LLP 2016 This publication is intended for general public guidance and to highlight issues. It is not intended to apply to specific circumstances or to constitute legal advice. Taylor Wessing s international offices operate as one firm but are established as distinct legal entities. For further information about our offices and the regulatory regimes that apply to them, please refer to: TW_001721_06.16