The Patent Box regime is a generous tax incentive that is less well-known than Research and Development (R&D) tax credits. It could be time for your company to take advantage of this underutilised tax relief.
Furthermore, with corporation tax rates having risen to 25% from 1 April 2023, this scheme becomes increasingly attractive to UK companies looking to reduce corporation tax liabilities.
What is the Patent Box regime?
The regime is a tax incentive introduced in 2013 to encourage innovation in the UK. Companies can benefit from an effective 10% corporation tax rate on relevant taxable profits arising from patented technology, medicinal and botanic innovation rights.
In general, approximately 20,000 patent applications are submitted each year to the Intellectual Property Office (IPO), and whilst the number submitted annually has been decreasing over recent times, the number of patents the IPO has granted has been increasing. In 2021 this reached a level in excess of 10,000 successful applications. It should be noted that it can take several years from submission of a patent to it being granted.
As innovation in areas such as artificial intelligence and alternative technologies continues to develop apace, both companies and entrepreneurs at the forefront of such innovation should certainly keep in mind the opportunities which Patent Box presents.
Is your business eligible for the Patent Box scheme?
To qualify for Patent Box, a company liable to UK corporation tax must make profits from exploiting qualifying patented inventions.
A product may only need one patented component for all its revenue to fall within the regime. By way of a simple example, if one component of a car is patented (eg an exhaust), it may be possible for the total taxable profits from the sale of the car to be brought into the Patent Box regime. Relevant intellectual property (IP) profits should then be subject to an effective 10% corporation tax rate – saving up to 15% corporation tax on these profits.
It should be noted that Patent Box can also be claimed on processes (and not just products/innovations). More detail about this can be found in the next sections of the article.
Broadly, companies already owning qualifying patents (or holding exclusive licences for the rights to those patents) granted by the IPO, the European Patent Office or other certain European patent offices will meet the first condition for eligibility. These businesses should consider whether they can take advantage of this very beneficial regime which complements the R&D tax credit relief system.
If you’ve applied for a patent that is expected to be profitable, but it’s not yet been granted, the benefit of Patent Box can still apply, although the related relief will be provided in the period the patent is granted.
For those not already holding patents but undertaking innovation, it may be worthwhile thinking about applying for a patent to benefit from the Patent Box regime.
In all cases, the company must be involved in the development/innovation of the qualifying IP rights or products incorporating the patented invention.
How to determine your taxable profit calculation?
The rules and calculations for determining the level of taxable profits to be taxed at 10% can be complex. Not only do the taxable profits arising from patented technology have to be identified, but further adjustments need to be made.
These can be summarised at a high level as follows:
- Identifying relevant IP taxable profits: Although taxable profits may include income and expenditure relating to patent licencing and royalties, patents used in processes or services, damages, infringement income and patent rights sold, the majority of taxable profits will be generated from products or parts of a product covered by the patent. HM Revenue & Customs (HMRC) has provided detailed guidance on how to stream qualifying IP income.
- Removing the routine return: This aims to remove the profit a business might be expected to make if it did not have access to IP or other intangible assets.
- Removing the Marketing Asset Return (MAR): This aims to remove the arm’s length element of profit that relates to the company’s brand and marketing assets. For companies which trade business-to-business (B2B), the MAR may be zero.
- Calculating the R&D fraction: This limits the level of profits eligible for the effective 10% regime depending on the level of R&D work undertaken in-house/sub-contracted to connected/unconnected parties and amounts paid for the IP. This step therefore requires a company to track and trace its R&D expenditure relating to the development of a particular qualifying IP right.
R&D tax relief and Patent Box calculations
The effective 10% tax rate is given by an additional deduction within the corporation tax computation. This reduces taxable trading profits or creates/increases taxable losses, which can be used to offset against previous/future or group companies’ taxable profits. Unlike R&D tax credits, it can’t be exchanged for a cash repayment.
As the Patent Box complements the R&D tax relief regime, companies claiming under one regime should consider the possibility and merits of claiming under both.
It is widely accepted that the Patent Box regime is complex. However, the benefits of claiming Patent Box can be significant, and so those companies that meet the qualifying conditions should consider taking advantage of it, particularly with UK headline tax rates having increased to 25% from 1 April 2023.
Business owners operating specifically in the manufacturing sector should be aware of the Patent Box relief. Statistics published by HMRC indicate the manufacturing sector accounted for more than 30% of all relief applied. Across all sectors the number of Patent Box claims submitted annually is approximately 1,500, which have resulted in £1.2 billion of tax relief being applied, and since its introduction in 2013, over £6 billion has been claimed (up until 2019-20). Together with R&D claims, the Patent Box relief presents an excellent opportunity for businesses who hold patents for the innovations they have created.
Patent Box Regime – how can we help?
We advise a range of businesses and entrepreneurs on the Patent Box to ensure they select the most advantageous time to elect into the regime. We often work with our clients on both R&D and Patent Box to optimise the business’ R&D tax credit relief, as well as to increase the benefit of the Patent Box.
If you’d like to understand more about Patent Box and how it could benefit your business, or if you’d like us to put you in touch with patent attorneys to discuss whether a patent application may be successful, please get in touch with your usual Saffery contact, or speak to one of our specialists: Justine Stalker or Rachel Chappell.