The patent box – can it reduce corporation tax liability?

The patent box – can it reduce corporation tax liability?

From time to time, a change occurs that significantly shifts our reference points. The Patent Box transforms Patent rights from being simply an overhead to a potentially significant tool in reducing a company’s corporation tax liability. Failing to recognise this now may cost innovative UK companies significant amounts of hard-earned cash.

Following the successful introduction of Research and Development tax relief legislation, the government has continued to look at ways to encourage innovative industries in the UK to develop new and pioneering technologies. With strong competition from EU countries on patent schemes, the government recognised that the UK would also need to introduce incentives to avoid UK companies locating patents offshore. This scheme is an important part of UK tax legislation.

The Patent is being phased in gradually over five years, from 1 April 2013. Companies can elect to pay a reduced rate of UK corporation tax on profits attributable to qualifying patents and certain other Intellectual Property (IP), as opposed to corporation tax rates of 20% and above. The reduced rate of corporation tax will be as low as 10% and this will be fully phased in by 1 April 2017.

The interesting part of this tax legislation is that the scheme is not restricted to wholly patented products and will include products that have patented components integrated within them. HMRC guidelines use the example of a printer cartridge. If a printer cartridge was patented, the qualifying relevant income would include that attributable to the sale of the printer cartridge, the printer and the sales of spare parts of the printer.

Similarly, the Patent Box relief is not only available to companies owning patents, but may also include those holding exclusivity rights.

As a rough guide, if you are a producer, either directly or indirectly, of physical objects then the Patent Box may be relevant. Hence, for companies involved in service provision, distribution, marketing and advertising, the scope is likely to be limited.

So what is a patent?

A patent is a monopoly right granted, such as by the UK Government, to give exclusive rights to a defined technical advance. Such an advance needs to be both new and more than an obvious extension of what preceded it. Such thresholds are often overestimated by companies who become blasé about their company’s know-how and their own accumulated skills. It is therefore one of the skills of a Patent Attorney, who combines a knowledge of science and law, to evaluate these issues.

There are a significant number of companies that are developing patentable products or components that yield a profit, but have simply not had their product patented due to the cost, lengthy process, and public disclosure of the invention. Despite this, there are considerable savings to be made under the new Patent Box scheme (in addition to gaining valuable patent protection) and so, in most cases, applying for a patent is now considerably more favourable.

Historically, British industry has often kept key knowledge and information as proprietary secrets. In the days when product lifecycles lasted decades this made sense, but when staff turnover and product lifecycle are more likely to be measured in months and years this is a less logical approach. There must be a significant reservoir of patentable subject matter available to most established manufacturing companies, and this can be accessed by asking the right questions. The issue is therefore more as to whether the financial incentive of the Patent Box is sufficient to justify an investment in patent rights.

Essentially, in assessing this incentive, you start with total profits of a company and the legislation gradually slices away the profits that are taxed at 10%. It is a complicated calculation but nevertheless, at least for a profitable company, the threshold for making this relief worthwhile is relatively low.

If a given product has the potential to generate annual profit in the region of £200,000 and a patent was sought on this product, or an integral part of this product, it may result in a corporation tax saving of up to £20,000 a year in tax for over 20 years. In this case the likely cost of generating patent rights for the life of the product can be recovered in around two years with, potentially, 18 years of further tax benefits. Obviously at higher profit levels or for groups of products which can all be covered by similar patents (and hence grouped) the return is higher and the payback quicker. As you may guess, there is a reasonable amount of work necessary to generate patent rights and a guarantee of success depends much on the technology but basically it is a realistic proposition.

So how does the Patent Box work and how does this opportunity arise?

From 1 April 2013, companies have been able to elect for a reduced rate of UK corporation tax. The reduced rate is 10% which will be phased in gradually over a five year period applying in full from 1 April 2017.

The 10% rate of corporation tax is applicable to products and services that incorporate patented inventions as long as the company owns or has an exclusive license under the patent and meets certain development criteria. For example, profits from the sale of a product that has a patented part integrated into it can qualify in full for the reduced rate. The patent could be on a very small component that forms a much larger product. This piece of legislation is surprisingly generous. It is even possible to include profits from unpatented spares sold which are designed to be used with the patented product.

About the author

Sumit Agarwal
Sumit Agarwal (ACMA ACA India), the Managing partner of dns accountants is a highly respected accountant with expertise in helping owner-managed businesses.