From April, profits generated by patented products will qualify for a lower rate of corporation tax, falling in stages to 10 per cent by 2017. For companies with a large amount of intellectual property, the new rules could more than halve their tax bills.
The government has introduced the Patent Box to stem the exodus of top research talent to lower-tax jurisdictions.
The UK has always enjoyed world-class research facilities, but recently many highly paid research posts have disappeared to countries with more favourable tax regimes. The new rules should make the UK a hub for pioneering research and development (R&D) once again, at a cost to the Treasury of nearly £1 billion a year by 2017.
The policy is already having an impact. Last year, drugs giant GlaxoSmithKline announced a £500-million investment in UK manufacturing over the next eight years, creating 1,000 jobs, as a direct result of the Patent Box.
In a recent KPMG survey of tax executives, nearly a quarter said the Patent Box regime would encourage their group to conduct more R&D and high-value manufacturing in the UK. Nearly half said the policy had improved the UK’s competitiveness.
Accountants and patent attorneys are expecting a boom in patent applications
The biggest boon for many companies is that the new regime will apply to existing as well as new patents. And it will not be necessary for an entire product to be patented to qualify. If, say, a bike had a patented chain, worldwide profits from the entire bike could qualify for the lower tax rate. Unpatented products, sold alongside a patented item, will also qualify. So a printer sold with a patented ink cartridge could be included.
Accountants and patent attorneys are, unsurprisingly, expecting a boom in patent applications and the Patent Office has already seen a 14 per cent increase in requests.
“Just one patent covering a relatively small technical feature may be enough for profits from sale of the entire product to be taxed at the reduced rate,” says patent attorney Laura Ramsay at Dehns. “And it’s not just the home markets that are covered, calculations are based on worldwide profits.”
Smaller firms could be deterred from applying to enter the Patent Box because of a perception that the process is expensive, but Ms Ramsay says the benefits would more than outweigh the costs, particularly as companies can potentially make a double corporation tax saving because R&D spending is also eligible for tax credits.
“Companies can get a credit for their R&D spending and, if they patent the results, the income will be taxed at just 10 per cent,” says Frank Buffone, head of R&D tax services at Ernst & Young. “It certainly makes it attractive for global companies looking at where they should base their R&D.”
A patent can cost between £3,000 and £5,000 to reach the grant stage, and this may take one or two years. Firms can claim tax relief for up to six years prior to a patent being granted, although the taxman will claw it back if the patent is subsequently denied.
There are some restrictions. The company must have either developed the product itself, although not necessarily in this country, or be actively managing it.
The Patent Box regime will be phased in gradually, starting with only 60 per cent of the full benefit from April 2013 and increasing by 10 per cent for each tax year until it reaches full effect from April 2017.
To calculate how much of a company’s profits qualify for the lower rate, the taxman will take all the profits attributable to the patent and knock off 10 per cent to give a “residual” profit. A further deduction will then be made to take account of returns from marketing and brand rights.
Nevertheless, many influential commentators remain sceptical about the benefits of the Patent Box. The Institute for Fiscal Studies has warned it will do little to boost R&D, particularly as existing patents will qualify for the lower tax rate.
“If you were going to sit down and design innovation policy, you would not design the Patent Box because it targets the income rather than the underlying innovation,” says the institute’s Helen Miller.
There is even a danger that multinationals could simply route their patent income through the UK, rather than base their R&D operations here as the government hopes – not dissimilar to the practice of “profit shifting” by big multinationals that has attracted such public outcry.
Accountants argue, however, that the opportunities for abuse have been greatly reduced by the general anti-avoidance rule, or GAAR, which also comes into force in April. This will put the onus on companies to disclose any scheme that has been set up specifically to avoid tax.
Tax experts agree that the economic benefits of the Patent Box will far outweigh the risks of widespread avoidance. “Attracting inward investment brings with it much more in terms of the benefits to our economy than the costs of reducing corporation tax,” says Richard Woolhouse, head of tax at the CBI. “You get it back many times over.”