The UK Patent Box is an elective tax regime designed to encourage innovation in the UK and promote the development and ownership of certain intellectual property in the UK. Broadly, the regime allows eligible companies to elect to apply a lower rate of Corporation Tax to all profits attributable to qualifying patents, whether those profits are received as patent royalties or embedded in product prices. This relief reduces the effective tax rate on worldwide profits attributable to qualifying patents and similar intellectual property to 10%. Given that the 

UK’s main rate of Corporation Tax is 25%, the Patent Box regime can provide valuable tax relief for eligible companies.

Eligibility for the regime is based on the “modified nexus” approach, which takes into account the jurisdiction in which the research and development activities undertaken to develop a patent or product take place. By requiring eligibility for tax relief to be directly linked to R&D expenditure, the UK Patent Box regime aims to ensure that the substantial economic activities associated with developing intellectual property take place in the UK.

Companies may still qualify for Patent Box relief even when R&D activities are outsourced to unrelated third parties. Where two or more companies jointly undertake R&D under a “cost-sharing arrangement,” the participating companies are treated equitably, and the arrangement does not advantage or disadvantage any party. Companies must maintain comprehensive records documenting the income and expenditure associated with each patent.

Intellectual property acquisition costs and expenditure on R&D outsourced to related companies may still qualify under the Patent Box regime, provided that their combined amount does not exceed 30% of the total of the company’s own R&D expenditure and expenditure on R&D outsourced to unrelated third parties. R&D outsourced to related companies, even if they are also UK companies, or costs incurred in acquiring intellectual property may restrict Patent Box relief. Corporate groups may need to restructure to ensure that intellectual property is held by the company that actually incurs the R&D expenditure.

Qualifying Intellectual Property

Intellectual property eligible for the UK Patent Box regime includes:

· Patents granted by the UK Intellectual Property Office;

· Patents granted by the European Patent Office under the European Patent Convention;

· Patents granted by other specified European Economic Area (EEA) member states, including Austria, Bulgaria, the Czech Republic, Denmark, Estonia, Finland, Germany, Hungary, Poland, Portugal, Romania, Slovakia and Sweden;

· Supplementary protection certificates for medicinal or plant protection products granted by the UK Intellectual Property Office or issued by other authorities under the relevant EU regulations;

· UK plant breeders’ rights and European plant variety rights;

· Certain UK and European data protection or regulatory marketing exclusivity rights applicable to medicinal, veterinary medicinal or plant products.

Unlike Patent Box regimes in some other countries, the UK regime does not include software copyright within the scope of qualifying intellectual property.

If a granted patent is subsequently held invalid under patent law, it ceases to be qualifying intellectual property under the UK Patent Box regime from the date on which it is declared invalid.

Which Profits Qualify?

Broadly, the Patent Box tax rate applies to a proportion of a company’s profits derived from the following sources:

· Licensing or transferring qualifying intellectual property;

· Selling products incorporating a patented invention;

· Using a patented invention in the company’s business activities; or

· Receiving damages for infringement of qualifying intellectual property.

Profits arising from a company’s routine manufacturing, development and marketing activities fall outside the scope of the relief.

Profits are calculated using a streaming method, which divides income and expenditure into two categories: intellectual property income and non-intellectual property income. A separate sub-stream must be established for each individual intellectual property right; where a reasonable separation is not possible, separate streams are established for each patented product or product family. This requirement for separate streaming means that companies must establish robust systems to allocate and match income and expenditure to the relevant streams.

The Development Condition

A company can elect into the Patent Box regime only if it satisfies the development condition. This condition specifies the extent to which the company must have participated in developing the qualifying intellectual property. Merely holding a patent is insufficient to qualify for Patent Box relief. A company needs to satisfy the development condition only in respect of the intellectual property for which it claims Patent Box relief.

Broadly, the development condition requires a company to satisfy either of the following:

· Create, or make a significant contribution to the creation of, the invention underlying the qualifying intellectual property; or

· Undertake a significant amount of activity to develop the invention or any item or process incorporating it.

Whether an activity is “significant” must be assessed in light of all relevant circumstances. Guidance from HM Revenue & Customs (HMRC) makes clear that merely applying for a patent in respect of acquired rights, or marketing a fully developed patent, invention or product incorporating the invention, is insufficient to satisfy the condition.

Reform of the Patent Box Regime

To implement the recommendations made by the Organisation for Economic Co-operation and Development (OECD) under its Base Erosion and Profit Shifting (BEPS) project and reduce international tax avoidance by multinational enterprises, the UK comprehensively revised its Patent Box regime in 2016. The OECD was concerned that preferential tax regimes such as the Patent Box could be used to shift profits unless their application was linked to substantial economic activity in the relevant country.