Following on from our previous reports of the highly anticipated Patent Box Scheme announced by the Australian Government in May 2021 as part of the 2021-22 Budget (see our previous publication here and our 2021 Budget Alert here), the Treasury Laws Amendment (Tax Concession for Australian Medical Innovations) Bill 2022 (the Bill), has been introduced into the Australian Parliament.
The Bill sets out the proposed design of the Patent Box Scheme.
The introduction of the Bill brings industry participants one monumental step closer to additional concessional tax incentives for income derived from research and development (R&D) activities in relation to medical and biotechnology patents that is conducted in Australia. This move by the Federal Government complements the Government’s additional $2 billion investment in the R&D Tax Incentive program (see our recent update on the draft Determination in relation to the application of the R&D Tax Incentive to clinical trials here) and is part of the Government’s increased focus on reinforcing Australia’s viability as a leading research jurisdiction. The Patent Box Scheme is set to protect and promote home-grown innovation by encouraging companies to base their medical and biotechnology R&D operations and patent commercialisation activities in Australia.
This publication is part of our ongoing coverage of the progress of the Patent Box Scheme. In this update, we examine the structure of the Scheme presented in the Bill and discuss the implications for stakeholders in the industry.
What’s the incentive?
The Bill amends the Income Tax Assessment Act 1997 (Cth) (the Act) to provide concessional tax treatment for corporate taxpayers undertaking R&D activities concerning medical or biotechnology patents granted or issued after 11 May 2021 in respect of income years commencing on or after 1 July 2022. The Bill provides for a reduced tax rate to be applied to ordinary and statutory income derived from exploiting an eligible medical or biotechnology patent (referred to as a “patent box income stream”), so that such income is subject to a reduced tax rate of 17%.[1]
Eligibility
To be eligible for the preferential tax regime under the Patent Box Scheme, the corporate taxpayer must meet the following eligibility criteria:
- it must be an “R&D entity” for the purposes of section 355-35 of the Act (i.e. be an Australian resident or a foreign resident operating through a permanent establishment in Australia subject to a double tax agreement);[2] and
- it must be a patentee who holds rights over an eligible medical or biotechnology patent.[3] An exclusive licensee of a patent will not meet this eligibility requirement.
A medical or biotechnology patent will be eligible if it is linked to a therapeutic good included on the Australian Register of Therapeutic Goods (ARTG)[4] and is one of the following:
- An Australian standard patent granted by the Commissioner of Patents;
- United States Utility Patents issued by the USPTO; or
- European Patents granted under the Convention of the Grant of European Patents.[5]
A patent will be considered sufficiently linked to a therapeutic good included on the ARTG where the therapeutic good either contains or consists of a pharmaceutical substance, or incorporates an invention, that is in substance disclosed in the complete patent specification and falls within the scope of the claim or claims of the patent specification.[6] The patented invention or pharmaceutical substance does not have to account for the entire therapeutic good and instead can be a singular component of the good to qualify for the Patent Box benefits.[7] “Therapeutic good” has the same meaning as in section 3 of the Therapeutic Goods Act and includes medicines, medical devices and other goods used for therapeutic purposes, for example blood products and certain disinfectants.
Election
To access the Patent Box Scheme, the corporate taxpayer must elect for the regime to apply before or at the time the taxpayer is required to lodge its income tax return for the relevant income year. This election applies in respect of all the taxpayer’s eligible medical and biotechnology patents on a prospective basis and is irrevocable. It is important for taxpayers to note that the election does not operate retrospectively. That is, if the time by which the election must be made for an income year passes, the taxpayer will not be able to benefit from the regime for that income year.[8]
Where income is derived in an income year prior to the remaining conditions of the Patent Box Scheme being satisfied (e.g. milestone payments being received), the taxpayer can later seek to amend their income tax return in order to claim the tax concession in respect of that income once those conditions are satisfied, provided they have made the required election.[9]
Income rules
Under the Patent Box Scheme, only the proportion of the patent box income stream that is attributable to the corporate taxpayer’s development of the medical or biotechnology patent is subject to concessional tax treatment. This proportion is ascertained by undertaking the following steps:[10]
identify all eligible patents that underlie the patent box income stream;
- determine a reasonable apportionment of the income arising from the patent box income stream that is attributable to those patents; and
- reduce that amount to reflect the extent of the taxpayer’s Australian R&D activities.
A portion of this remaining amount is then made non-assessable and non-exempt income to achieve an effective tax rate of 17%.[11]
The nexus requirement under the Patent Box Scheme, and alluded to above, leverages the R&D Tax Incentive, including existing R&D legislative framework, as a basis for determining qualifying R&D expenditure.[12] Pursuant to the nexus requirement, a taxpayer can only benefit from the preferential tax regime to the extent the underlying R&D expenditure was incurred by the taxpayer in Australia.[13] As such, benefits must decrease where the taxpayer does not conduct the R&D itself, but either outsources R&D activities to a related party overseas or acquires intellectual property developed by another party. In relation to the latter, the taxpayer may only benefit to the extent of improvements to the patented invention that the taxpayer made after acquiring the patent.[14] This approach has been taken to protect profits from being artificially shifted away from Australia.[15]
Key implications
It is important to note the limitations of the Patent Box Scheme. Linking it to therapeutic goods on the ARTG means that those wishing to take advantage of the concessional tax treatment need to be able to link relevant patents arising from R&D activities to those goods.
While the Bill is a welcomed introduction, as drafted, multinational entities wishing to access the tax concession will also need to be mindful of potentially substantial tax compliance costs as:
- the concession requires the determination of a reasonable apportionment of the income arising from the patent box income stream attributable to those patents, in accordance with the OECD’s transfer pricing guidance; and
- any income rendered assessable under Australia’s transfer pricing provisions or general anti-avoidance provisions will not be eligible for concessional treatment.
As there are inherent difficulties in valuing intangible assets like patents, it will be critical for multinational entities to prepare robust and defensible valuation and transfer pricing documentation, as well as ensure they do not fall foul of Australia’s general anti-avoidance provisions, in accessing this regime.
Multinational companies will be familiar with these issues from patent box schemes in other jurisdictions and the Government hopes that the introduction of the Australian Patent Box Scheme will attract additional investment in the Australian medical and biotech sectors and prevent companies from choosing to go off-shore to conduct research and development.
What next?
The second reading of the Bill took place on 10 February and no amendments have been proposed. Once the Bill passes Parliament and becomes law, eligible taxpayers may be able to enjoy the concessional tax treatment under the Patent Box Scheme as early as the second half of this year. In the meantime, it is important for companies in the medical and biotechnology field to follow the passage of the Bill and, if it is passed in its current form, consider whether to opt into the Patent Box Scheme prior to filing a tax return for the relevant year of income.
Observers who were keen for the Patent Box Scheme to be extended beyond medical and biotech inventions, to low emissions and clean energy technologies following the Government’s foreshadowed consultation relating to those areas, will be disappointed to note that the government has not yet made any policy decision regarding expansion of the scheme.
If you have any questions about the operation of the Patent Box Scheme, please contact our team of experts.
References
[1] Treasury Laws Amendment (Tax Concession for Australian Medical Innovations) Bill 2022 (TLA Bill) Schedule 1, item 1, section 357; Explanatory Memorandum, TLA Bill 4.
[2] TLA Bill Schedule 1, item 1, section 357-10.
[3] TLA Bill Schedule 1, item 1, subsection 357-15(4).
[4] TLA Bill Schedule 1, item 1, section 357-20.
[5] TLA Bill Schedule 1, paragraph 357-15(1)(a), (3).
[6] TLA Bill Schedule 1, item 1, paragraph 357-15(1)(b) and subsection 357-15(2).
[7] Explanatory Memorandum, TLA Bill 9.
[8] TLA Bill Schedule 1, item 1, section 357-10.
[9] TLA Bill Schedule 1, item 1, section 357-35.
[10] TLA Bill Schedule 1, item 1, subsection 357-25(1).
[11] Ibid.
[12] Explanatory Memorandum, TLA Bill 4.
[13] TLA Bill Schedule 1, item 1, subsections 357-25(1) and 357-30(1).
[14] TLA Bill Schedule 1, item 1, section 357-30.
[15] Explanatory Memorandum, TLA Bill 4.
