Patent Box – Amendments at Committee Stage Finance Bill 2016

Tue 02 Aug 2016

Further amendments have since been announced to the new patent box regime (was Clause 60, now Clause 63) during the Finance Bill’s passage through Parliament at the Committee stage, and these are covered below.  References are to CTA 2010 unless stated otherwise.  The new patent box regime has been introduced in response to international developments on harmful tax practices.

Election to be treated as a new entrant

Any company will be able to elect to fall under the new regime, instead of having to operate a combination of both old and new regimes.  Normally, companies that have elected into the old patent box regime for periods prior to 1 July 2016 would continue to operate that regime until 1 July 2021 (‘grandfathering’).  As the old patent box regime is more beneficial than its replacement, then it is unlikely many companies would wish to forego their old patent box benefits, but if the benefits were very low so that the administrative cost of running two sets of patent box calculations outweighs the benefits, this election may be attractive or to benefit from the new global streaming election for small companies (see below). The new election will be included at s357A.

Small claims treatment simplifications

Changes are being made to reduce the administrative burden on smaller companies to encourage them to elect into the patent box:

• New s357BNB – to simply use 25% as the marketing assets return (at new s357BKA);
• New s357BNA – to simply use 75% for calculating the notional royalty (at s357CD(5));
• New s357BNC – a global streaming election so that the company can stream income on a company wide basis instead of having to separate income into separate sub-streams.  This election is not available where the company has profits eligible for both new and old patent box regimes.

Note: somewhat confusingly the statutory references in the explanatory notes do not match the references in the tracked version of the Finance Bill (which is what we have quoted above).

Tracking IP income and expenditure – multi IP items become IP items

A very useful relaxation is that it will now be possible to track IP income and expenditure on developing the IP at the level of product categories or families where only one qualifying IP item is included (instead of the products having to include more than one qualifying IP item).   So, for example, a product containing only one qualifying IP item can now be included in a product family with multi-IP items.  References to multi-IP items will be changed to IP items.

Acquisition costs in R&D fraction

Under the new patent box regime, the R&D fraction must be applied to each income sub-stream.  Broadly speaking, this has the effect that expenditure on R&D incurred in-house or sub-contracted to third parties is ‘good’ expenditure, whilst costs on acquiring IP or sub-contracting to connected parties will dilute patent box benefits.  Certain acquisition costs (income related payments) need not now be included in the R&D fraction.  This is because those costs would have been taken into account twice – firstly reducing patent box profits and then again in applying the R&D fraction.  Income-related payments would mean payments such as royalties. Therefore, these payments will only be deducted in Step 4 of s357BF(2) if the R&D fraction is affected.

The timing of the inclusion of IP acquisition costs in the R&D fraction is also being changed, so that they are included when paid rather than when they are deductible for corporation tax purposes. If there is a series of payments, these will all be included in the R&D fraction at the same time as the first payment in the series – say where there is one agreement covering a number of payments for qualifying IP.  The objective here is to try to ensure that the acquisition costs in the R&D fraction are aligned as closely as possible as the period over which the IP itself is protected.  What this also then means is that acquisition payments for IP after 1 July 2016, but which were part of a series of payments starting pre 1 July 2016, should be excluded from the R&D fraction (and hence not reduce it).

Qualifying IP

A new category of qualifying IP right is being introduced – being expenditure in return for disclosure of an item or process in respect of which the company applies for and is granted a relevant qualifying IP right.

Sub-contracted R&D

The entire amount of expenditure on sub-contracted R&D expenditure will now be included in the R&D fraction.  Before this amendment, it would have been necessary to include only 65% of these amounts (following the definitions of S1 and S2 in the R&D fraction).  As S2 (R&D sub-contacted to connected parties) only appears in the denominator of the R&D fraction, S2 will be higher as 100% of this expenditure will now be included instead of only 65%, thus reducing patent box benefits for those companies that sub-contact R&D to connected parties.

If the R&D expenditure is sub-contracted to a branch in respect of which a branch profits exemption election has been made (under s18A CTA 2009), it will now be treated as it is expenditure sub-contracted to a connected person.  It will therefore not be possible to get round the restriction for connected persons by using an exempt branch.

IP acquired from connected person between 2 January – 30 June 2016

Where IP was acquired from a connected person within the above period, the IP would count as ‘new’ IP where the main purpose or one of the main purposes was the avoidance of tax. This power may not be exercised after the end of 2016. The ‘tax’ being avoided here refers to foreign tax.

Anti-avoidance

A further anti-avoidance measure will be included to counteract schemes which result in the R&D fraction being inflated, compared to what it would have been, absent the scheme.

Transfer of a trade or part of a trade

A very important amendment has been made which will allow the transferee company to assume the R&D history of the transferor.  Thus, the transferee will have the transferor’s expenditure in the R&D fraction, which is very important, as in the absence of this amendment, that previous expenditure would have been lost. This will only apply where one company ceases to trade and transfers its IP to another company which begins to carry on that trade (similar to the transfer of tax losses carried forward when a trade and assets are transferred intra-group).  The transferee will not be treated as a new entrant provided the transferor was not a new entrant; and the qualifying IP will be ‘old’ as opposed to ‘new’ if it was ‘old’ in the transferor company.  The transferee will not need to treat the cost of the transferred IP as an acquisition cost in the R&D fraction (but this only applies where the means of exploiting the IP i.e. the trade, is also being transferred).  These rules also apply where part of a trade is transferred.

This may facilitate the reorganisation of how IP is carried on within a group – for example to bring R&D in house – so as to maximise patent box benefits going forwards both for new IP and when grandfathering ceases in 2021.

Conclusion

The ability to transfer a trade with the transferee inheriting the patent box history of the transferor is to be welcomed, and will enable groups to consider how best to reorganise how their activities are organised to maximise benefits.  In addition, there are some other useful relaxations, notably for small claims treatment, and for the ability to include products with only one qualifying IP item into a product family with multiple qualifying IP items.

However, we still have no further consideration of how other commercial arrangements, such as cost-sharing arrangements, will be catered for.